Emerald Isle losing EURO fight

There so many moving parts to decipher, the market needed and appreciated the break in market volatility yesterday to lick its wounds. The fear of emerging markets entering a new tightening cycle has certainly reduced risk appetite greatly this week, especially amongst the commodity and growth sensitive currencies. The Fed and its policy makers have taken a fair share of criticism over their QE2 program, however, this weeks inflationary data seems to justify their position thus far. Finally, the Emerald Isle, true to her nature does not seem to be giving up without a fight. The ongoing discussion of her debt problems remains the primary market focus this morning. Investors are trying to comprehend if a rescue package for the country will be enough to reduce the funding costs of Spain and Portugal. The EUR is only tentatively grinding higher on positive opinion could be a problem.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

Yesterdays’ data goes some ways in justify why the Fed is QE2ing it. US core-CPI was flat for a third consecutive month. Even the headline disappointed, advancing +0.2% in October (+1.2%, y/y). The market had been expecting a +0.3% gain. Most of the support came from the usual suspects, higher cost of energy (+2.6%) and food (+0.1%). Theses subcategories account for +23% of the overall basket. The core reading on a yearly basis straddles +0.6%, the lowest reading in half a century.  Its biggest decliners were new vehicles (-0.4% and +6.4% of the baskets weighting) and clothing (-0.3%, +3.7%). Most of the other subcategories provided a negligible contribution to the overall headline. It’s worth noting that the housing component (+42% of the index) happened to reverse the previous month’s equal decline (+0.1%). The obvious risk to the heavy housing weighting is that if this category shows any sign or normalization (flat to higher) would add strong upward momentum to the core readings. Do not expect that to occur soon as the shadow inventory variable should prevent that.

Housing starts fell much more than expected last month, plummeting -11.7% from +600k to +519k and are now at their lowest level in 18-months. Such a poor number will again have the housing sector providing a sizable drag on the 4th Q’s GDP growth. Building permits rose +0.5% to +550k vs. market expectations of +570k. Analyst’s note that the recent housing trend remains intact with lower permit releases and proof that the new home sales is expected to remain depressed for the future. Weakness was concentrated in multifamily starts, which plunged -43.5% and single-family starts retreating -1.1%. The market will remain depressed because of the enormous inventory of existing homes on the market, either distressed sales or homes that are going through or will go through foreclosure.

The USD$ is lower against the EUR +0.69%, GBP +0.24%, CHF +0.38% and higher against JPY -0.01%. The commodity currencies are stronger this morning, CAD +0.71% and AUD +0.89%. The loonie happened to cap its early declines yesterday, to its weakest level this month, as global stocks eked a gain on speculation that softer US data will push the Fed to follow through on its plan to buy $600b’s worth of debt. The currency has been under pressure most of this week, like other growth sensitive currencies, on fears of further emerging market tightening, commodities plummeting, and global bourses finding it difficult to maintain traction. The increased risk appetite as Ireland nears the foregone conclusion of accepting aid has provided some support for the currency in the O/N session. With weaker Canadian data of late, expect the currency to underperform against its other trading partners, at the moment it seems well contained in its recent range. It’s interesting that the currency has not received any aftershock from the BHP derailed takeover of Potash by the Federal Government. At the moment, the market is tentatively happy buying the loonie on dollar rallies.

The AUD is inching higher for a second consecutive day, as speculation that Ireland will eventually accept aid revived demand for higher-yielding assets and reduce concern that the European nation’s banking crisis may spread. Also aiding the currency was the RBA’s deputy governor stating that the country will likely face upward pressure on inflation. Commodity and growth sensitive currency have taken a specific beating over the last week as the Irish debt problems talks intensified. As the leading commodity currency, the AUD is highly vulnerable to growing speculation that China will hike rates as early as Friday. Despite appreciating vs. all its 16 trading partners, the declines have been somewhat limited after a government report earlier this week revealed that wages rose in the third quarter by the most in almost two years (+1.1%) and that the RBA minutes indicated that Governor Stevens decision to raise interest rates was ‘finely balanced’. Policy makers said a ‘modest tightening’ was considered prudent when they increased the benchmark rate earlier this month (+4.75%). Market players are viewing corrective rebounds as fresh selling opportunities short term on the back of the Chinese variable (0.9875).

Crude is higher in the O/N session ($81.87 +$1.43c). Oil prices have pared most of yesterday’s losses after a surprisingly weak EIA report number has finally kicked in and on the back of increased risk appetite. The commodity has been under pressure on concerns that a Euro-zone’s deepening debt crisis coupled with emerging markets Cbanks tightening monetary policy would reduce demand for the asset class. The market remains on tender hooks, fearing that China may also attempt to rein in inflation, further reducing demand. However, this week’s inventory numbers are more bullish than what the market is giving them credit for. Crude stocks fell by -7.3m barrels last week, the largest weekly decline in 15-months. The market had been expecting a small decline of -100k barrels. Not to be outdone, the other fuel categories also declined. Gas inventories were down -2.7m barrels, while distillates (heating oil and diesel) fell by -1.1m. The market had expected a decline of -600k and -2.2m barrels respectively. Despite the negative readings, the US continues to experience a ‘large supply glut’, with crude and fuel inventories above five-year average levels. In Sept. inventory levels happened to print a 27-year high, and have been declining ever since. The ‘big’ dollars value will continue to influence prices despite the fundamentals. The oil market has lost -6.2% during the last five sessions. This week’s inventory numbers should be able to provide support ahead of the psychological $80 level.

Gold prices climbed in the O/N session, the first day in five, ending its longest losing streak in six months on increased investment demand. Investors to date have been aggressively using the commodity as a hedge against inflation and store of value. The fear that emerging markets are beginning to tighten their monetary policy could curb the demand for the commodity as a safe-haven asset. For most of this week a stronger greenback has restricted the demand for bullion, with gold usually trading inversely to the dollar. Speculators are expecting European debt concerns to eventually provide more support on these pullbacks, as Capital Markets shift their focus toward sovereign debt issues and away from QE2 debates. Year-to-date, the metal is up + 22.1% and is poised to record its 10th consecutive annual gain. For most of this year, speculators have sought an alternative investment strategy to the weaker dollar and have been using the commodity as a proxy for a ‘third reservable currency’ ($1,355 +$18.50).

The Nikkei closed at 10,013 up +201. The DAX index in Europe was at 6,790 up +90; the FTSE (UK) currently is 5,758 +65. The early call for the open of key US indices is higher. The US 10-years eased 3bp yesterday (2.86%) and another 4bp in the O/N session (2.90%). A softer CPI print and weaker housing data pushed treasury prices reluctantly higher yesterday, somewhat vindicating policy makers QE2 stance. The Fed also happened to buy $8.154b of the 10-year sector as part of its plan to buy $600b more Treasuries. After plummeting price action for most of this week, Fed rhetoric is also stemming the bleeding. To date, policy makers have come under a fair amount of criticism for their buyback policy and the market has been pricing in the possibility of them backing off. They still have some ways to go in convincing the market. Increased risk appetite is shifting the curve higher.

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Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell