EURO Longs Squeezed

The EURO continues to struggle this morning, under weight from a combination of ‘soggy’ PMI data and continuing concerns over Greece’s finances. The possibility that austerity measures may not pass through the parliament is again weighing on investors appetite for risk.

The market is reacting to the dovish tone in Bernanke’s press conference by selling risk assets and buying the dollar. Not entertaining the possibility of QE3 implies risk pricing needs to remain ‘skewed significantly to negative outcomes’. It seems Ben is willing to allow a much more significant deterioration in his economy before they return to a pro-active monetary stance.

Least we forget, flash China PMI O/N (50.1) points to a sharper slowdown in Chinese growth. Now that both the employment and new order categories have edged just below 50 suggests that the official PMI will fall at least in line with seasonal patterns, anything greater and more risk will want to be taken off the table.

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

Forex heatmap

The Fed continues to look through weakness and is staying the course. The FOMC statement was largely as expected yesterday, giving no signal of any policy changes soon. Policy makers acknowledges that the US economy is in a soft spot, but advised markets to look through the effects of supply shocks emanating from Japan and the demand destruction caused by previously higher commodity prices. Through the distortions, the Fed is saying that it remains on course on policy measures by allowing QE2 to expire and sticking to its previously understood policy of ‘reinvesting coupon so as to flat line the Fed’s balance sheet’.

Probably the most interesting point of the communiqué was on inflation. The committee ‘anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate’. Does inflation ‘at or below’ their target range possibly give the Fed an out if or when it needs to implement further monetary easing?

The dollars is higher against the EUR -0.55%, GBP -0.39%, CHF -0.13% and JPY -0.29%. The commodity currencies are weaker this morning, CAD -0.01% and AUD -0.32%.

Governor Carney presented the BoC Financial system review yesterday and concluded that they see overall risks to financial stability has elevated in the last six months. It seems that global sovereign debt issues and a low interest rate environment in major economies has fueled greater risk taking. How will Canadian policy makers deal with this? Hike rates. The hawkish tone gave the loonie its bid with real money the buyers.

With the Fed cutting its growth objective for the remainder of the year has higher yielding growth sensitive currencies trading under pressure. The CAD health is heavily linked to its southern economy because of the close trading relationship between the two countries. On the crosses the loonie has performed well. Expect the Canadian dollar to be subjected to the pull of either risk or risk aversion trading strategies (0.9742).

The Aussie remains on the soft side against most of its trading partners on prospects that Greece will struggle to pass austerity measures next week to avoid a default, damping demand for growth-sensitive currencies. Previously, it was the RBA’s board minutes for June reaffirming a noncommittal Central Bank that first applied the pressure this week. The market pricing for rate hikes over the next year has fallen 7bp to-6bp.The AUD slide has continued for a second day against the greenback after the Fed signaled it would not add to record stimulus even after growth slowed, spurring declines in higher-yielding assets.

Governor Stevens and company cited growing concerns in Europe, downside surprises in US data and deterioration in non-mining related industries as giving the board enough reason to remain on hold until further notice. The minutes were also less explicit than RBA Governor Stevens’ speech last week on emphasizing upcoming data like the CPI report. The market is pricing a no hike in August unless inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite. Global data needs to improve before we can embrace any rate hike policy thinking. Investors remain better sellers on rallies this morning (1.0513).

Crude is lower in the O/N session ($93.79 -$1.62c). Oil prices rallied from their four-month lows on the back of a softer weekly EIA report and after European industrial orders climbed, suggesting the Euro region’s economic expansion maintained some momentum into the second-quarter yesterday. This morning the commodity has given up some and more of these gains. Investors are speculating that US fuel demand may weaken after the Fed lowered its economic growth outlook. Analyst’s note, that from its peak this year, crude is off-20%.The technicals see strong support first appearing at around $87.

Last week’s EIA reports showed that oil inventories fell -1.7m barrels to +363.80m, but remain above the upper limit of the average range for this time of year. A surprise was gas inventories falling by +500k barrels last week, after increasing by +600k barrels in the prior week. Analyst’s we expecting a build up of inventories of around +1m barrels. Currently it remains near the upper limit of the average range. Refinery inputs averaged +15.3m barrels per day and +409k above the previous week’s average as refineries operated at +89.2% of their capacity.

The market believes that the US has ample crude stocks, allowing WTI prices to remain in check, while the Brent market continues to price in lost production of preferred sweet crude from Libya. Economic headlines are more important to the market right now than inventory levels.

Gold rose to a seven-week high as fluctuations in FX-land boosted demand for the yellow metal as an alternative investment yesterday. The commodity is in a unique position, this week it has been able to rise despite a dollar strengthening, testament to the demand for the asset. Last week, the metal dropped -0.3% and this after falling -0.9% the previous week. Year-to-date, the commodity has climbed +7.3%. This morning the commodity trades on the back foot after the Fed dampened speculation it would expand stimulus measures and the dollar strengthened.

Big picture, the yellow metal remains in demand on speculation that borrowing costs in the US will remain low after economic data signaled that the recovery may be faltering and on the back of Bernanke’s comments that further stimulus is required. The Euro-carnage will continue to support gold buying.

Support is also coming from the physical gold markets, especially Asia. Their demand for the commodity currently tops the last two-year similar period appetite. Last month alone, India’s demand grew +22%, m/m.

Gold is being used as a store-of-value and trades like a currency. The metals bull-run is far from over with speculators continuing to look to buy commodities on these pullbacks ($1,544 -$8.80c).

The Nikkei closed at 9,596 down-32. The DAX index in Europe was at 7,217 down-61; the FTSE (UK) currently is 5,732 down-40. The early call for the open of key US indices is lower. The US 10-year backed up 1bp yesterday (2.98%) and has eased 2bp in the O/N session (2.96%).

Treasuries pared their advances yesterday after the Fed said it would let asset purchases end while maintaining record monetary stimulus. Bonds pulled back after the statement release, disappointed that the Fed did not ‘indicate any inclination’ to move towards further policy accommodation either QE3 or capping certain market rates.

Now that the market is speculating that the end of the Fed’s debt-purchase program this month will slow inflation is again providing a market bid. Some investors continue to apply risk-off trading strategies afraid of a Greek meltdown.

The FI market will now be trying to set itself up to take down supply next week (2’s, 5’s and 7’s). Record monetary stimulus is still needed to support US economic recovery. With the Fed expected to remain on hold for a considerable time is creating a new paradigm of longer term lower interest rates.

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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