Hawks support dollar against Yen and Swiss

Markets seem oblivious to any geopolitical data and event risk. Even another Portuguese and Greek downgrade, not far from junk status, has done little for or against the EUR. It just puts further pressure on their bond yields, making it more expensive for Portugal to fund, proof that markets remains resilient or something else at play?

The more hawkish rhetoric we are exposed to the higher US yields want to go. It seems to be Fed Bullard and Fisher’s new ‘vocation’, spread the hawkish gospel. This pick up is supporting the dollar especially against the CHF and JPY and not so much so versus the EUR. This morning’s ADP employment data could set the stage for Fridays’s NFP. The consensus forecast is for +210k this month. Close to expectation and we are back to trading these contained ranges. The market requires a surprise to break the monotony. A strong NFP this Friday will be the best of excuses to push US yields much higher.

The US$ is stronger in the O/N trading session. Currently, it is higher against 12 of the 16 most actively traded currencies in a somewhat ‘subdued’ session.

Forex heatmap

The US housing market recession is not over yet. January’s reading for the 20-city S&P/Case-Shiller HPI yesterday (-3.1%, y/y) points to further softening in house prices before the housing sector reaches a bottom. Analysts note that the monthly decline is similar to the two preceding months, but, seasonally adjusted and the loss was the ‘smallest of the seven straight negatives which followed the loss of tax credit support to home buyers’. This data supports the disappointing housing starts and sales reports and provides some confirmation that we are in the midst of a double-dip scenario.

US consumer confidence fell shy of expectations this month (63.4 versus 64.9), entirely because of less confidence in the ‘future’ whereas confidence in the ‘present’ circumstances picked up. This scenario is at odds with market thinking, who expected that currently higher fuel costs, stock market volatility, little job growth and falling house prices would hit the assessment of ‘present’ circumstances. This thinking is leading to lower spending intentions as higher fuel and other charges crowd out discretionary spending.

Digging deeper, the expectation index (next six-month) led the decline, falling sharply to 81.1 from 97.5, the lowest reading in five-months and the first decline in seven. It was not the only category at fault, weakness was widespread. Consumers’ views on business conditions, employment and income deteriorated, as did their buying intentions for major appliances.

Inflation expectations jumped aggressively (6.7% a year from now versus 5.6%) from February. The problem with this indicator is that customers are influenced by what is already happening to ‘highly visible prices’ (food and energy) rather than where inflation is going in the future.

The USD is stronger against the EUR -0.11%, CHF -0.24% and JPY -0.74% and weaker against GBP +0.35%. The commodity currencies are stronger this morning, CAD +0.22% and AUD +0.16%.

The loonie only knows one direction when global risk sentiment increases and commodity prices remain elevated, and that’s higher outright. Despite a Canadian government being toppled last week, the ‘hawkish’ tone from Governor Carney over the weekend about how the elevation in commodity prices generally leads to higher interest rates is giving the loonie its bid tone.

Investors should expect the Federal political uncertainty to have a limited affect on the Canadian dollars strength. The currency will be supported in the long term by its fundamentals, a sound financial system and a strong job environment.

The market continues to focus on the global ‘big picture’. With stronger data from its largest trading partner and global hawkish rhetoric ahead of inflation will in the end benefit the CAD. Its longer term support will continue to come from commodities and increased risk tolerance.

These dollar rallies are providing an opportunity to want to own some of the commodity and growth sensitive currency (0.9715).

The AUD rose to its strongest level since its 1983 float benchmark high (1.0316) in the overnight session, as demand for the Aussie on these pullbacks is being boosted by expected government reports this week likely to signal a strengthening in the domestic economy. The twin theme of inflation and commodity prices continue to support the currency. The AUD had failed on its last attempt at the new record, on speculation that the Fed will end its bond-buying program, raising prospects the supply of dollars will eventually fall.

The currency has been supported by investors pricing out the possibility of a rate cut and pricing 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.

Appetite for growth and commodity sensitive currencies depends on the new found stamina of risk tolerance by investors. Further appreciation depends on investor’s interpretation of global future interest rates (1.0287).

Crude is little changed in the O/N session ($104.54 -0.25c). Crude prices broke the trend and rallied for the first time in four-days in yesterdays session on signs that the US economy is gaining momentum. Fed Bullard indicating that the CBank may need to exit QE2 early and US bourses seeing black has given some positive sentiment to the black stuff. Oil has risen +28% in the past year.

Also aiding prices was the Saudis indicating that they were planning to boost its drilling rigs by as much as 30% to maintain its spare capacity after making more oil available to compensate for shortfalls in Libyan production.

Expect the market to remain skeptical about how soon things could return to normal if NATO and the rebels get the upper-hand in Libya. Damage to the Libyan facilities remains unknown. Libya has seen its oil exports cut off due to the month long rebellion and Western sanctions. Market participants continue to worry about contagion. Recent events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region.

Today we get the weekly inventory report and the market anticipates a small headline drawdown, unlike last weeks EIA inventories reporting the expected supply increases. Stocks of crude rose +2.1m barrels, right on estimates. Unlike gas, whose stockpiles declined -5.3m barrels versus a market drawdown of only-2m. Distillates (heating oil and diesel) were flat for the week. Analysts had anticipated a decline of -1.5m barrels.

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

Gold is trading on the back foot again, capping its longest losing streak in three months, on bets that US interest rates are about to move higher as the economy strengthens, eroding the allure of the yellow metal as an alternative investment.

Despite prices gaining 28% in the last year, the commodity is down -0.3% this quarter. The prospects of a sustainable economic recovery will crowd out some of this over subscribed trade. After reaching record highs last week commodities are finding it difficult to create any follow through, apart from silver. However, with so much global uncertainty it’s difficult to find a reason not to own some of the commodity in your portfolio.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. These price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets and push for those new record highs.

Geopolitical uncertainties and event risk to date have managed to support higher commodity prices. With the metal being used as a store of value, the asset class is expected to remain better bid on deeper pullbacks ($1,420 up+$3).

The Nikkei closed at 9,708 up +250. The DAX index in Europe was at 7,016 up+82; the FTSE (UK) currently is 5,956 up+24. The early call for the open of key US indices is higher. The US 10-year backed up 4bp yesterday (3.49%) and is little changed in the O/N session.

Treasuries fell as the US government sold $35b of five-year notes at the highest yields in almost a year on concern that the Fed may end debt purchases early as the economy is beginning to shows signs of recovery. Fed President Bullard stating that they may be able to cut about $100b from QE2 program managed to push the curve higher.

Yesterday’s five-year auction was ‘soft’, indicating that investors and dealers are confused in what the Fed is going to do. The issue was 2.79 times subscribed, versus four-auction average of 2.73%. Indirect bidders took 42.4% of the supply, above the 36.6% average and direct bidders took 11.2%. The market will now focus on the last of the week’s auctions, the $29b 7-year issue this afternoon. Will dealers manage to make it a third consecutive soft issue this week?

Investors can expect geopolitical and event to continue to support FI on much deeper pull back.

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