EUR Neutrals trump the Bears

Trichet’s tough talk on inflation over the weekend pushed the EUR to a two-month high. Ireland’s political turmoil highlights the uncertainties facing the debt laden PIIGS and to the Euro-zone directly was capable in dragging it down again. To a certain extent, the market is also getting ahead of US economic data flow this week, where it’s anticipated to be supportive for the dollar. None of these reasons are compelling enough for a EUR bear. Investors are beginning to buy into the pro-Euro rhetoric. The market seems to believe Merkel when she say’s that Europe will do anything to save the regions currency. With Germany contemplating expanding the financial backdrop, sentiment is shifting from bearish to neutral, forcing analysts to stop cutting their EUR estimates. Live with it, it’s a large trading range.

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

The market believes that US data this week will likely show evidence of reaccelerating economic activity. On Tuesday, investors expect a stronger consumer confidence print. Wednesday an uptick in new home data and by Thursday, an appealing durable goods number, rounding the week off with an advance in fourth-quarter US GDP. This should support the dollar and higher yields, but, by how much? That will be down to the FOMC, who will covet the limelight on Wednesday. There will be no change on interest rate policy, however, with five district bank presidents rotating into voting positions, the market will be focusing on the actual count. Maybe a shift towards a hawkish position?

The USD$ is higher against the EUR -0.37%, GBP -0.26%, CHF -0.27% and JPY -0.26%. The commodity currencies are weaker this morning, CAD -0.36% and AUD -0.05%. The fear of China extending a tighter monetary policy has had commodity sensitive currencies on the back foot over the last five-trading sessions. The loonie happened to breach parity for the first time in two weeks late last week on the back of falling gold and oil prices. An unexpected Canadian November retail sales print on Friday (+1.3%) gave the CAD some positive temporary momentum that ended up being an ideal opportunity for some speculative longs to offload their positions. Year-to-date, the loonie has benefited by association with stronger US data. The BOC dovish position, after keeping rates on hold at +1% last Tuesday, has also helped to push the loonie to back off from its strongest level in two-years as the market digests rates being on hold and an economic recovery being threatened by a European fiscal crisis. Expect short term profit taking to remain the focus we attempt to breach parity once again (0.9963).

The AUD is pigging backing a two-month low outright after producer prices data last night rose less in the fourth quarter than analysts anticipated (+0.1% vs. +0.5%-the slowest rise in a year). The report on the prices has reduced the markets expectations for a medium term interest-rate hike (+4.75%). Last weeks data out of China has the market convinced that the PBOC will move quickly to hike their reserve rates. Their actions have temporarily increased the appetite for the safety of the greenback and reduced the demand for the commodity sensitive growth currency. Domestically, the Queensland flood is expected to temper the country’s economic outlook. Governor Stevens kept rates on hold last month (+4.75%) as some indicators were suggesting a ‘more moderate pace of expansion’. Treasury Swann stated that the country faces an ‘enormous’ economic fallout from floods. ‘Queensland’s rapid development has meant that its economic performance has a much bigger influence over our national economy’. With growth expected to slow this quarter, a tightening policy would not be the prudent course of action. Currently, the market pricing of rate cuts (4.75%) for the RBA February policy meeting and of rate hikes later in the year remains broadly unchanged. Offers again appear at parity (0.9893).

Crude is lower in the O/N session ($88.86 -26c). Crude prices remain soft on fears that China will hike rates to combat inflation, slowing economic growth and demand for energy. They are the world’s second largest energy consumer. Last week’s inventory report provided another excuse to offload oil contracts. Dealers are preempting any Chinese action. Any move from the PBOC will always affect commodity demand. Weekly crude stockpiles increased +2.62m barrels to +335.7m. Not being left behind were gas supplies rising +4.4m to +227.7m barrels. It’s worth noting that the four week gas demand was +2% y/y higher and averaged +9m barrels a day. US refineries ran at +83% of total capacity, a drop of -3.4%. The supplies of distillates (diesel and heating oil) rose by +1m to +165.8m barrels vs. an expected weekly increase of +900k barrels. OPEC believes that supply and demand are ‘in balance,’ and believes that demand growth will slow as the global economy struggles to recover, amid ample supplies. The market again has topped out in the early $90’s on this run. There is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in the medium term. The commodity is expected to test key support levels around $85.

On Friday, gold prices capped its third straight weekly loss, on speculation that borrowing costs will rise as the US economy recovers, eroding the metal’s appeal as an alternative investment. The commodity is heading for the first monthly drop in nine months. Optimism on the US economy is testing the strength of the commodity bull’s conviction. Gold is trading in the red this month, only one month after recording an annual return of +30%. Recommendations by hedge funds to cut long positions last week, has the lemming one directional trade tentatively testing key support levels before the market witnesses a mass exodus to the door. The commodity also fell on speculation that China will raise interest rates to fight rising prices and in turn affect global growth. The price erosion thus far this year is promoting some physical buying, specifically in Asian and on concerns that Europe’s sovereign-debt crisis may linger, even after the Euro-finance minister’s pledge to strengthen a ‘safety net for debt-strapped countries’. On a macro level, analysts expect the losses may be limited on concern that inflation will accelerate. Technical analysts believe that gold ($1,348 +$7.50) will outshine other precious metals in 2011 and peak somewhere above $1,600 in 2012. Current trading does not feel like it.

The Nikkei closed at 10,345 up+71. The DAX index in Europe was at 7,023 down-38; the FTSE (UK) currently is 5,902 up+7. The early call for the open of key US indices is higher. The US 10-year eased 4bp on Friday (3.41%) and is little changed in the O/N session. The belly of the US curve printed six-week high yields last week, as economic data in the US and the Euro-zone boosted speculation that a global recovery is building momentum and dampens the need for government debt as an alternate for safe heaven requirements. The 2’s/Bond spread widened to almost a new record (399bp), as investors demand compensation for the potential risk of inflation rising. This week, the Treasury will auction $99b of new debt which should require dealers to more make room to take down. The strong data is again creating a choppy trading environment with medium term support levels becoming questionable (+3.50%).

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