EUR flatlines ahead of ECB decision-Not for long

When President Obama finally hits the airwaves this evening, capital markets will already be juggling with a few extra balls. Bernanke gets to front run Obama’s highly anticipated job speech, where market participants are already expecting measures to extend unemployment benefits and the employment tax break, with a speech of his own.

This will be a good opportunity for Ben to manage market expectations down if he cannot deliver ‘new’ steps next week, as the rates market has almost fully priced in a maturity extension announcement. Any such hint and risk will take a hike.

Investors could be interpreting new Cbank language from the ECB. President Trichet has indicated that the ECB may shift to a neutral inflation risk statement later this morning, after keeping rates on hold for now. There is some risk that he will signal an easing on the back of rapid deterioration in recent regional data. An in vogue ‘dovish’ statement will not be EUR supportive, nor likely will a hawkish statement given the likely negative effect on the risk environment in the Euro-zone.

The US$ is stronger in the O/N trading session. Currently, it is higher against 14 of the 16 most actively traded currencies in a ‘subdued’ trading session.

Forex heatmap

These are extraordinary times which have required the SNB to unilaterally act outside of the box. Their actions this week threaten the beginning of a public currency war and a U-turn from various policy makers. The SNB has announced its intention to fight massive overvaluation by doing all it can to keep EUR/CHF above 1.20. ‘The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities’. I am sure the BoE thought that when Soros was about!

In this fallout, investors continue to try to decipher or analyze the markets next move. They should be expecting a ‘big turnaround’ in rhetoric from various Cbanks. The ECB is expected to be ‘tweaking’ their language this morning, which in turn should provide hope for the ‘doves’. Other Cbanks will be going to currency war, now that the fiscal freedom has virtually gone and the success of monetary actions in doubt. However, some analysts state that it remains unclear whether policy actions can drive a recovery in risk assets, instead it would only reinforce the direction of the bond rally.

The Fed’s Beige Book said the economy grew at a slower pace in some regions of the country as consumers limited their spending and factories curbed production. ‘Economic activity continued to expand at a modest pace, though some districts noted mixed or weakening activity’,. Bernanke noted last month that the economy was weaker than anticipated and said policy makers will review ways to bolster growth and reduce unemployment next week. He stated ‘only a portion’ of the economy’s weakness stemmed from temporary factors such as a surge in energy prices earlier in the this year. This is not so good! ‘Persistent headwinds are also holding back the recovery, including high unemployment, tight credit and a flagging housing market’. It’s nothing new, same old same old. Now the market will have to contend with President Obama’s speech this evening.

The dollar is higher against the EUR -0.16%, GBP -0.29%, CHF -0.79% and JPY -0.09%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.25%.

There were no surprises with the BoC yesterday who held rates steady at +1%. The expected ‘dovish’ tone was applied with Governor Carney sticking to his script laid out in August. However, the BoC explicitly noted ‘the need to withdraw monetary stimulus has diminished’ which is an ‘expected about-face from the July statement in which they removed the word eventually’.

The BoC does not seem to be at the growth concern stage as they argue in the communiqué that the second quarter weakness was largely due to temporary factors. They modestly continue to talk up Canadian growth prospects. Market expects the Governor will be turning towards becoming more concerned about global growth going forward. The hard forecast numbers will appear in the October MPR. There was no mention of the role of inventory cycles in driving broad GDP growth. This variable is important to forecasting how inventory contributions to GDP could swing adversely in the second half of this year. Likewise, there was nothing in the statement that would support an easing bias. Futures traders anticipate the BoC remain on hold until the end of the third quarter of next year.

Other data yesterday showed that the Ivey PMI rose to 56.4 last month on a seasonally adjusted basis, following a July reading of 46.8. The loonie continues to trade within a cent and change of parity despite global bourses in the black. Year-to-date the loonie has weakened -3.9% outright and depending on risk appetite, investors remain better buyers of dollars on pullbacks (0.9840).

Down-under, markets reacted negatively to the weaker Aussie employment report o/n. So much so that dealers have increased the pricing for RBA rate cuts by +13bp to +130bp over the next 12-months. Employment fell -9.7k in August, far below the consensus forecast for a +10k gain. Digging deeper, the fall was due in part to a -12.6k fall in full-time employment, while part-time employment rose +2.9k. This has now pushed the 12-month rolling jobs created figure to +140k from the peak of +400k one year-ago.

Most importantly for the market, employment growth is worse than the RBA was anticipating, and reflects the accelerated ‘structural change’ partly due to the AUD strength. The unemployment rate rose two ticks to +5.3% from +5.1% in July. Despite being close to full-employment, the pace is now questionable. Already noted this week, the RBA remains firmly on hold, however, the next employment report in October will be important in guiding future market rate expectations.

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 (1.0639).

Crude is lower in the O/N session ($89.27 down-0.07c). Crude prices are running ahead on the back of a potential shortfall of inventory stockpiles. Prices rallied the most in a month yesterday as a weather system threatened to reduce US production in the Gulf of Mexico. The region has already being under pressure from inventory concerns after last week’s storm. The market expects the EIA to report a shortfall of-2m barrels later this morning on the back of Tropical Lee.

Last week’s EIA inventory report revealed that crude stockpiles unexpectedly moved up. Inventories increased by +5.3m barrels to +357.1m. On the flip side, gas inventories fell by -2.8m barrels and this after gaining by +1.4m in the prior week. 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, 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.

The Gold bulls have been taking a beating after gold prices happened to retreat the most in two-weeks yesterday, as a rebound in global equities eroded demand for an alternative asset and spurred investors to sell the metal after its rally to an all-time high late last week. Other investors have 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, 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 commodity prices has recently undergone a strong correction, followed by a decent consolidation and particularly as European sovereign concerns escalate. They 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 guessing that the Fed will be required to ease monetary policy in answer to stimulate the economy. This will boost the appeal of the yellow metal as an alternative asset class. Year-to-date, the lemming commodity trade is up +24.2%, as the global debt crises and volatile stock markets have 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 ($1,835+$17.00c).

The Nikkei closed at 8,793 up+30. The DAX index in Europe was at 5,445 up+45; the FTSE (UK) currently is 5,355 up+32. The early call for the open of key US indices is unchanged. The US 10-year eased 1bp yesterday (2.03%) and is little changed in the o/n session.

“Da Bears” are back in town, temporarily at least with longer yields backing up ever so slightly from their all-time low on speculation that Obama’s plan to spark hiring by injecting more than $300b into the economy will bolster growth. With global bourses in the black yesterday pushed the long end of the US price curve lower as investors pared some of their risk aversion appetite. The 2/30’s spread trades close to +312 basis points after falling earlier in the week to +308 (the narrowest on a closing basis since in 12-months).

The pullbacks will run into support on concern that the Euro-zone’s debt crisis will cripple financial institutions. Thus far, dealers have managed to flatten the US curve from +270bp two-months ago with a target in mind of +150bp as they trade in front of the Fed who is expected to introduce new stimulus measures at its next meeting. This is the flattest the curve has been in two-years. The process is known as *‘operation twist’. 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