EURO: Signs of Competence ahead of Bernanke

Positive Chinese and Japanese data surprise overnight is supporting the markets and trumps Moody’s downgrade of Ireland’s sovereign rating to sub-investment grade Ba1 or junk.

All eyes will now be on Bernanke who will be stepping up to the plate at his Humphrey-Hawkins testimony. Ben is not expected to give too much away in his prepared statement but when asked is a different matter. If pushed in questioning expect him to hint that policy makers have ‘the capacity and will to do more to support the economy’ following discussions of possible further easing in the Fed minutes.

What will this do? Potentially, the market will begin pricing out the ‘rate of longer term growth’. An absence of any indication of ‘new’ future support or rhetoric that QE is dead would have capital markets ‘further pricing the downside scenarios for growth’, both in the US and Europe.

So far, Capital markets have gotten the support from the IMF after Lagarde’s U-turn on her comments. They are willing to work with European and Greek officials to develop a bigger package to tackle the country sovereign debt crisis, to help stem contagion in Europe. Euro-sentiment is improving slightly on speculation of the ECB buying some Euro-zone government bonds, signs of the Italian parliament pushing for passage of an austerity package and some commitments from Euro officials on providing a backstop to banks that would fail a stress test. ECB has said that ‘All Europe will safeguard financial stability in the Euro area’. However, capital markets are mightier than Europe!

The US$ is weaker in the O/N trading session. Currently, it is lower against 14 of the 16 most actively traded currencies in a ‘volatile’ session.

Forex heatmap

US trade deficit certainly surprised the market yesterday, and it was not at the top of most investors agendas because of all the other periphery action going on. US’s overall deficit widened nearly +$5b more than expected, pushing the deficit up to its highest level of -$50.2b in nearly three-years. Digging deeper, the ‘surprises’ were split between exports and oil imports.

Total exports fell by -0.9%, with the biggest surprise occurring in industrial supplies, where nominal energy exports declined, and in capital goods, which grew only modestly. The market had been expecting the total reverse. Imports of capital goods climbed faster than exports, which will boost the official estimate of domestic business investment for the second-quarter.

Analysts note that nominal oil imports rose by more than +$4b (twice estimates). The price factor increase took the market by surprise (+4%) and investors should be expecting the impact is likely to be reversed next month, contributing to a pullback in imports. Meanwhile, non-oil imports were broadly in line with expectations with a +0.9% increase, consistent with ongoing expansion in global trade flows. The composition of the data offsets the surprise in the headline number. Depending on what US retails sales are like this week, this set of data should have only a modest impact on the second quarter GDP estimates (+1.5%).

The Fed minutes leaves open the possibility of further ease. Another positive development for markets is that the Fed minutes released contained discussion by FOMC members ‘of a willingness to consider further measures to ease US monetary policy if the economy remains weaker than the Fed desires’.

The dollar is lower against the EUR +0.69%, GBP +0.27%, CHF +0.01% and higher against JPY -0.03%. The commodity currencies are stronger this morning, CAD +0.50% and AUD +0.63%.

Canada’s trade deficit narrowed in May, but only slightly (-$0.8b). Digging deeper, export volumes rose +1.5% with prices decreasing -0.3%, while import volumes decreased-1% and prices increased +2.1%. Exports were led by higher volumes in machinery and equipment while imports saw all sectors recording gains. The increase in exports, despite a strong currency, is paramount to an export dependent economy. May was the fourth consecutive month with a trade deficit.

The loonie continues to trade within a confided trading range as investors hum and haw over risk and aversion trading strategies. Depending on who is speaking on the Euro-zone or on the US debt ceiling at that moment does the currency again become in vogue. The market has been taking it cues from investors risk appetite and ignoring most of the good domestic data like last week’s Canadian employment report. Until policy makers can take a firm grip on the contagion fears that continue to reoccur and on the US reluctance to find a solution for their debt ceiling debates, uncertainty will breed volatility. On stronger dollar rallies the CAD is in demand (0.9607).

The AUD gained O/N for the first time in four days after China reported that economic growth (+9.5%) and industrial output increased more than the market had been predicting. Any rally in Asian bourses and commodities tends to support a demand for higher-yielding currencies. However, gains have been tempered after a report showed consumer confidence fell this month. The sentiment index dropped -8.3% to 92.8 in July from a month earlier, the lowest since May 2009 and the biggest decline since October 2008. The market seems to be taking it as justification for the RBA to do nothing with monetary policy for several months.

Fundamentally, Governor Stevens will wait for actual evidence that the consumer is back in play before he considers hiking rates rates.Weaker confidence and slower consumer spending add to the pressure on Governor Stevens to keep its key interest rate unchanged (+4.75%) until December.

Despite stronger Aussie domestic data of late, investors own risk attitude has the growth higher yielding currencies underperforming, with investors looking to cut further their risk exposure, afraid that China, Australia’s largest trading partner, will take further action to cool growth. Currency gains have been capped on fear that Greek austerity plans will not resolve Europe’s sovereign-debt crisis. Concerns that global growth is slowing has prompted some investors to bet that the RBA will cut interest rates some time this year.

Currently, the market is pricing a no hike in August unless both inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite (1.0690).

Crude is higher in the O/N session ($97.67 +$0.69c). Oil prices rebounded from its lowest levels so far this week as the dollar pared some of its gains yesterday. Uncertainty over Europe’s debt crisis continues to keep a lid on prices. Up to now, oil prices have been under pressure from a decline in Chinese imports, on a horrid NFP release and on Cbanks hiking rates. All these good reasons have damped optimism for an economic rebound and growth in fuel-demand from the world’s largest consumers.

Today we get the new weekly inventory report. Last week’s EIA data showed inventories falling more than expected for a second consecutive week. US commercial crude stocks decreased-900k barrels to +358.6m, but remains above the upper limit of the average range for this time of year. Not to be left behind, gas inventories fell by-600k barrels, after decreasing by -1.4m in the prior week, and is in the lower limit of the average range. Oil refinery inputs averaged +15.3m barrels per day during the week, which were +68k barrels per day above the previous week’s average as refineries operated at +88.4% of their operable capacity.

The market is concerned that the ‘tightness’ in the oil market will continue to undermine the fragile global economic recovery. This is why the IEA and its members agreed to release crude from their SPR’s to ease some of this market tension. This year’s energy spike is being cited ‘as the reason for the global economic slowdown.

Gold prices remain elevated and are preparing to make new record highs again and again this week, as the European sovereign debt crisis increases demand for the metal as a haven. A rate hike from China and the Euro-zone has dragged inflation concerns back into the spotlight. The PBoC and ECB are clearly stating that ‘taming inflation is a top priority even at the expense of their economies slowing gently’. Investors have been demanding the metal as a protection of wealth.

In real terms you are not making any money by just holding cash, so there is demand for gold as a store of wealth. Even a stronger dollar has found it difficult to stall the metals rally. Longer term, weaker global fundamentals are expected to support this crowded trade during the second half of the year. The commodities dependency on the buck and the outlook for US rates is likely to remain its biggest supporting factor. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on these deep pullbacks until proven wrong ($1,571 +$9.00c).

The Nikkei closed at 9,963 up+37. The DAX index in Europe was at 7,201 up+27; the FTSE (UK) currently is 5,877 up+9. The early call for the open of key US indices is lower. The US 10-year backed up 4bp yesterday (2.92%) and is little changed in the O/N session.

Big picture, Treasury yields remain under pressure as the Euro-zone debt crisis intensifies. As expected, and ahead of this week’s three auctions, dealers having been trying to cheapen up the curve somewhat. It’s difficult in this environment with investors briefly embracing risk or welcoming aversion trading strategies.

Yesterday’s $32b three-year issue was a decent auction, with the US selling at the lowest yield in nine-months (+0.67%). The sale was 3.22 times subscribed, just below the four auction average of 3.25 bid-to-cover. There was a direct bid of +16.5%, above the +11.4% average, while the indirect took down +34.5% in total.

The US government will issue $21b 10’s today and $13b 30-year bonds tomorrow. Previously, the Fed had been the only consistent buyer of product. Now, this week’s supply under these conditions may be well received.

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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