EURO has Lost its Teflon?

It’s a thin market, liquidity at a premium, a holiday weekend and now we get a disastrous set of Euro-zone manufacturing data, a day ahead of the highly anticipated NFP report. The market has been slicing through the EUR like knife through butter already this morning, mostly on concern that Euro sovereign-debt crisis may worsen, curbing the demand for the currency and triggering some sizable stop losses that have helped to quicken the downward pace.

The IMF is helping to speed up the EUR downfall by its negative comments on European banks balance sheets. It does not help the currency that the Euro-finance ministers continue to struggle to agree on the details of possible securities for bailout loans for Greece. With these ministers continuing to put their national interests first, nothing will ever be decided.

Manufacturing activity in the Euro-zone fell back into contraction last month (PMI-49), ending a two-year run of growth as activity shrank in France and Italy, two of its biggest economies. The forward looking indicators are also looking suspect. Its expected that US ISM Manufacturing PMI will mark its first sub-50 reading in two-years later this morning. Look on the bright side, that print is still above the 42 levels that would signal recession!

The US$ is stronger in the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in a ‘whippy’ trading session.

Forex heatmap

Yesterday’s data was met with little fanfare. The market is keeping that for tomorrow’s employment report. Private businesses added a modest number of jobs last month. ADP reported a gain of +91k. Dealers were expecting a gain of +100k. On a disappointing note, the June headline print was revised down to +109k from +114k. Analysts are expecting an NFP print around +80k, anticipating that the headline print was held down by workers on strike at Verizon. No one seems to be expecting any movement in the unemployment rate (+9.1%). Data this week continues to point towards a sluggish labor market as the US economy cannot seem to ‘rev up quick enough’ to generate new jobs.

Business activity in the US continued to expand last month, but at a slower pace (+56.5 vs. 58.8). Despite beating market expectations (53.5) it still was the lowest reading in two years. That’s a long way from the February print of 71.2, which was the highest reading in two-decades. Digging deeper, the production index plummeted from 64.3 to 57.8, the worst print in two-years. New orders declined from 59.4 to 56.9, the lowest in three-month. Inventories eased from 53.2 to 52.9, while the prices paid component continued their slow downward trend from 71.7 to 68.6. Interestingly, employment rallied slightly to 52.1 and remains in line with other regional releases, signaling that manufacturing will be contributing modestly to August’s payrolls.

The dollar is higher against the EUR -0.66%, GBP -0.30% and JPY -0.35% and lower against CHF +0.87%. The commodity currencies are weaker this morning, CAD -0.18% and AUD -0.08%.

The loonie has pared its biggest monthly decline since May as data yesterday showed that the economy grew by +0.2% in June. Unfortunately the bigger picture was not so pretty. The quarter GDP declined -0.1%, for an annualized drop of +0.4%, marks the first decline since the second quarter of 2009. Exports fell -2.1%, the sharpest drop in two-years and imports grew +2.4%, which points to net exports of having a significant affect on growth. Japan has been the only other G7 country to have had a negative decline in the quarter.

Month-to-date, the loonie is heading for its biggest drop in a year on speculation that the BoC would refrain from tightening rates anytime soon. This week’s month-end pressure on global equities has also discouraged investors from wanting to own higher-yielding assets. Now it’s a new month, but a day before payrolls and a long weekend.

The market will have to wait and see what tomorrow’s US employment number bring to the table before investors place their ‘new bets’. This week’s Fed minutes revealed a dovish meeting and one that shows that policy makers are still prepared to act if things get worse from here. This has allowed investors to become better buyers of dollars on dips (0.9790).

Aussie retail sales for July rose +0.5%, m/m, last night, more than the consensus forecast for a +0.3% print. Even the private capital expenditures (capex) came in healthy with the final estimate for growth for this year of +12%. Despite being below the government’s earlier estimate of +16%, y/y, expected spending for next year was essentially unchanged at +41%. The data certainly supports the RBA forecasts that mining investment will keep the Australian economic growth strong despite soft consumer and housing growth.

Australia is the only developed economy to avoid a recession during the global contraction of 2009, and is undergoing a ‘structural adjustment’ as the biggest mining boom in more than a century drives the nation’s currency to a record. The rising local dollar is hurting exporters, and the unemployment rate last month rose for the first time in 11-months.

It seems that the currency cannot lose at the moment. If US data continues to improve then local market pricing for interest rate cuts by the RBA will evaporate. On the flip side, if US data takes a turn for the worst, then the AUD will benefit from a weaker dollar. Now that this growth and interest rate sensitive currency would likely be supported on both poor and strong US data, certainly favors a test of the old highs north of 1.10. Currently, investors are better buyers of Aussie dollars on pullbacks as long as this risk loving environment remains (1.0696).

Crude is lower in the O/N session ($88.47 down-0.34c). Crude prices fluctuated yesterday as it headed for its biggest monthly drop since May after the weekly inventories increased unexpectedly and equities and gas prices surged. As East Coast refineries continue to work to restart refineries after Irene is providing price support for the black-stuff.

Last week’s EIA inventory report revealed that crude stockpiles unexpectedly moved up. Inventories increased by +5.3m barrels to +357.1m, and are above the upper limit of the average range for this time of year. On the flip side, gas inventories fell by -2.8m barrels and this after gaining by +1.4m in the prior week. They remain at the upper limit of the average range. Analysts were expecting crude oil inventories to dip by-500k barrels and gas stocks to fall by nearly +1m. Oil refinery inputs averaged +15.4m barrels per day, which were-219k barrels per day below the previous week’s average as refineries operated at +89.2% of their operable capacity. It’s also worth noting that over the last four-weeks, imports have averaged +9.2m barrels per day, which were-441k barrels less than the same period last year.

For the moment, Crude prices continue to hold just above strong support levels, supported by unrest in Libya where the availability of light oil with low-density and sulfur content output has fallen. The Fed’s monetary policy should be bearish for the dollar and bullish for crude in the longer term.

Gold completed its biggest monthly gain in two years yesterday, on speculation that the Fed will take more action to spur growth. The metal has rallied aggressively after the US consumer confidence number sank to a 28-month low earlier this week. Investors again are speculating that the Fed will be required to ease monetary policy in answer to stimulate the economy. This is boosting the appeal of the yellow metal as an alternative asset class. To date, the Fed has kept borrowing costs at a record low for nearly three-years to stimulate the economy.

Already this week the possibility of a stimulus package from the Fed in the weeks ahead had seen the return of risk appetite to the market with ‘safer haven assets’ being liquidated. The commodity is close to paring all of this week losses where both fundamental and technical pressures bore down on the commodity once it approached new record levels.

Year-to-date, the lemming commodity trade is up +29%, as the global debt crises and volatile stock markets boost the appeal of the metal as an alternative asset. The Fed’s efforts to drive interest rates lower to support lending should curtail the dollar’s appeal and by default, support commodities. The commodity is heading for its eleventh consecutive annual gain ($1,826-$5.60c).

The Nikkei closed at 9,060 up+106. The DAX index in Europe was at 5,691 down-94; the FTSE (UK) currently is 5,379 down-15. The early call for the open of key US indices is lower. The US 10-year eased 1bp yesterday (2.19%) and is little changed in the O/N session.

Treasuries completed its biggest monthly gain in nearly three-years as investors ignored the US’s first-ever credit rating downgrade and sought a refuge in the safest securities amid signs of slowing global growth. This week US Treasuries prices have rallied, especially longer dated securities, as consumer confidence plunged this month to the lowest in more than two years.

Yields on shorter term treasuries remain rooted to their record lows after the Fed signaled earlier this month that they are willing to take further measures to prevent the US from falling back into a recession. The spread between 2/10’s has again flattened (+201bp).

The market will try to stay out of trouble and peacefully wait for tomorrows NFP release.

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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