Merkel’s efforts provide a brief EUR rally

Merkel has taken much heat domestically and continues to face resistance in Germany in handling of the Euro-zone crisis. This past weekend, her party was stung by a series of party losses in local elections. This morning’s German Constitutional Court ruling marks a victory for the German Chancellor, who continues to fight for the Euro cause rather than being totally swayed by domestic influences.

The Court ruled that that the Eurozone’s 2010 bailout for Greece and subsequent aid granted through EFSF was legal, eliminating a major hurdle to Euro’s sovereign debt crisis. The peripheries can now breath a little easier. The ruling also noted that the German Government would only require approval from the parliaments budget committee rather than a plenary approval. This would potentially speed up future bailout efforts.

Despite the ECB buying Italian bonds and stronger than expected German Industrial production data (+4% vs.-1%), the EUR is finding it difficult to rally but is expected to trade sideways until NY open as a tired market reflects on the Swiss initiative and the Euro-zone debt crisis. It will not be too long before investors are back attacking the Euro-zone’s fundamental weakness of having one currency without having a common fiscal policy.

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 ‘whippy’ trading session.

Forex heatmap

Now that the Swiss policy makers have said their piece, what should the market be expecting going forth? With the SNB continuing to stress a floor for EUR/CHF would imply increased pressure on other EUR crosses to fall over time. The removal of the CHF as a hedge to Euro area risk will require the market to sell the Euro against other currencies, like the dollar, JPY, NOK and AUD. By default, this would apply downward pressure on the EUR outright. The market can expect the SNB to join the EUR offer over the next several months as it rebalances its FX reserve portfolio. A year ago, when this was last required, the SNB were ‘big’ buyers of JPY, the USD and the CAD. Analyst’s do not expect them to want to raise its EUR share or lower its USD share further given these have been stable since the third quarter of last year. This time around, the intervention was almost entirely in EUR/CHF whereas much of it in 2010 was in USD/CHF.

A surprise print in the US non-manufacturing sector yesterday took some of the sting out of the SNB’s actions, despite the strong rhetoric of ‘aiming for a substantial and sustained weakening of the franc.’ The ISM non-manufacturing index defied expectations and strengthened last month (53.3 vs. 52.7). However, the underlying respondents comments were ‘mixed’ with a degree of uncertainty surrounding business conditions for the remainder of the year. Digging deeper, new-orders index rose to 52.8 from 51.7, while business activity eased to 55.6 from 56.1. Again disappointing was the employment index slipping to 51.6. Last week, the ISM manufacturing sector softened, but managed to keep its head above water and in contraction.

The dollar is lower against the EUR +0.74%, GBP +0.41%, CHF +0.72% and JPY +0.64%. The commodity currencies are stronger this morning, CAD +0.43% and AUD +1.27%.

Bond investors are betting again that Governor Carney may ease monetary policy by year end after reports last week showed that the Canadian economy shrank and US job growth stagnated. Yields on overnight index swaps this week indicate that the odds that the benchmark rate will be cut from +1% after the bank’s December meeting are +64%. Already, Brazil and Turkey have made surprise interest-rate cuts in the last month to guard against a global slowdown, while reports last week showed Canada’s economy shrank in the second quarter for the first time in two-years. In July, when Carney signaled rates could rise, investors began raising bets on a September increase before starting to price in a decrease last week.

The loonie continues to trade within a cent of parity despite US ISM Non-Manufacturing PMI beating expectations. Year-to-date the loonie has weakened -3.9% outright and investors are looking for some guidance from Governor Carney. With a negative Canadian GDP and a deteriorating global backdrop, the market expects a dovish tone from Governor Carney this morning (0.9880).

The AUD is leading the rally versus the USD in the o/n session, maintaining its medium term bullish bias. Stronger than expected data last night has again put risk lovers front and center. Aussie GDP rose a stronger +1.2%, q/q, in the second quarter versus the consensus forecast of +1.0% rise, driven by robust consumer spending and strong exports. The first quarter print was also revised higher from -1.2%, q/q, to -0.9%.

In a speech earlier this morning Governor Stevens reiterated that policy rates are likely to remain on hold and did not point to policy easing anytime soon. Earlier this week the RBA kept rates steady. With the RBA unlikely to cut rates coupled with the ‘new’ easing that the market expects from the Fed and Ben should drive rate spreads further in the AUD’s favor, promoting the carry trade.

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. Currently, investors are better buyers of Aussie dollars on pullbacks as long as this risk loving environment remains (1.0696).

Crude is higher in the O/N session ($87.02 up+$1.00c). Crude fell to its lowest level in more than a week yesterday as speculation that the European debt crisis is spreading pressured the Euro and global bourses. The commodity has been able to trim some of its losses after a surprisingly strong print from US ISM-non manufacturing report. Futures also fell as Tropical Storm Lee weakened to a depression after making landfall.

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 has fallen from a record high printed yesterday as some investors sold the yellow metal to cover losses in the CHF and other asset classes after the SNB pegged their currency to the EUR. Technically, to date, a sum of individuals that have been long the CHF are likely to be long some gold, an alternative safe commodity which has also required some paring back. The SNB is ‘aiming for a substantial and sustained weakening of the franc’ and ‘is prepared to buy foreign currency in unlimited quantities’. In the medium term this can only be bad news for the commodity.

The gold bulls would have us believe that the commodities price has recently undergone a strong correction, followed by a decent consolidation and particularly as European sovereign concerns escalate, believe that all the variables are in place for another impressive gold rally. Last month, gold completed its biggest monthly gain in two years, on speculation that the Fed will take more action to spur growth. Investors are speculating that the Fed will be required to ease monetary policy in answer to stimulate the economy. This has been 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.

Year-to-date, the lemming commodity trade is up +26.3%, as the global debt crises and volatile stock markets has supported 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 ($1,848-$25.00c).

The Nikkei closed at 8,763 up+173. The DAX index in Europe was at 5,338 up+145; the FTSE (UK) currently is 5,268 up+111. The early call for the open of key US indices is higher. The US 10-year eased 22bp yesterday (1.94%) and has backed up +10bp in the O/N session (2.04%).

Yield’s further out the US curve fell to an all-time low yesterday, as concern that the Euro-zone’s debt crisis will cripple financial institutions again boosted the demand for the safest assets. Investors are favoring long dated product over the short-end. Dealers have managed to flatten the curve from +270bp two-months ago to +174bp, with a target in mind of +150bp. This is the flattest the curve has been in two-years. The process is known as *‘operation twist’.

Yields on shorter term treasuries remain rooted to their record lows after the Fed signaled last month that they are willing to take further measures to prevent the US from falling back into a recession. The market waits for the two day FOMC meeting on 20-21st of this month.

*The potential term extension by the Fed is being dubbed a new Operation Twist, a reference to the program in the early 1960s in which the Fed and Treasury department collaborated to try to reduce longer term rates without reducing short rates. The US was in recession at the time, but also on a modified gold standard, and so wanted to avoid cutting short term rates, in the belief that lower short term rates would exacerbate flows of gold and dollars out of the US into Europe.

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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