Event risk leaves EUR longs vulnerable

Something is going to give and today’s Portuguese Austerity Bill vote may be that reason to find the politics of financing a Euro-region periphery too unsettling to justify these EUR hawkish longs.

This afternoons vote may create opportunities in the Euro as Portugal’s minority government attempts to pass new austerity measures through parliament. It’s expected to be opposed. The Prime Minister is threatening to resign. Just what the EUR requires, another potential political crisis ahead of this weeks EU summit. Any resignations will make it difficult for Portugal to continue financing in the markets in the three weeks ahead of the country’s first large bond maturity of the year.

This makes the EUR vulnerable to today’s event risk and ahead of this weeks EU summit. The danger is not to the upside of the currency, most of that hawkish rhetoric is already priced in, but the vulnerable left hand side where weak longs continue to gather.

The US$ is mixed in the O/N trading session. Currently, it is lower against 11 of the 16 most actively traded currencies in another ‘subdued’ contained session.

Forex heatmap

Data was thin on the ground yesterday, and whatever we had had minimal affect on the asset classes. US house prices fell -0.3% in January according to the FHFA. The Richmond Fed manufacturing activity index fell to 20 from 25 which still indicates very strong activity given the average is only 0.4.

There were two Fed speakers, Fisher who said that the US recovery was gathering momentum and needs no further support, that would strike out the potential of QE3 from his perspective, and Pianalto stating that the recovery was modest, it’s actually strong – ISM at highest in 27-years. He believes that rising inflation pressures were temporary.

In Europe, the ECB’s Stark said that events in Japan and elsewhere had increased uncertainty but they had not changed the inflation picture, the growth picture and the threats to price stability. Strong proof that Trichet and company will not be changing their appetite for a rate hike anytime soon.

The USD is higher against the EUR -0.14% and GBP -0.24% and lower against CHF +0.44% and JPY +0.24%. The commodity currencies are weaker this morning, CAD -0.14% and AUD -0.09%.

Weaker Canadian data yesterday has only temporarily derailed the loonies’ direction. Support for the currency continues to come from commodities. Canadian retail sales declined -0.3% in January from the previous month. The market had been expecting an increase of +1%. Ex-autos and the print came in flat. In a separate report, the country’s leading-indicators index rose in February the fastest in nine months (+0.8%), led by gains in stock prices and ‘a turnaround in manufacturing’.

On the face of it, the currency’s recent moves are oblivious to domestic fundamentals. Last week, the loonie lost the most in four months against its largest trading partner after Japan’s earthquake and Middle-East geopolitical events dampened investor appetite for higher-yielding currencies. This week seems to be starting off on the other foot with investor’s risk appetite found wanting again.

The market it seems is in a wait-and-see situation to see what comes out of Japan and whether investors have the tolerance for taking on more risk. Positive developments with Japans nuclear reactors will improve markets risk appetite. Expect the depth of the backup to be dictated by cross-action.

Last night, opposition leaders have signaled they will not support the ruling Conservatives budget, making a spring election all but inevitable.

These dollar rallies provide an opportunity to want to own some of the commodity and growth sensitive currency that is supported by stronger fundamentals and a sound fiscal position (0.9805).

The AUD trades close to a one week high ahead of this evenings Financial Stability Review release this evening. The currency is getting a leg up as investors price out the possibility of a rate cut and price in the chance of a rate hike again next month. The probability of a reduction in Australia’s benchmark interest rate on April 5 is 13%, down from as much as 34% last week.

Gains have been limited as regional bourses remain under pressure, damping demand for higher-yielding assets, and amid speculation a rally this week has been too rapid. By day’s end, its all about what happens at the Fukushima nuclear plant and the threat that G7 members will again be needed to calm the markets (1.0110)

Crude is little changed in the O/N session ($105.07 +0.10c). Big picture, oil prices remain volatile, torn between the pressure of Japan’s demand loss and the Middle-East tensions. Any uncertainty adds a premium. Libya has seen its +1.3m barrels a day of oil exports cut off due to the month long rebellion and Western sanctions. Market participants continue to worry how long the disruption will last and it’s this along with contagion fears in the region that is providing a bid.

Prices have also got a boost from a smaller-than-expected increase in last weeks US inventory report. Crude inventories rose +1.7m barrels last week, less than the +2.1m barrels expected. Gas supplies fared no better, declining -4.2m barrels, vs. expectations of a decline of -1.5m. Stocks of distillates (heating oil and diesel) decreased -2.6m vs. a drawdown of +1.4m barrels.

Over the past fortnight we have witnessed Middle-East potential supply constraints being cancelled out by the world’s third largest economy short term lack of demand. Japan has closed 29% of their domestic refining capacity. This has affected about +1.3m barrels of the country’s total of +4.52m barrels per day of capacity. With future consumption questionable, demand from the region is expected to remain soft in the short term.

On deeper pull backs the Middle East and North African situation will continue to dominate.

War premium has gold remaining better bid. Tensions in the Middle-East and Libya is boosting demand for an investment haven. Investors continue to worry that high oil prices could end up being a drag on global economic recovery. With a weak dollar and fears that Cbanks could use the events in Japan as justification for maintaining their loose monetary policy is also supporting the yellow metal.

After making back all of its early losses last week, the commodity’s bull run is far from over with investors continuing to look to buy the metal on dips. This asset class has been a profitable lemming trade this year (climbing +26%). These price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets and again threaten new record prices.

Big picture, commodity prices are being supported by geopolitical factors and inflation threats. Even hawkish global rhetoric has managed to support higher commodity prices. With the commodity being used as a store of value, the asset class is expected to remain better bid on deep pullbacks ($1,431 +$3.90c).

The Nikkei closed at 9,449 down-158. The DAX index in Europe was at 6,723 down-58; the FTSE (UK) currently is 5,745 down-17. The early call for the open of key US indices is higher. The US 10-year backed up 1bp yesterday (3.34%) and eased 4bp in the O/N market (3.29%).

Treasuries have held onto this week’s losses ahead of reports that are expected to show new home sales (this morning) and orders for durable goods orders increased last month despite receiving a small bid from global equities being in the red. The longer end of the curve remains under pressure after the US Treasury earlier this week announced it plans to offload its holdings of MBS’s that it accumulated under QE1 and on signs that Japan’s nuclear crisis is easing.

With the US economy on a recovery track and inflation expectations getting higher, yields have the potential of going much higher. With this risk aversion momentum easing, ten-year yields are in danger of snapping back towards their medium term highs north of 3.40%.

The market remains on edge and subject to headlines at any time. Investors can expect geopolitical and event risk in the Middle-East to continue to support FI on deeper pull back in spite of stronger economic data.

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