Central Bank’s Battle with Currency’s

It has been awhile since Cbanks have made investors so trigger happy. This week, the market did not even get time to digest the magnitude of Bernanke comments before rumor mongering forced risk to ‘go walk about’, pressuring policy makers to be at the ready to defend their currency. This market is constantly trading looking for Cbank activity. There are there.

So far, the SNB has been the most innovative. For political or operational reasons, they seem extremely hesitant to intervene directly in the FX market to weaken an ‘overvalued’ currency. To them, no measure is excluded when it comes to concerns about the CHF. This year, it has appreciated +31% against the EUR. So far, policy makers have boosted liquidity in money market’s and pushed borrowing costs to zero. This has had little effect on the currency value, a value which is choking economic growth and exports.

This morning, they have even been thinking about a ‘temporary’ peg to the EUR. Temporary measures are permissible under their mandate as long as these are consistent with long-term price stability. Global policy makers are desperate to weaken their own currencies. Ben’s statement this week will create the perfect ‘funding‘ currency, weakening the dollar without making it an official policy statement. It’s ‘Battle of the Banks’

The US$ is weaker in the O/N trading session. Currently, it is lower against 12 of the 16 most actively traded currencies in a ‘whippy’ session.

Forex heatmap

The market did not even get a day to digest what the FOMC was doing before we had to deal with further Cbank intervention, rumors of French banks in serious trouble, and speculators ‘hell-bent’ on having a go at France. Most of the EUR’s wild moves yesterday can be attributed to French financials exposure to ‘shaky’ sovereign debt and its possible spillover into US banks. Risk aversion remains the dominant theme in this nervous market.

No one is immune and anyone is being blamed, as policy makers continue to be dragged over the coals. SNB’s Hilderbrand is being branded a speculator. To date, the SNB probably executed the most expensive FX trade in history. In Mar 2009 EUR/CHF was at 1.47. After intervening to weaken the currency, the market traded 1.52 and 1.53, a good average to be short. They have not reversed those positions. The best moves they have done since then was probably not intervening and adding to their reserves. By January 2010 EUR/CHF was at 1.40, Jan 2011 1.30 and Tuesday 1.10. They reported FX loss in 2010 was -$26.5b, the first six months of this year -$9.9b and now that we are threatening parity, they may have doubled this years loss again. Wow! It’s no wonder that the Swiss policy makers are tentative over currency intervention.

The dollar is lower against the EUR +0.48%, GBP +0.25% and JPY +0.46% and higher against -1.58%. The commodity currencies are stronger this morning, CAD +0.53% and AUD +0.96%.

The loonie along with other commodity sensitive currencies is again threatening to revisit this week’s low, for CAD that’s above parity. As the market digests the FOMC communiqué, the CAD has fallen on concern that Canada’s largest trading partner’s growth is flat-lining. The loonie is heading for its third straight weekly loss after climbing to 0.9407 late July, its strongest level in more than three-years, as the outlook for the global economy saps demand for risk assets.

There is a flip-side, because of the stronger Canadian fundamentals and yield differential, investors will want to divest away from the EUR and USD. Once the markets absorb all of this weeks Cbanks actions or lack of, there will be an appetite from investors for a second tier reserve basket. Most commodity and interest rate sensitive currencies certainly belong to this basket.

For now, the loonie remains at the mercy of risk aversion trading strategies and commodity prices. In the O/N market, investors look to be better sellers of dollars on rallies (0.9910).

The wild ride for commodity currencies continues, with the AUD being the prime example. A matter of day’s ago, the market was happily singing its praises, witnessing the currency breach the 1.10 barrier, some weaker global data and a credit downgrade later and this growth and interest rate sensitive currency is bouncing back from the USD trading premium a couple of sessions ago.

In the O/N session, Aussie data was mixed. Full-time employment fell -22.2k in July, while part-time employment gained +22.1k, keeping total employment largely flat. June full-time employment was revised down to +18.2k from +23.4k. The unemployment rate rose to +5.1% from +4.9% in June, with the participation rate unchanged at 65.5%.

On the flip-side, consumer inflation expectation fell to +2.7% in August from +3.4% in July. The weak employment print should keep Governor Stevens rate changes in check, remaining on hold until further notice. Even with core inflation still running above the RBA’s target range, the policy makers can afford to step aside, unless there a dramatic collapse in global financial markets. That can be said for all other Cbanks. Just like the loonie, the AUD will trade with the swings in global risk appetite (1.0250).

Crude is higher in the O/N session ($83.84 up +$0.94c). Crude prices have rallied, rebounding from their ten-month low, after the weekly EIA report revealed an unexpected decline in inventories and on speculation that the Fed will implement a third round of asset buying to bolster the economy.

The bullish report showed that oil stocks fell -5.2m barrels to +349.7m. The market had projected a +1.5m barrel build. Crude imports fell-34k barrels per day to +9.07m. The IEA stated that the US’s SPR saw its stock levels fall -2.5m. Not to be outdone, gas stocks dropped -1.59m barrels to +213.5m, compared with market projections for a +500k barrel build. The average gas demand in the last four-week’s fell -3.4%, y/y. Distillates (heating oil and diesel) fell-737k barrels to +151.5m versus an expected rise +1.1m barrels. Refinery utilization increased +0.7% point to +90% of capacity, whereas the market projected a decrease of -0.4%

Currently, crude is holding just above strong support levels ahead of the psychological $75 barrier. Fed monetary policy will be bearish for the dollar and so should be bullish for crude in the medium term.

Gold has surged to another new record high, breaking through key psychological barriers ($1,800), after a US downgrade and on escalating concerns that global economies are losing momentum. The yellow metal continues to be a recipient of safe-haven flows. The metal’s price has more than doubled since the recession began in late 2007 and has rallied more than +6% so far this week. This summer, its climb has accelerated because of the US Congress inability to stabilize the government’s ‘medium-term debt dynamics’, and on the back of Europe’s debt crisis threatening to spread to three of its biggest economies, France, Spain and Italy. The Fed’s efforts to drive interest rates lower to support lending are curtailing the dollar’s appeal as a safe haven.

With global bourses on the back foot, liquidation of the metal to cover margin calls in other asset classes could pare some of these sharp gains. Investors have bought more gold in the last month than in the prior six months according to CFTC data last week.

Year-to-date, the yellow metal has advanced +24.3%, 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 class. In this environment $2,000 is very much in the realms of possibility over the next six months ($1,794 +$9.70).

The Nikkei closed at 8,981 down-57. The DAX index in Europe was at 5,758 up+145; the FTSE (UK) currently is 5,104 up+97. The early call for the open of key US indices is lower. The US 10-year backed up 10bp yesterday (2.23%) and is little changed in the O/N session.

Treasuries are rising, pushing 10’s and two-year note yields to an all-time low after Ben promised to keep benchmark rates at record lows for two more years in a bid to revive economic growth. The market is trying to flatten that curve quickly.

Yesterday’s government sale of $24b 10-year notes drew a stronger-than-average demand in the second note sale since their debt rating downgrade despite depressingly low yields. Demand for US debt has surged in the last few sessions, as plummeting global bourses boosted the demand for the safety of US product.

The notes drew a record low yield of +2.14% with a bid-to-cover ratio of 3.22, compared with an average of 3.16 for the past 8 sales. Indirect-bidders took down +35.4%, lowest since March 2010. Direct-bidders surged to +31.7%, the highest level in two-years. Today, Treasury issues the final of this week’s supply, +$16b of 30-year bonds. Yield remains in demand and hard to find.

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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