‘Shock and Awe to Shucks and Oh’ in two days

The market will talk this up as being the biggest week ever for all asset classes. Copious CBank meetings, mid-term elections and extremely influential data will provide the ingredients for volatility. The jewel in the crown will be the two day FOMC meeting, where the market expects helicopter Ben to announce further QE spending. The problem is that no one knows how much, and Ben, himself, was looking for some ideas last week when he supposedly sent out a survey to FI dealers seeking their opinions. Watching the price action in both FX and FI, one gets the feeling that the market is happily pricing in a large repurchasing program. Do not be surprised to see some of that bullish theory being pared back today.

The US$ is mixed in the O/N trading session. Currently it is higher against 9 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

On Friday, the US economy advanced at an annual pace of +2.0%, q/q, and came in bang on expectations. It marks the fifth consecutive quarter of expansion. However, some of the underlying details emphasize softer growth, like the larger inventory contribution, which analysts believe could provide downside risks for 4th Q GDP. The data in no shape or form should influence policy makers over the next couple of days. To them, they will be focusing mostly on fiscal policy uncertainty. Digging deeper, the mix of growth was weaker, with final domestic demand posting growth of +2.5%, down from +4.3% in the previous quarter. The biggest decliners were net exports (-2.0%) and residential fixed investment (-0.8%). Exports contributed +0.6% to overall growth, while imports took that and more away. It was mostly inventories that dominated the headline, adding +1.44% to the print and remains notably blow the +2.6 to +2.8% growth levels that we witnessed in the early phase of the US recovery. Finally, prices continued to move up, but registered their second straight quarter of decelerating growth (+0.8%). Bring on QE2.

The USD$ is lower against the EUR +0.30%, GBP +0.01% and higher against CHF -0.28% and JPY -0.05%. On Friday, the Canadian growth rate for Aug. came in as expected (+0.3%), with all the subcategories again putting in a solid performance for the month. Analysts note that the release will in no way influence Governor Carney at the BOC. Policy makers remain focused on the downside risks of the US economy. The Canadian economy continues to be shackled to its largest trading partner, the US, and the very reason why the BOC have prudently stepped to the sidelines. The loonie has been caught in a dollar debasing jet-stream for most of last week. Over the past month, the CAD has been one of the worst performers vs. the buck, despite all the negativity surrounding the greenback. Last week Governor Carney stood down on hiking rates as expected, citing a softer outlook for the Canadian economy. Futures prices have priced in a ‘no-hike’ for the next six-months despite policy makers continuing to see the risk to the inflation outlook as being balanced. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way.

The AUD has held investor support for a third consecutive day on speculation that the region will maintain its interest-rate premium as the US and Japan debate further monetary-easing measures this week. Inflation data down-under last week disappointed hawkish speculators. Australian CPI rose +2.8% in the third quarter from a year earlier, after increasing at a +3.1% pace in the previous three month. The market was expecting a rate of around +2.9%. Futures traders have pared their bets from a +47% chance that the RBA would hike to a +16% chance this evening. It’s now expected that any rate increase ‘will be only gradual’. With such a benign rate outlook, the market was betting that the currency would ‘struggle in extending its gains far above parity’ in the medium term. However, the currency has gotten a boost from the price of commodities and the weaker dollar of late. With these variables remaining intact the market can expect another attempt at parity (0.9900).

Crude is higher in the O/N session ($81.95 +52c). Crude prices fell on Friday after a weaker than expected US consumer sentiment print, the ending of a French Port oil strike and the reluctance of the markets to make any major moves ahead of the FOMC meeting. Even with supplies growing, it’s the dollars direction that dominates the black-stuffs prices. Last week’s EIA report again blindsided the market to a certain extent, although the direction was not surprising the volume headline print was. The release was greater than five times analyst’s expectations. Crude climbed +5.01m barrels to +366.2m last week, the biggest increase in four-months. The market had only priced in a +1m barrel gain. Offsetting the reported surplus was the plunge in gas stocks, falling -4.39m barrels to +214.9m. Analysts were estimating an increase of +625k barrels. The net effect was a zero-sum report. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. The ‘big’ dollars value continues to push prices about.

Gold again rallied, recording its third straight monthly gain, on speculation that Ben and his fellow policy makers will increase their debt purchase numbers, weakening the ‘mighty buck’ and boosting the commodity’s appeal as an alternative investment. Gold, month-to-date was up +3.1%, while the dollar index recorded a loss of -1.9%. There are two trains of thought dominating the market at the moment, some argue that a measured move this week may have a muted affect on the dollar, while others suggest that further easing would weaken the dollar irrespective of the size as investors chase higher yielding assets in other countries. The dollars negative correlation relationship remains intact with commodity prices. For most of this year investors have sought an alternative investment strategy to the historical reserve currency. Investors have been using the commodity as a proxy for a ‘third reservable currency’, pushing the metal to record new record highs. To date, gold has outperformed global equities and treasuries (+22.7%), prompting record investment in gold-backed exchange-traded products. The debasing issues of the dollar, coupled with the sustainable growth issues of the US economy have investors generally seeking protection in an asset with a ‘store of value’. Everyone is now focused on the FOMC meeting ($1,362 +$5.10).

The Nikkei closed at 9,154 down -48. The DAX index in Europe was at 6,665 up +64; the FTSE (UK) currently is 5,719 +45. The early call for the open of key US indices is higher. The US 10-eased 2bp on Friday (2.60%) and is little changed in the O/N session. Longer maturities were better bid after the Fed’s preferred inflation measure, core-GDP price gauge, increased less than forecasted (+0.8%) and adds to speculation that helicopter Ben will boost purchases of longer-term assets. Fundamentally, the US continues to experience softer-than-expected inflation data, and it’s this data that will trigger whether or not the Fed does QE. So, it’s back to speculating on the buy back numbers again.

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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