Dollar fights EURO ‘Hope’ Trade

Just cause its a roadmap for ‘stability and growth’ does not get us to the promised land. It’s only natural to want to take the foot off the gas, take a breather and access the risk reward of any move. Recent European policy statements and better than feared North Atlantic macro data encouraged investors to embrace risk appetite and short squeeze the market over the last two trading sessions. Now, the dollar is fighting back in an orderly manner, questioning whether policy makers are able to execute on their plans?

This market has come a long way too fast on ‘hope’ alone. What are the risk-reward trades at these elevated levels? There are dealers with deeper pockets that will use the current upswing in sentiment to position for possible disappointment on October 23. Someone eventually will put the ‘donkey in front of the cart’!

The start of yesterday’s EUR rally was fueled by rumors that the BoJ would do an SNB and implement a floor in USD/JPY. The SNB who has installed a EUR/CHF floor has the responsibility for monetary and FX policy. In Japan, the BoJ and MoF operate separately, making such a step more difficult. Over +70% of Swiss trade is in EUR, this is not the same for Japan, making it impracticable to implement a floor in USD/JPY. However, this is not dissuading Japanese exports from being on top, offering dollars again at 77.50.

The European session has seen most of this week’s volatile price action with little follow through in North-America. While other asset classes are rocking, currencies are flat lining, making it difficult to scrap together any profit to offset losses from the O/N moves. Let’s hope this is shortish trend!

The Fed’s September minutes happened to come and go without a fuss, yesterday. The meeting emphasized the ongoing debate about how monetary authorities can help support the struggling US economy. Fed counting revealed that two officials favored bolder action, something with a ‘twist’. While no indication of future moves, options were left on the table.Together it was déjà vu, again!

The dollar is higher against the EUR -0.29%, GBP -0.27%, CHF -0.31% and lower against JPY +0.53%. The commodity currencies are mixed this morning, CAD -0.33% and AUD +0.14%.

There was no way that the loonie was going to be left out in the cold. When risk is on and commodities are in demand, investors naturally look at higher yielding interest rate sensitive currencies like the AUD and CAD. The loonie rallied the most in more than two months outright as optimism that European officials will agree a plan to recapitalize the region’s banks sparked advances in higher-yielding assets.

Canadian data yesterday showed that the new-home price index rose for a fifth month in August, led by a gain in Toronto. The index advanced +0.1% matching the July increase. Most of the big risk move occurred in the European shift just on the hand over to the North American session, whose own session flat lined with little intraday interest. This move has been swift and probably over extended on the ‘hope’ idea. Little fundamentals or actual physical action has been able to move this market. Don’t be surprised if for no better reason than profit taking this market gives up as quickly as it gained.

The loonie, like any risk or interest rate sensitive currency, remains vulnerable to following the broader trends, especially what is transpiring in Europe on the verbal front. The market is a good buyer on dips, with strong corporate interest ahead of 1.0150 and down to parity (1.0224).

The AUD has maintained its week long rally and the only commodity currency to hold its O/N gains on the back of stronger domestic data, but not for long.This morning’s September employment increase was a positive surprise, but not a ‘strong’ number. Australian employment rose +20.4k, twice the monthly expectation of a +10k gain that was expected, and neatly reversing the previous two months of declines. This eased the unemployment rate lower to +5.2% from +5.3%, m/m, with the participation rate steady at +65.6%. Analysts note that this gain has kept this years trend stable, rather than a picture of growth. Futures dealers in response to the data print, pricing for a November rate cut fell-8bp to +19bp and a flattened bear curve.

It’s not a surprise to understand that the RBA is still being heavily dependent on how the crisis in Europe affects global growth over the next month. An increase in risk and RBA interest rate cuts again will be off the table and visa versa. However, similar to other growth and commodity sensitive currencies, the market bias prefers to be better sellers of the AUD on these rallies, until the panic flows have abated (1.0136).

Crude is lower in the O/N session ($84.47 down-$1.10c). Oil prices were not going to be left behind in this environment of ‘hope’. They rose for a six consecutive day yesterday on continuing hope that Europe’s leaders can fashion an agreement on the region’s debt woes and ahead of weekly oil inventory reports today. US crude stockpiles are expected to be up slightly, with products inventories slightly lower this morning. Prices were unable to get that ‘extra leg up’, similar to other commodities, after the IEA reduced estimates for world oil consumption by-210k barrels a day and said Libya would pump about +600k barrels a day by the end of 2011 once they get back online.

Last week’s EIA data reported US commercial crude inventories had decreased by -4.7m barrels from the previous week. At +336.3m barrels, oil inventories are above the upper limit of the average range for this time of year. Total motor gas inventories decreased by -1.1m barrels are above their upper limit of the average range. Analysts were expecting crude gain by +2.5m barrels and gas stocks to move up by +1.30m barrels last week. Oil refinery inputs averaged +15.1m barrels per day during the week, which were +73k barrels per day below the previous week’s average as refineries operated at +87.7% of their operable capacity.

The old support levels now become the new key resistance points. Weaker growth predicted by the IMF, which points to lower oil demand, will have dealers thinking of shorting the market again. Expect investors to run into technical selling on some of these rallies.

Gold rallied tentatively yesterday, dragged higher by a stronger EUR, resulting in the dollar sliding to a four-week low outright. The EUR happened to benefit from ‘hope’ that European authorities will successfully agree on a plan to solve the euro zone debt crisis. The roadmap for ‘stability and growth’ had investors in the Euro session willing to strap on risk.

After last months rout, investors remain very cautious about this trade. In the last two weeks, gold has had one of its “steepest corrections in history, weighed down by a sharp margin increase, the fourth hike this year and heavy liquidation by hedge funds in a technically overbought market”. Demand for ‘physical’ gold is again expected to support the market. Under normal conditions, the Indian festival season helps drive buying from the world’s biggest gold consumer. Retail gold demand traditionally gains pace from August.

Gold has moved in line with other commodities and assets seen as higher risk, like equities, in recent weeks, despite moving in an inverse relationship with them earlier in the year as buyers sought the metal as a haven from risk. In fundamental terms, gold is trying to find a balance between ‘between the two opposing forces’, a risk investment or a safe haven. The Fed’s efforts to drive interest rates lower to support lending should, by default, support commodity prices in theory. However, the fed is currently losing the “Operational Twist’ debate ($1,677 down-$5.40c).

The Nikkei closed at 8,823 up+84. The DAX index in Europe was at 5,946 down-49; the FTSE (UK) currently is 5,414 down-28. The early call for the open of key US indices is higher. The US 10-year backed up +5bp yesterday (2.25%) and has eased -4bp in the o/n session (+2.21%).

Treasuries fell, pushing 10-year yields to a one-month high, as the Treasury department prepared to sell +$66b in notes and bonds this week and on the back of global pessimism may tentatively be easing, as leaders seem to be to containing the Euro-region’s debt crisis. The market is encroaching on some strong resistance levels, with good buying interest reported at +2.25-30%.

Is the Fed’s stimulus driving investors into riskier assets, as it did after QE2? It seems to playing its part, along with the reversal in European sentiment. This means that if sentiment turns south any time soon, safe haven investing would be attractive at these levels. Losses by Treasuries may be limited as there’s still a chance US GDP will contract and because of Operation Twist. The Fed is expected to lower longer term rates and hopefully kick start growth again in a stagnant US economy. Analysts guesstimate for 10-year yields is around +1.50%. At these current levels it looks a tad strong.

Dealers own yesterday’s $21b 10-year auction (+58.5%), which tailed +3.1bp. With global equities in the black there was little appetite for US product. The issue had the smallest demand since last November and was offered at a yield of +2.271%. The bid-to-cover ratio was 2.86, compared to 3.17 for the previous eight sales. The indirect bid was +35%, versus the +48.8% average. There are buyers happy to buy on these pullbacks.

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