Euro-zone data digested sell the EUR preferred

Merkel seems to have got it right when she said the Euro is in an ‘exceptionally serious’ situation. With this morning’s Euro-zone data digested, selling is to remain the preferred option despite a stronger German IFO print (109.3). The weaker than expected New Industrial orders (-3.8% vs. -2.5%) and underlying Euro-zone debt should keep the EUR offered going forward. With S&P downgrading Ireland, political risk will likely remain in focus ahead of tomorrow’s by-elections there. The ruling party is likely to suffer a defeat, cutting their majority, thus heightening the risk that the government might be forced to call early elections ahead of the scheduled budget vote on 7th December. This would likely create additional EUR risk aversion in the market.

The US$ is mixed in the O/N trading session. Currently, it is higher against 9 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

Some unexpected upbeat data out of the US yesterday did little from a fundamental trading perspective. Markets are focusing on contagion and Korean fears which encouraged the strapping on of risk aversion trading strategies. US preliminary GDP grew at a +2.5% rate in the third quarter, beating expectations, as companies increased exports and consumers opened their coffers and seem to be slowly spending again. The revised print beat the +2% estimated last month and the +1.7% rise in the second quarter. Digging deeper, it’s worth noting that corporate profits grew last quarter at a slower pace and the increase in wages was twice as much as initially reported. On the flip-side, this effect continues to have problems bringing down the US unemployment rate which remains just under 10%. High unemployment and benign inflation seems to be justifying the Fed’s position to inject more cash into their system.

October existing home sales fell -2.2% to +4.43m vs. a +4.53m unrevised rate the previous month. The market was expecting a small decline, but the print beat the optimistic market expectations. Analysts believe the headline print was affected by a ‘legal fiasco which restricted foreclosures’ and the decline to the pending home sales release. On a y/y basis, existing home sales is down -25.9%, on par with Septembers release. On the month the median price edged lower but the average price inched higher, probably supported by higher end product. Overall, levels remain weak, tracking below the same levels that we last experienced a decade ago which also had a similar employment track record. The months’ supply remained flat at 10.5 months, which excludes the shadow inventories of foreclosed unlisted product. If we included this data the final number would be much higher as we head into next year.

The FOMC minutes was a highly anticipated event overshadowed by risk-aversion movements on the day. Ben and Co. downgraded their assessment of the economy as they debated the benefits and costs of a new bold step to support the recovery. They expect the economy to grow at a moderate pace next year, with unemployment staying disappointingly high and inflation uncomfortably low.

The USD$ is higher against the EUR -0.39 and JPY -0.02% and lower against CHF +0.20% and GBP +0.20%. The commodity currencies are stronger this morning, CAD +0.26% and AUD +0.37%. The flight to quality and the demand for the traditional historical reserve currencies, the dollar and yen, is pressurizing the loonie outright and on the crosses, and this despite stronger data. Canadian CPI advanced at the fastest pace in two years in October (+2.4% vs. +1.9%), and retail sales rose for a fourth consecutive month in September yesterday (+0.6% vs. +0.5%), proof that traction is occurring in the recovery process for Canada and its largest trading partner. However, the knock-on effect of lower commodity prices, together with excess capacity in product and labor markets, should combine to keep core-inflation (+1.8%) below the BOC 2% target. The loonie has backed down from its highest levels recorded earlier this 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. Emerging market negativity continues to dictate the loonies’ direction. For the time being the CAD will underperform, but not as negatively as some counter-parties to the dollar, as long as heighten risk aversion continues. Speculators look to buy USD on pullbacks eyeing 1.0300.

They are an optimistic bunch down under. The AUD rallied in the O/N session from its steepest drop in a month on prospects that global growth will weather Ireland’s debt crisis and tensions in the Koreas. The Aussie rallied against the EUR after S&P’s downgraded Ireland. It seems that there is strong support for interest and growth sensitive currencies on these deep pullbacks. The currency has climbed against all of its major counterparts in the past six months on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt over that of other developed markets. Futures traders are pricing in the RBA will raise its target rate by +35bp over the next year (4.75%). As the leading commodity currency, the AUD is highly vulnerable to any Chinese monetary actions, as China is its largest trading partner. 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 Steven’s 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. As proven in the O/N session, the market is happy to buy the currency on dips (0.9762).

Crude is higher in the O/N session ($81.52 +27c). Crude again is having problems finding support from any quarter. It fell for a third consecutive day yesterday as the greenback strengthened on contagion fears in Europe and on heightened tensions in Korea. The commodity has been sold all week 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 and this week we have Korea. Even further supply decline forecasts are having little supporting effect on the commodity. A week ago crude stocks fell -7.3m barrels, the largest decline in 15-months. Analysts expect this morning’s release again to be negative. 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.

Finally, the overweighed one-directional lemming trade has discovered newfound support. The yellow metal rose the most in two weeks yesterday, on demand for a haven in the midst of Europe’s sovereign-debt crisis and escalating tensions in Korea. Investors are shredding risk and seeking flight to quality assets, like gold, dollar and yen. All week, despite the plummeting EUR and a dollar in demand, the commodity has held its own. Investors, for most of this year, have been using the commodity as a hedge against inflation and store of value. Speculators expect the Euro-zones debt concerns to eventually provide stronger support on pullbacks, anticipating that Capital Markets may shift their focus toward other Euro-zone debt issues. Year-to-date, the metal is up + 22.1% and is poised to record its 10th consecutive annual gain ($1,381 +$1.70c).

The Nikkei closed at 10,030 down-85. The DAX index in Europe was at 6,714 up+20; the FTSE (UK) currently is 5,586 up+5. The early call for the open of key US indices is lower. The US 10-years eased 2bp yesterday (2.76%) and are little changed in the O/N session. Treasuries prices continue to climb as the North and South Korean spat has increased the demand for the relative safety of government debt. FI traders are also dealing with the potential fallout of contagion sweeping through the southern periphery Euro-zone. The US Government, with a holiday shortened work week, coming to the market with $99b of new product is always difficult to distribute ($35b-2’s, $35b-5s and $29b-7’s). Yesterday’s $35b 5’s was a disappointing auction with indirect bidders taking +31%, less than the +39.5% last month and less than the +46.9% four auction average. Direct bidders took more than usual +16% vs. the +10.1% average. Dealers do not expect today’s 7-years to fare as badly.

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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