Correction or Reversal? Perhaps NFP can tell

The fall in commodity prices ‘is good news and should help consolidate economic recovery’. However, the violent rebalancing act has the market showing few signs of even a tentative recovery, apart from the AUD supported by a hawkish RBA O/N, ahead of the employment numbers.

Has this flush out got stamina? Big picture, Chinese data has been moderate, tightening seems to be working, perhaps we should be worrying. Maybe it’s more than a correction and the beginning of a full scale reversal. Yesterday was the perfect storm for risk trades ‘characterized by position correlation between stocks, commodities and the EUR’ where investors held over extended long positions. This correction has been painful for many, but if its a reversal much more pain must be endured. Perhaps this morning NFP will be that trigger?

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘whippy’ session.

Forex heatmap

Yesterday’s US weekly initial claims jumped to +474k, up from the previous weeks +431k. The weak data combined with Trichet’s communiqué stating that authorities were ‘closely monitoring’ prices, a disappointing statement for a market that was hoping that he would use his hawkish code word ‘vigilance’ to signal a rate hike certainly threw the cat amongst the pigeons in the currency market.

The Labor department tried to explain away some of the blip to temporary layoffs of school support staff, an extended benefits program that spurred a number of re-filings, and auto-sector shutdowns caused by parts shortages due to the Japanese earthquake. Now that we have seen four consecutive upswings, the underlying trend has deteriorated. Digging deeper, continuing claims climbed to +3.733m. As long as the headline number stays above +400k, this would imply a slower recovery than the Fed would like.
Finally, the first quarter productivity estimates contained few surprises. Non-farm productivity rose at a +1.6% rate in the first quarter, beating the streets estimate of +1.1%. The preliminary estimate of hourly compensation (+2.7%) was half-a-percentage point higher, boosting the estimated growth rate of unit-labor costs to +1.0% versus a decline of 1.0% in the fourth quarter.

The USD is higher against the EUR -0.07%, GBP -0.01%, CHF -0.23% and JPY -0.34%. The commodity currencies are stronger this morning, CAD +0.15% and AUD +1.1%.

The loonie has continued to keep up the broad selling of risk assets in the O/N session, albeit in much smaller quantities than yesterday, as oil trades considerably lower and with investors being nervous to take on much risk ahead of the employment numbers this morning. Yesterday, the Ivey PMI came out at 57.8, unadjusted 57.7, plummeting from 73.3 last month, has also added to the ‘risk off’ tone in the market. Lost in the shuffle was March’s building permits, coming in much stronger than expected, with a massive +17.2% increase after a strong +9.8% gain in February. The rumors that Soros was exiting his commodity trades have triggered stop-losses in most growth and commodity sensitive currencies. With corporate CAD buying interest not appearing until above 0.97, the loonie is at the mercy of innuendos until today’s North American employment reports. The market expects a strong rebound from last month’s Canadian negative release (+15k vs. -1.5k) (0.9650).

The AUD strength dominated an otherwise range-trading Asian session as markets consolidated ahead of the NFP data this morning. The currency has rebounded just over +1% from its lows yesterday as the RBA sounded ‘surprisingly’ hawkish in its Statement of Monetary Policy. The hawkish Statement came in well above market expectations of forecasts remaining unchanged. Governor Stevens is signaling that ‘current mildly restrictive monetary policy is not enough to contain inflation pressures in the pipeline’. Furthermore, the RBA is indicating that market pricing of one hike over the next year is not enough. Underlying inflation is now expected to be above its 2-3% target band by the end 2013.

Aussie yields are still the highest in the G10 and do look attractive. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on pullbacks for the time being (1.0680).

Crude is weaker in the O/N session ($97.48 -$2.32c). Oil prices have plummeted, extending its four day dive and breaking all sorts of support levels as weaker US data boosted concerns that economic growth and fuel demand will decline in the biggest crude-consuming country. The commodity has retreated +12% this week.

Not helping the black-stuff is this week’s inventory numbers, which were much more bearish than expected. The weekly EIA report showed crude stocks rising +3.4m greater than the +2m barrel build expected by the street, signaling less demand from refiners. On the flip side, gas stockpiles fell-1m barrels, while inventories of distillates (heating oil and diesel), fell -1.4m. Analysts had expected that gas stocks would rise +100k barrels. They were looking for distillate stocks to climb +400k.Gas consumption dropped -2.2% to +8.94m barrels a day last week.

The IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are denting demand growth. So, the drop-off in demand combined, with the overall retreat in commodities, and a rising dollar is a forcing this drastic easing of oil prices. Will commodities get a reprieve from today’s employment numbers?

Gold prices have been dragged lower by the liquidating of silver position after the CME hiked initial margin requirements for the third time earlier this week and on reports that a Soros fund was exiting its commodity trade. Until now, the uncertain macro-economic and political environment has encouraged investors to own the yellow metal, as does the continuing weakening of the dollar on the back of US policy makers being slow to tighten their monetary policy.

Gold, as a non-yielding asset, has a higher opportunity cost when interest rates rise. Big picture, the precious metal has become the currency of choice with the dollar underperforming against its G10 trading partners.

The metals bull-run is far from over with speculators continuing to look to buy the commodity on these deep pullbacks, however, with inflation expectations dipping in the past few days has the weaker ‘long’s’ on the back foot and second guessing their outright positions ($1,484 +$3.40c).

The Nikkei closed at 9,859 down-145. The DAX index in Europe was at 7,397 up+21; the FTSE (UK) currently is 5,891 down-29. The early call for the open of key US indices is higher. The US 10-year eased 5bp yesterday (3.16%) and is little changed in the O/N session.

Treasuries rose, pushing 10-year note yields to a six-week low, as investors speculate that a weakening economic recovery will cool inflation, boosting demand for safer and more conservative assets. With initial weekly jobless claims unexpectedly rising yesterday and a lower than expected ADP report midweek has dealers cautious about this morning NFP release. With investors pushing inflation expectations further away by their liquidation of commodity positions has the FI market better bid on pull back in the short term.

Next week the US treasury plans to sell $72b of long-term debt. They will auction $32b-3’s, $24b-10’s and $16b long-bonds. At the moment they certainly appear rich on the curve.

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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