Three More Strikes against the EURO

Euro-sovereign debt fear is again dominating this mornings market. Moody’s has placed Spain’s Aa2 rating on review for a possible downgrade and has threatened to lower the ratings on four Spanish banks. Arguably not in the Greek boat just yet, Spanish 10-year yields have backed up +60bp so far this month. Once the market begins to lose confidence, yields creep much quicker, just look at Italy this week, surging Italian yields on speculation that Tremonti may quit.

Euro-zone inflation rate fell to +2.5% in July, after having climbed +2.7% in June, y/y. It’s still above the ECB’s target of just below +2%. Perhaps this may persuade Trichet and company that further tightening is not warranted over the coming months.

The EUR bulls should be more concerned now that the currency has failed to rally significantly on the back of inept Washington politicking doing everything it can to destroy trust in the dollar. What if the lawmakers finally get their act together and increase the debt ceiling?

The US$ is stronger in the O/N trading session. Currently, it is higher against 10 of the 16 most actively traded currencies in another somewhat ‘subdued’ session.

Forex heatmap

US data yesterday was positive for the dollar, certainly encouraging after that soft durable goods print earlier in the week and especially so amongst this political high stakes fiasco being played out in Washington.

US Pending Home Sales surprised to the upside again this month, adding a +2.4% month-over-month increase in June to the +8.2% gain in May. The market will take this as a good omen for existing home sales, which analysts note ‘lagged severely in the previous monthly reporting cycle’. It is not unusual for both reports to move in opposite directions, especially in a one month cycle, but it will be unusual for it to extend into a second consecutive month. Big picture, all the signs point to the future level of sales to ‘remain weak in absolute terms’, however, yesterday’s print may suggest that the market may be overestimating the weakness. Let’s hope so, this sector needs a break!
US weekly claims was a pleasant surprise (+398k vs. +422k). The market prefers to buy into last weeks print with some gusto, believing the prior two releases (July 9 and 16) were unnecessarily depressed by ‘seasonal adjustment factors that still look too large’.
This report comes relatively late in the month and should not influence many to readjust their already weak prediction for next weeks NFP report. The market will now be hoping that the ‘new’ trend remains the markets friend, aiding August’s employment tally. However, there are a considerable chunk of new potential claims to be recorded from banks (HSBC, GSNY, Credit Suisse etc). With financial institutions under pressure to cut headcount, the broad market will eventually follow.

The dollar is higher against the EUR -0.40%, GBP -0.59%, CHF -0.01% and lower against JPY +0.08%. The commodity currencies are weaker this morning, CAD -0.16% and AUD -0.55%.

Earlier this week the CAD wore the ‘safer heaven’ hat as investors happily pushed the currency towards its four-year high. The rampant currency has taken a reprieve like most of its trading partners did against dollar. Some of the growth currency moves this week have been too quick, too strong and too far.

Overall, the game plan has not changed for this commodity and interest rate differential driven currency. Technically, there was strong dollar buying by corporates and institutions, acquiring fresh dollar long positions once the buck traded on top of its three and a half year lows. One of the factors pressurizing the loonie was the US durable goods orders for June falling for the second time in three months. Growth and risk currency pairs are very sensitive to these debt ceiling and Euro-contagion headlines of late. However big picture, the currency is still riding Carney’s hawkish coat tail comment from last week that has futures traders pricing in at least one more hike by year-end despite a subdued CPI print. Investors are looking forward to today’s GDP print for further currency bullish confirmation. Currently, the market is in dollar sell up tick mode. Of course, the US political fiasco may throw another spanner into the works before the weekend! (0.9505).

The AUD came under pressure in the O/N session, paring some of this week’s advance, as the US continues to struggle to find a long-term solution to curb its deficit, reduced demand for riskier investments. Moody’s putting Spain’s credit ranking on review for a possible downgrade is also affecting the risk appetite of investors.

Earlier this week, the currency vaulted to a post float record after the market digested a higher than expected second quarter inflation print. Year-to-date, the currency has climbed +23% against the greenback, as a mining-investment boom has driven unemployment to below +5%. Higher inflation data points to a rate hike rather than a cut. With core-CPI advancing by +0.9% on the quarter and +3.6% on the year is a blow for the doves who expected Governor Stevens to perform a rate cut before the year is out, beginning with a 25bp cut in December. US politicians will dictate investors next move. The market continues to wait for Washington.

Crude is lower in the O/N session ($96.88 -0.56c). US fundamentals benefited oil prices yesterday, first time in a while, edging higher after weekly US jobless claims fell to their lowest level in almost four-months. The market took this as a sign that future energy consumption may increase as the weakness in the labor market fades.

Midweek, the commodity came under pressure as weekly inventories unexpectedly increased. The market had been expecting another drawdown on stocks. However, the EIA reported a data gain of +2.3m barrels to +354m last week. The build up should have not been a surprise after the SPR announcement last month. The Energy Department also announced that they will deliver +30.6m barrels of crude oil from the US’s SPR in July and August. Not to be out done, gas inventories rose +1.02m barrels to +213.5m. Stockpiles of distillate fuel (heating oil and diesel) surged +3.39m barrels to +151.8 m, its highest level in three-months. Refineries operated at +88.3% of capacity, down-2% from the prior week and the biggest decline also in three-months.

Until the market can expect some sort of US debt resolution, the oil market should look forward to remaining volatile. Big picture, failing to raise the debt ceiling would mean the US could either default or have to cut spending on a variety of social services, which would have a negative affect on domestic oil demand, translating into lower prices.

Gold prices fell for a second consecutive day yesterday on investor sales after the commodity surged to new record prints this week as the “prolonged” US debt stalemate boosted demand for the yellow metal as a haven. Some investors needed to sell the commodity to cover increased deposits on margin accounts in equity markets.

Year-to-date, the yellow metal has advanced +15.3% and +8.2% this month alone, heading for its eleventh consecutive annual gain. Despite many believing that a deal will be done, “Rational” fear ahead of “the” decision continues to pressurize the dollar, hurting bonds and benefiting commodities. In real terms you are not making any money by just holding cash, so there is a demand for gold as a store of wealth. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on pullbacks until proven wrong ($1,615 -0.40c).

The Nikkei closed at 9,833 down-56. The DAX index in Europe was at 7,136 down-54; the FTSE (UK) currently is 5,839 down-34. The early call for the open of key US indices is lower. The US 10-year eased 4bp yesterday (2.93%) and is little changed in the O/N session.

Treasuries rose, pushing 10-year yields to a one-week low yesterday, on concern that the debt ceiling impasse will end up damaging the US economy even more. By day’s end, yields ended up backing away from their lows as investors worried that lawmakers would not reach a deal and on the back of the seven-year auction. The $29b issue was the last of the week, it did see weaker demand, similar to the five’s, but a ‘no buyers strike’.

The seven’s were sold at a yield of +2.28%, compared to +2.26% just before the sale. Non-dealers took +39.6%, higher than last month, but below the four-auction value of +42.1%. The bid-to-cover was 2.63, compared to the average of 2.82. Now, the market waits on both political US parties to do their magic and buy back some foreign respect. On the flip side, even if Treasuries were downgraded, there’s not a lot out there of alternatives investment strategies now that there is so much cash on the sidelines.

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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