Periphery yields support short EUR

Portugal’s EUR-1b auction was greeted with some relief, despite the yields been sharply up from the last sale in September, but not as high as feared with yields coming down from this mornings high. The average yield was able to sneak in to just below 6%.

Away from the auction, the sentiment in the periphery markets is not good, and without ECB intervention, periphery yields out the curve continue to back up to record highs. Greece’s cash yields are back out to pre-bailout record levels. How is a hawkish ECB going to help the peripheries? The EUR continues to make hard work of paring any losses before Friday’s mini-Summit.

The US$ is mixed in the O/N trading session. Currently, it is higher against 10 of the 16 actively traded currencies in a ‘whippy’ O/N session.

Forex heatmap

It was inevitable that with no data in the US, the market was going to be easily swayed by periphery fears now that its front and center again. Despite stronger economic data out of Germany yesterday, the periphery predicament is a long way from being resolved. Currently there is no consensus among the Euro-states ahead of this week’s summit.

Germany is proposing a watered down assistance package in exchange for tough conditions to promote competitiveness. The weaker states, like the Moody’s slashed Greece, Portugal and a new government elect Ireland are arguing for greater political solidarity and larger financial backstops to literally ‘stay afloat’. The states tread a fine line in trying to weed the ECB addicted peripheries lending without specific countries going bust.

There has been too much optimism been priced into the EUR currency regarding the Euro-states ability to deal with the debt and default risks outright. Price action remains soft and vulnerable ahead of Friday. Not helping the currency is commodity prices backing off from record highs and a market believing that the Fed maybe close to removing ‘an extended period’ from their communiqués.

The USD$ is higher against the EUR -0.13% and JPY -0.20% and lower against GBP +0.17% and CHF +0.22%. The commodity currencies are mixed this morning, CAD +0.11% and AUD -0.02%.

The loonie is trading tight with the dollar, mostly supported by cross action, specifically EUR/CAD, despite weaker commodity prices. It’s not trading under the commodity growth sensitive currency banner, but as a North American unity. Loonie traders are fickle. They have multiple reasons for wanting to own the CAD in times of stress and elation. It can be owned for risk adverse, growth and commodity reason. Fundamentally and technically the currency probably overshot its near term target, music to Carney’s ears. With an insurance premium heavily priced in commodities it would not be a surprise to see the loonie backup outright short term. The depth of the backup will be dictated by current cross action.

Canadian housing starts yesterday (+6.6% to +182k, m/m) was supportive for the loonie and keeping it contained in its trading range outright and this despite Governor Carney’s views on an elevated currency price. The cross currents in commodities and cross currency flows seem to ‘be buffering spot’ from too much movement. The new reality is a Canadian dollar at or close to parity as the economy adjusts to this paradigm.

The market has preferred been long this currency for both risk averse and commodity supporting reasons. Big picture, the currency’s rise remains orderly. Dollar rallies provide an opportunity to want to own some of the commodity and growth sensitive currency (0.9707).

The AUD has been trading heavy on the back of softer Australian consumer confidence (-2.4%) and home loan’s data (-4.5%) last night. RBA Assistant Governor Lowe’s comments in a speech was balanced and in line with RBA Governor Stevens’ recent rhetoric. The focus of the speech was again structural change of the economy, suggesting that the RBA will remain on a medium-term tightening bias. However, the RBA remains on hold in the near term because consumers remain subdued, as evident from a weaker consumer confidence.

Australian home loan’s falling have been affected by the natural disasters in January. The number of loan’s fell over four times more than the market had been anticipating.

The currency continues to hover close to its six-week low vs. the EUR on fear that Trichet and Co. will raise interest rates faster than the RBA this year. However, Australian fundamentals continue to support a higher policy rate environment, and a currency appreciating medium term.

The futures market is pricing in further modest tightening starting in third quarter as the data strengthens and the threat to inflation rises along with commodity prices and higher wage growth. Commodity prices continue to provide support on pull backs. Investors are looking for dips to just above parity to give themselves better risk-return for wanting to own AUD.

Crude is lower again in the O/N session ($104.88 -14c). After advancing to a two and a half year high on speculation that the turmoil in Libya will spread to other energy exporters in the region, affecting global supplies, crude has been able to back off and price out some of last weekends insurance premium as OPEC contemplate holding an ‘urgent meeting’. However, the commodity is in demand on pullbacks, even in technical overbought territory.

Prices remain elevated despite the rumors that Gadaffi could be stepping down with terms. Contagion fears continue to price in a substantial risk premium. ‘The IEA’s chief economist said that ‘higher oil prices pose a danger for a global economic recovery’ and at $110 a barrel the world should be very concerned.

Last week’s EIA report is also providing support for the US crude market on pull backs. The report showed a smaller-than-expected increase in supplies. Crude inventories fell by-364k barrels to +346.4m vs. an expected increase of +750k. Even worse was the gas inventory headline declining, stocks plummeted -3.59m barrels to +234.7m, greatly exceeding market expectations for a-400k draw. Inventories at Cushing rose by +1.13m barrels to a record +38.57m.

This rise is partly responsible for the wide discount of WTI to Brent crude in recent weeks. Distillate stocks (heating oil and gas) fell-751k barrels to +159.1m, less than analyst expectations for a decline of -1.2m barrels. Refinery utilization rose +1.5% to 80.9% of capacity. With supply the number one concern, the commodity will stay bid because of the contagion concerns.

Healthy selling to lock in recent profits was able to push Gold back from record highs. However, the commodity remains in demand as Middle-East tension boost the appeal of the yellow metal as an investment haven. Commodity prices continue to be supported by geopolitical factors and inflation threats. Gold prices have rallied more than +7% this month, as investors grown increasingly uneasy that the crisis could spread.

Even hawkish global rhetoric has managed to support higher commodity prices. Higher consumer prices are boosting the demand for the precious metal as a hedge against global inflation. Recent data reveals that Chinese’s inflation has accelerated the most in six years, and UK consumer prices the most in two years. Even US data is showing that their inflation numbers are edging higher. With the commodity being used as a store of value the asset class is expected to remain better bid on deep pullbacks, at least until there is peace and less threat of inflation ($1,430 +$3.20).

The Nikkei closed at 10,589 up+64. The DAX index in Europe was at 7,197 up+33; the FTSE (UK) currently is 5,959 down-16. The early call for the open of key US indices is higher. The US 10-year backed up 2bp yesterday (3.53%) and is little changed in the O/N session.

Treasuries fell as oil backed off from just under a three-year high and equities rose, reducing demand for the safety of government debt. FI prices are soft out the curve, as signs of faster job growth and inflation is proof that the US economic recovery is building momentum. With supply coming down the pipe this week, dealers will want to make room and cheapen the curve even more.

Yesterday, treasury auctioned $32b of three-year notes ($21b of 10’s today and $13b of 30’s tomorrow) and it was well received. They came at a yield of 1.298%. The bid-to-cover ratio was 3.22, compared with the average of 3.06 from the previous four sales. The indirect bid was 34.4%, while the four auction average has been 34.7%. The direct bid was 12.3%, compared to 14.6% average.

Geopolitical and event risk in the Middle-East continues to limit FI losses in spite of stronger economic data. Product should remain better bid on these pull backs, even with Fed Fischer stating that he may vote to end bond buying before June.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

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