ECB risk moves working?

It’s done. S&P did what many had only thought they would do. Stripping the US of it’s AAA rating, citing a negative outlook, will provide another hit to an already fragile business and consumer confidence landscape. The US’s fiscal path and its broken political system are to blame. The political scene is ‘so caustic that lawmakers are unable to make the tough choices needed to correct the debt-to-GDP rise’.

A future downgrade had been voiced, but a negative outlook on top of a downgrade was not factored into expectations. It suggests a potentially sharper bond market sell off over time with European style pressure upon the US to bring forth additional fiscal austerity; or face another downgrade.  

What has S&P done? All weekend we saw their actions fuel the political blame game. Capital markets expect a responsible response to this downgrade and not a mathematical error explanation. Speculators will be trying to figure out if the Euro-zone problems outweigh the S&P move.

Panic selling requires a ‘massive coordinated policy response’. From the G7 it was inevitable, the ECB got the green light to buy ‘all’ bonds in the secondary market. Trichet has been buying Italian and Spanish bonds straight out the gate this morning, a move well telegraphed. With European Governments failing to act swiftly enough to stop contagion, it has fallen to the ECB to battle the crisis, ‘again intervening as the last line of defense’.

The problem, the ECB after 18-week’s is again expanding its balance sheet by buying sovereign bonds in the secondary market. This will breach a key treaty in the Euro’s founding treaty and undermine even further the banks fragile credibility. How persistent will the ECB be? How much support it will get from Germany? Merkel has already said that the volume of the EFSF will not change and that they will stick to the July 21 summit decisions. Typical, prefers to abide by a reactionary rather than a proactive policy. Expect the Fed to introduce new stimulus measures that will ultimately weaken the USD. However, tomorrow’s FOMC meeting is probably too soon for any announcement.

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

Forex heatmap

Last Friday’s NFP was a small positive, providing us with a modestly better than expected print on the headline (+117k vs. +75k). However, the positive release will end being a distant memory to ‘the’ historic downgrade. US Job growth is still not fast enough to put sustained material downward pressure on the unemployment rate, despite it easing to +9.1%. The Fed will remain discouraged.

Digging deeper, not only was the headline print better, but both May (+25k to +53k) and June (+18k to +46k) were revised up with a net increase of +56k. The unemployment rate declined back down to +9.1%, contraction in the labour force is behind the improvement, the second consecutive monthly decline. The private sector added +154k jobs. This was partially offset by a-37k drop in public sector jobs that was mostly concentrated upon a-35k drop at the state and local level. Analysts note that the number for total hours worked remains somewhat static, rising only +0.1%, month-over-month.
The problem for the employed, wage growth is accelerating ever so slightly, rising +2.3%, y/y, but inflation adjusted wages still have many consumers unable to ‘keep their heads above water while paying more for food and gas over time’.  

In the household survey, employment registered a modest decline on the month. Most of the weakness was in the part-time sector, as full-time jobs posted their first gain in three-months. The services sector accounted for the majority of gains, rising by +75k.

The dollar is lower against the EUR +0.35%, GBP +0.18%, CHF +1.10% and JPY +0.75%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.80%.

On Friday, the Canadian jobs report was firmer than the headline would suggest (+7.1k vs. +15k), however, wages remain the biggest concern, as Canadians continue to take pay cuts as measured by inflation adjusted wage growth. Analysts suggest that this is bearish for consumption going forward.

Digging deeper, any weakness in the headline is due to the education sector (-30k). Again analysts suggest that StatsCan has had problems in adjusting for contract shifts within the education sector and it is this thats is causing the ‘temporary anomaly’. The market can expect a sharp upward surprise in next months release. Wage growth decelerated to +1.4%, y/y, and is negative after adjusting for inflation. Total hours worked accelerated to +2.2%, y/y and should help insulate against some of the wage weakness, but combined, wage and hours growth still leaves a soft influence on take home pay.

The private sector drove all of the gains in July, adding almost +100k jobs, while both the public and self-employed components witnessed a decline of -71.5k (includes the problematic educators) and -15.9k, respectively.  

The loonie ended last week on a losing footing, falling against dollar on concern slowing global economic growth will weigh on demand for raw materials and increase risk aversion trading strategies. With global bourses continuing to trade on the back foot, is temporarily discouraging the demand for higher-yielding assets and pushing the currency to take out the weak stop-losses that has opened up this new trading range.

Friday’s historic S&P’s downgrade announcement will create a new financial and trading environment. For the time being, the loonie will remain at the mercy of risk aversion trading strategies and commodity prices. In the O/N market, investors remained better buyers of dollars on dips (0.9860).

Last week, the AUD succeeded in printing its biggest weekly decline outright in twelve months after the RBA cut its forecast for 2011s economic growth. This week, the currency continues its slump, taking its run of daily declines against the greenback to the longest in a decade, as concern the global economy is slowing sapped demand for higher-yielding assets. The US credit downgrade is pressurizing commodities, which in turn is negative for all growth sensitive currencies. Output concerns slowing in the Euro-zone and the US has spurred declines in prices of commodities that account for a majority of the country’s exports. After keeping rates on hold earlier this month, Governor Stevens signaled a tightening bias once the world outlook improves. Global data of late is pointing towards the threat of a ‘double-dip’ recession scenario. In the futures market, the pricing of an RBA cut has increased +15bp to +41bp over the next 12-months.

While policy makers have pointed to downside risk to the global outlook, they have also added their concern about Australia’s medium term inflation. Last weeks inflation data would suggest that there is a greater possibility of an RBA hike rather than ease in the latter half of this year, of course that all depends on world growth. With commodity prices feeling the pressure, selling of AUD on rallies is preferred. The currency is approaching some key support levels, any further decline in investors appetite for risk or their lack of need for a second tier reserve currency could push the currency to trade once again towards parity. In current climate conditions, investors remain better sellers on upticks (1.0335).

Crude is lower in the O/N session ($84.33 down -$2.55c). Crude prices have plunged again, extending last week’s biggest weekly decline in five-months, after S&P’s lowered the US credit rating to AA+, the first-ever reduction for the world’s biggest crude consuming nation. Disappointing US data shows that the consumer continues to spend less in response to a sluggish job market and higher fuel costs. The US global economic recovery is stalling and sapping demand from the world’s biggest consumer.

Last week’s inventory build has helped prices to slide. US gas stockpiles rose sharply and demand over the past four-weeks fell-3.6% compared with a year-ago, adding to concerns about tepid consumption in the midst of the peak summer demand period. Inventories increased by +1m barrels to +355m, and remain above the upper limit of the average range for this time of year. Not to be outdone, gas inventories moved up by +1.70m barrels last week, and are in the upper limit of the average range. Analysts had expected crude stocks to gain by +1.5m barrels and gas inventories to rise by +250k. The commodity sector is expected to remain volatile on the back of weaker fundamentals.

For seven months it’s been a safe bet. Gold surged to another new record high this morning, breaking through key psychological barriers, after a US downgrade and on escalating concerns that the global economy is losing momentum. The yellow metal continues to be a recipient of safe-haven flows. However, with the equity market route, liquidation of the metal to cover margin calls in other asset classes could pare some of the O/N gains.

Year-to-date, the yellow metal has advanced +21.3%, heading for its eleventh consecutive annual gain. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on pullbacks until proven wrong. There remains a demand for the commodity for insurance purposes as alternative asset classes under perform with many investors receiving margin call ($1,707 +$56).

The Nikkei closed at 9,092 down-202. The DAX index in Europe was at 6,189 down-46; the FTSE (UK) currently is 5,230 down-16. The early call for the open of key US indices is higher. The US 10-year backed up 9bp on Friday (2.51%) and is little changed in the O/N session.

Yield curves have taken a battering from growth nervous investors and from a credit agency and a math problem according to the US treasury. Normally, a credit downgrade would probably have many dumping the assets of that nation. However, that nation been the US is a different problem. Foreign investors maintain a large share of their FX reserves in treasuries because it is the deepest and most liquid bond market. The S&P notch should have little affect on bond prices because sentiment has been weak already and because no one needs to change their risk weighting because of the Euro-zone sovereign debt issues.

In the short end, two-year note yields fell to a record low amid growing concern that a slowing domestic economy and spreading debt problems in Europe will prompt Bernanke to take additional steps to bolster growth (Jackson Hole). With yields already so low will it have an impact?

The ECB this morning has been forced to intervene and begin buying Italian and Spanish assets in their riskiest attempt yet to tame their sovereign debt crisis. Italian 10’s have surged with yields falling-70bps, dragging bunds and US 10’s higher. Market is waiting for the US open to gauge true North American sentiment.

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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