Republic downgrade hurts EUR focus shifts to Iberia

When bringing ‘these’ PIGS to their knees, two out of four is not a bad hit ratio. However, Capital Markets seem intent on the perfect record. Political uncertainty has taken the gloss off the EU/IMF Irish handout, a headline number yet to be determined. Even Moody’s has a nail for the coffin, saying that a rescue package could cause another debt burden that would pose a ‘credit negative’ for Ireland. Contagion concerns are affecting the EUR. To date, the currency’s vulnerability is cushioned by a weak dollar, but, with Euro periphery bonds spreads widening, it will soon rain on any Spanish party. The more ‘punters’ talk about an Irish bail out and the need for private creditors to take a ‘haircut’ on bad debts, the more risk aversion trading strategies will be implemented, with EUR selling the way.

The US$ is stronger in the O/N trading session. Currently, it is higher against 14 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Finally we get something else to focus on rather than event and contagion risk running amuck. The market has been starved for some fundamental releases of late and today its delivered in this shortened trading week in the US. It most likely will not matter as contagion and event risk fear continue to dominate. The dollar was already sought after before the O/N skirmish in Korea and now it seems well supported as investors turn their attention towards Spain and Portugal. Euro data this morning has been on the positive side despite the issues in Ireland, and softening the fall for the EUR. Growth in the Euro-zone private sector expanded sharply this month, supported by strong performances in France and Germany and this despite the southern periphery concerns. The preliminary composite PMI for the Euro-zone rose to 55.5 from Octobers 53.8. The services PMI also rose more than expected to 55.2 from 53.3 while manufacturing gained to 55.5.

The USD$ is higher against the EUR -0.42%, GBP -0.24%, CHF -0.01% and JPY -0.12%. The commodity currencies are weaker this morning, CAD -0.06% and AUD -0.77%. The loonie has backed down from its highest levels in over a week as a renewal of risk aversion diminished demand for assets tied to growth. With commodities under pressure is bound to act negatively on the CAD. On the crosses, the loonie has held its own, but vs. its largest trading partner, the dollar has taken the broader lead. Contagion and tighter emerging market policies is beginning to have an impact on overall growth positions. Like any commodity and growth sensitive currency, market increased risk-appetite favors the loonie. However, this time risk aversion trading strategies are being implemented. Earlier this week, BOC Governor Carney said that their monetary policy was flexible that he would adjust interest rates to meet inflation targets if the loonie continued to strengthen. The BOC has greater flexibility than the Fed as a result of a more robust recovery. Market waits for this morning’s data for general guidance rather than hearsay.

Like all growth currencies, the AUD is under pressure on concern that Ireland’s debt crisis will cause contagion across other southern European nations, damping demand for higher-yielding assets. With global bourses seeing red and commodities on the back foot is providing little support for the Aussie short term. There is also the little matter of a skirmish in Korea. As the leading commodity currency, the AUD is highly vulnerable to any Chinese monetary actions. Any currency gains have been somewhat capped after China ordered banks to set aside larger reserves for the second time in two weeks, draining cash from the financial system to limit inflation and asset-bubble risks earlier this week. From a fundamental perspective, thus far the decline has been somewhat limited after last weeks 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 and Euro variable (0.9825).

Crude is lower in the O/N session ($81.45 -29c). Crude again is having problems finding support from any quarter. The commodity is under pressure on speculation that Ireland’s bailout will not slow the spread of Europe’s debt crisis, hindering economic growth. Last week we had the Chinese decisions to rein in inflation. Speculators are beginning to cut their long positions amid the fallout from the Irish debt crisis and the PBOC efforts to curb inflation assuming event risk will sap demand for fuel. Crude stocks falling -7.3m barrels last week, the largest weekly decline in 15-months has done little to lend support. The market had been expecting a small decline of-100k barrels. Even gas inventories were down -2.7m barrels, while distillates (heating oil and diesel) fell by -1.1m. Despite the negative readings, the US continues to experience a ‘large supply glut’, with crude and fuel inventories above five-year average levels. In September, 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. Continue to follow the dollar for direction as fundamentals take a back seat.

The euphoria of the Irish bail out is proving short lived and is trying to pressurizing commodity prices as the dollar rallies vs. the EUR. Initially, the yellow metal lost support as investors began to price out the insurance premium once an EU/IMF deal was agreed in principle. The commodity is experiencing its longest losing streak in six months. Last week when the dollar came under pressure it boosted the demand for the commodity as an alternative investment. Investors, for most of this year, have been 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. Speculators are tentatively hoping that European debt concerns to eventually provide stronger support on these pullbacks, anticipating that Capital Markets may shift their focus toward other Euro-zone debt issues. Year-to-date, the metal is up + 21.8% and is poised to record its 10th consecutive annual gain ($1,364 +$6.60).

The Nikkei closed at 10,115 up +93. The DAX index in Europe was at 6,804 down -17; the FTSE (UK) currently is 5,657 down -33. The early call for the open of key US indices is lower. The US 10-years eased 9bp yesterday (2.78%) and are little changed in the O/N session. Treasuries prices continue to climb after Moody’s said it may downgrade Irish debt by more than anticipated yesterday. This has provided the demand to own ‘the relative safety of US debt’ despite the US Government coming to the market with $99b of new product this week ($35b-2’s, $35b-5s and $29b-7’s). Investors are happily reversing some of the upward shift in the yield curve as the Fed’s buyback program, dovish rhetoric and risk-aversion trading strategies finally start to kick in. Yesterday there was $35b 2-year notes sold at a yield of +0.52% vs. +0.527% WI’s. The bid-to-cover ratio was 3.7 compared with the four auction average of 3.42.

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