Traders know leverage. Do EURO Policy makers?

It no wonder investor confidence is at such low levels when you have to interpret irresponsible politicking as well. It seems that Euro finance ministers cannot whistle to the same tune. There has been talk about leveraging EFSF monies to significantly boost the programs firepower. That reality would be opening a new debate on a new expansion without the previous EFSF program being completed.

Policymakers are believed to be working on a three-pronged plan to ‘ring fence the euro crisis around Greece’. Under the proposal, banks across the continent would be recapitalized, the €440b EFSF program would be ‘leveraged up’ through the ECB to provide €2t of firepower, and Greece would be subjected to a managed default on +50% of its debt, but stay in the EUR. Apparently Spain knows nothing about this plan! According to their Finance Minister this morning, a program like this is ‘not on the table’.

The EFSF amendments proposed on 21 July will undergo parliamentary ratification in Slovenia today, Finland tomorrow and Germany on Thursday. Presently, expectations of more positive policy action from Europe have helped to stabilize sentiment. The rates market is pricing in about +30bp of ECB rate cuts at next week’s meeting. The next few days will be rather telling. Does Europe what to hear the wrath of Geithner again? It’s normally ignored!

Forex heatmap

US housing headlines continue to paint an ugly picture. With the lack of any data released yesterday, the market was able to scrutinize the New-Home Sales release which fell for a fourth consecutive month (-2.35% to +295K). It was the biggest drop in prices in two years and failed to lure buyers away from even less expensive distressed properties. On a positive note, prior sales were revised higher to +302k units. New-home sales are currently at a quarter of their peak values, with sales well below analysts ‘healthy’ target of +750k.

Lower consumer disposable income is having little effect on US economic growth and by default any positive affect on unemployment. These factors combined with tighter lending standards again is not positive for the housing market. Lat week, the Fed announced that it would put payments from its MBS back into mortgages. This action will be able to push down mortgages even further. The problem is that buyers are not buying and sellers do not want to be selling at such low levels. The median price for a house last month, fell -7.7%, y/y, to +$209k. If there are buyers, they tend to be looking more at the foreclosed properties.

The dollars is higher against the EUR -0.15%, GBP -0.07%, CHF -0.24% and JPY -0.12%. The commodity currencies are mixed this morning, CAD -0.07% and AUD +0.54%.

The loonie and its commodity currency colleagues have received the brunt of the backlash over the past week, with mass portfolio liquidation pushing the CAD to revisit its 16-month low outright yesterday. This was temporary however, as equities in the black happened to drag risk currencies higher by day’s end.

The Fed’s significant risk statement last week had made all higher yielding currencies pay. The fear of what the Fed has left to fight ‘no growth’ with sent panic throughout the different asset classes and that European policy makers are struggling to resolve the debt crisis has reduced investor’s appetite for risk.

Year-to-date, the loonie has lost-3.9% versus its G20 partners and last week’s-5.1% drop was the biggest in three years. The IMF has stated that the global economy is entering a new “dangerous phase’. Presently Canada is experiencing the twin evils of a slowing economy and higher inflation and remains at the mercy of ‘external headwinds’.

Before sustainable risk can be applied again, the market requires seeing a bigger aid package, bank recapitalization and a framework for an orderly default by Greece. Can that be delivered?

Last weekend, BoC governor Carney was ‘encouraged’ by euro-area policy makers’ ‘diagnosis of the seriousness of the situation’. Carney has become more concerned about global growth, especially now that the IMF has revised their growth forecasts. Investors remain better buyers of dollars on dips in times of uncertainty (1.0254).

The AUD advanced outright in the O/N session on the back of global equities being in the black, supporting demand for higher-yielding assets. Earlier, currencies down-under wobbled outright and against the yen on concern European policy makers will struggle to resolve a debt crisis and ahead of data that may show US consumer sentiment remained near its lowest in more than two-years. Technically, the currency has come too far too fast, and on the first go around, the AUD is picking up some strong support at these below parity levels, especially now that commodities have got a ‘leg up’.

Despite domestically having all the strong fundamentals, cash-futures are showing that traders are betting the RBA will lower its key rate by at least-75bp by the end of the year. Last week and for the first time in six-weeks, the AUD traded below parity as all commodity and interest rate sensitive currencies suffered outright. Data from Australia’s largest trading partner, China, indicates that manufacturing may contract for a third month in September is not helping the Aussie cause. If anything, the RBA is likely to be on hold for an extended time, allowing investors to sell higher yielding assets on rallies with the top side more contained (0.9873).

Crude is higher in the O/N session ($82.53 up+$2.39c). Oil prices rallied from last weeks lows amid speculation that the ECB may alleviate the region’s sovereign debt crisis, boosting growth and fuel demand.

Last week’s US inventory report was also bullish for the market. Commercial crude inventories decreased by -7.3m barrels from the previous week. Analysts expected a-700k barrel decline. At +339m barrels, oil supply’s are above the upper limit of the average range for this time of year. This drawdown has left stocks at the lowest level in nine-months and was the biggest drop since December. Refineries operated at +88.3% of capacity, up +1.3% points from the prior week. On the flip side, gas inventories increased by +3.3m barrels last week and are upper limit of the average range.

Weaker growth as shown by the IMF, which points to lower oil demand, and production in Libya is coming on stream faster than expected will have investors thinking of shorting the market again. Expect investors to run into technically selling on some of these rallies.

What has been happening with commodities is a game of margin clerks vs. the market, a game of money and not a game of fundamentals. Even before North Americans began trading yesterday, the yellow metal happened to lose $100, and under the same breath recapture that loss and then some. To try to apply supply and demand logic in a panicked market is near impossible. Last Friday’s dollar decline was the largest dollar selloff on record. Investors have been selling metals to cover losses in other assets, however, the pace of sales has reduced. Gold is one of the few assets that remain in positive territory this year and, because of this as investors head for cash, they sell the assets that have performed,

The dollar’s rally has cut demand for the metal as an alternative asset after the Fed said it will implement ‘Operation Twist’. The mass liquidation of commodities to raise funds for margin requirements of other assets has dissuaded the implementation of any safe heaven investment strategies for the time being.

In reality, the continued concerns over euro-zone sovereign debt is likely to drive gold higher in the longer term before policy makers are forced to take more effective action. The Fed’s efforts to drive interest rates lower to support lending should, by default, eventually support commodity prices. For now, liquidation for margin requirements takes precedence ($1,624 down-$24).

The Nikkei closed at 8,374 down-186. The DAX index in Europe was at 5,311 up+115; the FTSE (UK) currently is 5,070 up+4. The early call for the open of key US indices is higher. The US 10-year backed up+7bp yesterday (1.94%) and is little changed in the o/n session.

Record low yields took a breather yesterday as longer dated product’s prices dropped on the hope that Europe was finally stepping up to the plate and would be containing their debt crisis. Treasuries are trying to move to fair value after the strong rally last week on the back of Bernanke’s “Operation Twist” where long bond prices had their biggest gain in almost three years as investors sought refuge in US debt amid concern the global economy is on the brink of a deep recession.

The US Treasury Department will sell $35b 2’s this morning, $35b 5’s tomorrow and $29b 7’s on Wednesday. Assuming no further go-political issues, dealers will be expected to cheapen up the curve to take down supply.

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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