What’s the FED to do?

It seems that any scrap of market confidence is met with a low blow from the extreme. Papandreou’s Government has blindsided the financial markets by calling a referendum on a supposedly agreed upon financial plan. The risk is that rejection by a referendum would spark a disorderly default and call into doubt Greece’s membership of the Euro.

Investors left October where a combination of better-than-expected US and Chinese data, rising hope of easing by several major central banks, and developments emerging from European authorities, helped to lifted risk appetite from a deep ‘panic’ region. One press conference too many and Papandreou is giving the market a license to sell the regions currency on rallies.  

Today investors will get more guidance from the Fed. Collectively, analysts seem to agree that policy makers are moving towards making future policy decisions more contingent on the progress towards its inflation and employment objectives and may signal accordingly in today’s policy statement. It seems to be agreed that its a tad early for authorities to let QE3 or even the notion of a new round of asset buying out of their tool bag. The buck should lose ground on the mention of it. A betting individual is leaning towards an unchanged statement, one that should again pressurize risk positions, benefitting the “dollar”.

The FOMC statement will be released at 16:30 GMT (12:30 EDT)

Forex heatmap

It’s difficult to believe that US data was reported during the market carnage yesterday. To a certain extent it was ignored as the rest of the world was preoccupied with the “Greek Tragedy”. Policy maker’s frantic phone calls and a Greek government that won’t back down took most of the shine off yesterday’s reporting.

The ISM manufacturing index dropped from 51.6 to 50.8 last month. It’s the second lowest reading since it last indicated contraction two years ago. Digging deeper, the decline was concentrated in the inventories index. The new order index happened to reenter expansionary territory (52.4 vs. 49.6) for the first time in a quarter. However, the inventories index plummeted to 46.7 from 52 (the lowest reading in thirteen-months). In the prices paid component, the index saw a large jump, falling 15 points to 41 (another “first negative reading in seven months).

The dollar is lower against the EUR +0.64%, GBP +0.43%, CHF +0.49% and JPY +0.37%. The commodity currencies are stronger this morning, CAD +0.59% and the AUD +0.59%.

The CAD was not going to disappoint the dollar bulls this time. The loonie had been out performing similar growth sensitive currencies in the previous session. However, the Greek’s surprise referendum decision quickly ended the CAD stellar action. Papandreou’s surprise announcement provided the reason for a shift out of riskier assets. The euphoria that was built up on the back of the agreement to restructure the EFSF began to unwind and is pushed the currency to test short term resistance points. The greenback has risen against all of its most-traded counterparts this week on demand for a ‘refuge in the world’s main reserve currency from European fiscal turmoil’.

Earlier, the Canadian Finance Minister stated that the BoC’s mandate will remain unchanged as the government prepared its five-year renewal of Governor Carney’s inflation target. The CAD, like other growth sensitive currencies, is trading under pressure as concerns that European leaders will struggle to rein in the region’s debt crisis, has eroded risk appetite. Last month, the currency rallied +5.4% outright, however, the BoJ’s intervening actions this week will be able to rock the currency’s recent climb some more.

With global sentiment again turning negative, coupled with the stress in the CDS market, will continue to pressure the long CAD positions and apply a firm cap on the four week loonie rally. Carney’s comments last week were very transparent. He is concerned about sustainable growth and the market will have to be cautious in trying to push the currency higher at speed. Corporate buyers remain below as dealers focus on the risk reward of owning the loonie at these levels (1.0172)

In the O/N session down-under, building approvals fell -13.6%, m/m, in September, the first decline in three months. The weakness in the Australian housing market supports the RBA’s move to ease policy to neutral. Early in the week the RBA cut rates (-25bp to +4.50%) and has moved to a more neutral policy stance. In Governor Stevens communiqué, the RBA concluded that a more neutral monetary policy stance would be appropriate to maintain growth now that inflation is likely to stay within its 2-3% target over the next two years. The RBA noted that while financial conditions have eased, overall conditions remain tighter than normal and the AUD is still at historically high levels.

The market is now estimating and pricing a neutral policy rate at around +4.0-4.5% and that the RBA is likely to cut by another-25bp in Q1 of next year. Futures dealers have priced in a market easing of about-88bp in total along the curve throughout this cycle. Currently that looks a tad rich, but hindsight is another matter. These cuts are likely to constrain and cap the Aussie. However, on the flip-side, better than expected data out of the US coupled with resilient growth from the Chinese economy will be supporting antipodean currencies. In this current environment, the market remains a better seller of the currency on rallies (1.0381).

Crude is higher in the O/N session ($92.81 up+0.62c). Oil prices are not immune to this commodity clean out. The very idea of Papandreou holding a referendum coupled with weaker growth data out of China is bound to affect the demand for the black-stuff. Futures intraday dropped as much as -4.3% yesterday after Greece decided to call a vote on its five-day-old ‘supposedly’ agreed upon Euro plan. Confidence and demand are the variables that support crude and so far this week both variables have again been called into question.

Last week’s EIA report showed that crude stockpiles rose +4.74m barrels to +337.6m vs. an expected build of +1.3m. Oil imports rose +1.45m barrels per day to +9.34m. On the flip side, gasoline stocks fell -1.35m barrels to +204.9m, slightly smaller than the -1.6m expected drawdown. The average gasoline demand in the last four-weeks fell -0.7% from a year ago. Distillates, which include heating oil and diesel, happened to fall -4.28m barrels to +145.4m. Analysts had been expecting a +1.9m barrel draw. The refinery utilization rate increased +1.7% points to +84.8% of capacity.

Japan intervened for the third time this year and pledged to keep selling the yen. Finance Minister Azumi said the move was carried out to combat ‘one-sided speculative moves that don’t reflect the economic fundamentals of our economy’. In the short term this is good enough reason for oil prices to remain capped. Market continues to sell the technical rallies.

Gold buckled under the pressure from the dollar yesterday after Greece blindsided the financial markets by calling a referendum on a supposedly agreed upon financial plan. In an illiquid market, and after Japan intervened earlier in the week to weaken its currency, has sent the greenback higher and other risk assets plummeting. The MoF and BoJ actions have just extended the recent “phase of consolidation” from last week’s short-covering surge that lifted the price to its highest level in more than a month. In relative terms, the commodity has traded rather tamely since Septembers purge mainly for margin cash requirements.

Despite the dollar being one of the major beneficiaries due to growth and global uncertainty, investor’s interest in the yellow metal has continued to pick up this week, as reflected by the inflows of metal into ETF’s according to analysts. In the O/N session the yellow metal has been capable of clawing some of this weeks losses.

Investors have been using the commodity as a safe-haven alternative to equities or FX. Individuals seem to want to insulate themselves from steeper price falls. The bullion is in its eleventh-year of a bull market and is up +19% this year.

Bigger picture, the commodity has also found support on concern that US monetary policy aimed at shoring up growth will eventually spur inflation. The FOMC statement is released later this afternoon. With global sentiment in the fragile category, gold remains the go to “safer-haven” prospect. If we include the demand for ‘physical’ gold from India, then both of these reasons should provide the strongest tangible support to want to own some on these pullbacks ($1,733 up+$22.80).

The Nikkei closed at 8,640 down-195. The DAX index in Europe was at 5,910 up+76; the FTSE (UK) currently is 5,451 up+30. The early call for the open of key US indices is higher. The US 10-year eased-13bp yesterday (+2.07%) and is little changed in the O/N session.

Treasuries again have rallied, extending the longest winning streak in two-years, as renewed concern Greece will default and the European rescue plan will unravel boosted demand for a safer asset class. It is the third consecutive day for the FI asset class to rally, shaving close to-42bp off the benchmark 10-year. Greek Prime Minister Papandreou has called for a referendum and a parliamentary confidence vote. He is risking pushing the country into default if rejected by voters.

The debt market has found further support from global equities plummeting over the last two sessions on growth worries from China. Later today, the market gets to hear from the FOMC and policy makers’ stance on perhaps QE3. With the Euro euphoria not being a solution and the possibility of contagion potentially appearing on the horizon will have product better bid on pullbacks. With reported US domestic data underwhelming has investors wishing to err on the side of caution.

Earlier this week, dealers have been front running the theory that with Japan intervening, because of an overvalued domestic currency, will be expected to translate into official buying in the Treasury market.

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