Derail the Dollar for the rest of December

There are a couple of events this week that may be expected to derail the dollar. On Wednesday, the market could be exposed to a soft US CPI headline and a new record low in core-CPI. Tomorrow, we should expect helicopter Ben and his fellow policy makers FOMC statement to reassert their commitment to QE2, and possibly offer further clarification on the rationale behind the policy decision. Thus far, it has been yield, yield, and yield that has garned support for the buck over the last week. With no Treasury supply coming down the pipeline for the next two weeks, and with the Fed’s purchasing schedule mandate, should be able ease rates and pressurize the dollar. Mind you, most trading strategies go out the window when holiday liquidity become a premium.

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 ‘subdued’ Monday morning trading range.

This past weekend, Chinese leaders pledged to change their nation’s growth model next year and focus on stabilizing prices. They are attempting to shift from dependence on investment in industry and exports to bolstering private consumption and the service industries. Their primary objective will be to contain inflation, stabilize growth and spur domestic consumption. They intend on pursuing a ‘prudent’ monetary policy and ‘proactive’ fiscal stance. Last week the PBOC raised banks’ reserve requirements as part of their ongoing effort to tame liquidity and cool prices, certainly the first of many steps. Inflation last month accelerated to +5.1%, the fastest pace in over two-years. Their tightening procedure to date has not been effective and the investors should expect a more vigilant stance net year, for now, Capital Markets are happy dealing with what is and ignoring what may happen.

The USD$ is higher against the EUR -0.06%, GBP -0.42%, JPY -0.41% and lower against CHF +0.03%. The commodity currencies are stronger this morning, CAD +0.01% and AUD +0.27%. The loonie struggled last week, despite been within striking distance of parity. Commodities underperforming probably had the biggest affect on the currency. The softer price action was also supported by a stronger dollar index. On a macro perspective, the currency has performed well on the crosses especially on global optimism in response to Obama’s tax-cut continuation. The market also expects further support from the Russian Cbank converting approximately 1-2% of total reserves into loonies. Some of the shine had been taken away with Governor Carney’s comments after the BOC kept rates on hold last Tuesday. Carney acknowledged economic growth in the second half of this year has been weaker than previously anticipated and expressed concern about the expected recovery in net exports (that’s a strong loonie problem). The market has taken this as a dovish sign. Futures traders are pricing out the possibility of any monetary stimulus in the first two quarters of 2011. Dollar buyers lurk on pullback, again they will try and protect parity.

The AUD was bound to be effected by the Chinese inflation numbers released over the weekend. China is Australia’s largest trading partner, and anything that may slow growth domestically in China will have a affect on the growth and interest rate sensitive AUD. With China’s leaders pledging to focus on stabilizing prices has pared the AUD recent gains. Risk appetite has waned ‘reflecting the comments from China that it will be looking to tighten policy next year’. The AUD has climbed +9.8% this year (second biggest winner after JPY), on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt compared with other developed markets. Domestic data remains strong, the employment data blew all analysts expectations out of the water and supports the currency on pullbacks. Not aiding the currency is the concerns for long dated interest rates in the US. Year-to-date, the Australian economy has added just over +425k new jobs, dragging down the unemployment rate to +5.2% from +5.4% month-over-month. Analysts are beginning to agree that the tight labor market will bring the RBA back into the picture, but agree that Governor Stevens is not behind the curve just yet and will not be required to hike rates in February. With consumers boosting their savings significantly in an environment of rising job and wage growth, suggests that the RBA is still ahead of the curve. Governor Stevens has also mentioned that rates are ‘appropriate’ for the economic outlook. Investors remain better buyers on dips, planning an assault on parity again (0.9880).

Crude is higher in the O/N session ($88.49 +70c). This weekend, OPEC discounted last week’s $90 oil price as a blip and kept its output targets unchanged. They believe that supply and demand are ‘in balance,’ and $70 to $80 is ‘a good price’ for oil and expect demand growth will slow as the economy struggles to recover, amid ample supplies. Prices have been somewhat elevated as investors focused on last week’s large fundamental drawdown of inventories and not on the strength of the dollar. The EIA inventory crude headline fell -3.82m barrels to +355.9m. Supplies were forecasted to drop by -1.4m barrels. However, there was an unexpected increase in gas and distillate fuels stocks. Gas inventories rose +3.81m barrels to +214m last week vs. a forecasted fall of-300k barrels. Supplies of distillates (heating oil and diesel) climbed +2.15m barrels vs. an expected decline of-900k barrels. Technically, the rise in these categories confirms there is nothing wrong with supply, but the demand picture is not that strong. The market seems to be also pricing in the possibility of a tighter Chinese monetary policy. If the PBOC raise rates too much, it could have a big affect on oil demand. Again, the market will meet resistance at the $90 print.

The strong dollar and the outlook for a more robust economy as well as better yielding treasuries hurt gold last week. The market is also having to contend with the stronger inflation numbers out of China. Concern that China may tighten monetary policy has also eroded demand for precious metals. Temporarily, bottom feeders have managed to stem the slide in the O/N session, believing that the $60 fall from its highs last week is a good opportunity to own a store of value as an alternative investment. It was only natural to see some profit taking after gold surged to a new record ($1,432.50). Even with the dollar strengthening, the commodity remains supported by the persistent concern over Euro debt levels. To date, debt contagion has driven investors into the third ‘reservable’ currency as they seek a store of value. Despite the fear that China will tighten their monetary policy, a move to curb speculation and dampen inflation, global demand remains robust. Even though the one direction lemming trade seems to be overdone, investors continue to hold gold as a hedge against currency debasement and long-term inflation. The Euro-zone backdrop will try to put a floor on gold prices on demand for a haven. Year-to-date, the metal is up + 28% and is poised to record its 10th consecutive annual gain ($1,392 +$7.10c).

The Nikkei closed at 10,293 up+82. The DAX index in Europe was at 7,027 up+21; the FTSE (UK) currently is 5,854 +42. The early call for the open of key US indices is higher. The US 10-year backed up 11bp on Friday (3.32%) and another 4bp in the O/N session (3.36%). Last week the US yield curve shifted aggressively higher, recording the highest yields in eight months after the Obama administration decide to extend the Bush-era tax cuts for another two years and as dealers took down the last of the weeks $66b of new product. The US government is to help boost economic growth but expand the deficit, both of which are negative for rates. These higher yield point to higher cost and certainly defeats Bernanke’s objective at the moment. The tax-cuts suggest that helicopter Ben’s stimulus package will probably ‘not’ require any increases in nominal note and bond sizes in the near term. Wit no Government supply coming down the pipe for a couple of weeks one would expect some support for yields at these levels.

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