Dollar friendly as Risk loses its Bite

Risk sensitive currencies are on the defensive this morning. The EUR is failing to retain its upward momentum as the market eyes option related levels below. The antipodean currencies are underperforming amongst the majors after the RBA disappointed the rate market in the short term, even a decisive business friendly Conservative majority has the loonie on the back foot. The message is risk off for the time being.

Cable has been one of the biggest losers, falling to a six-day low on the back of April’s much weaker than expected UK manufacturing sector PMI (54.6 vs. 56.7), which ‘underpins the consensus expectations that the BoE will keep rates on hold at +0.5% later this week’. Even the futures market is beginning to price out ‘any’ hike this year.

The US$ is stronger in the O/N trading session. Currently, it is higher against 12 of the 16 most actively traded currencies in a ‘whippy’ session.

Forex heatmap

US manufacturing slowed last month (60.4), but not as much as expected (59.5). However, rising costs remain a problem (85.5). The ISM report contrasts the Fed’s regional surveys which show that manufacturing expanded in April. The data showed that despite performing above expectations thus far this year, manufactures continue to experience significant cost pressures from commodities.

Digging deeper, the main subindexes were mixed, with new-orders falling to 61.7 from 63.3, the inventory index climbing to 53.6 from 47.4 and the employment index remaining little changed at 62.7. The report was not quite as strong as the headline measure would suggest, but indicates a solid ‘ongoing’ expansion in the factory sector. Apart from a mildly troubling reading for manufacturers’ own inventories, the forward-looking components of the survey seem to support the continuation of growth in the months ahead.

The USD is higher against the EUR -0.19%, GBP -0.98%, CHF -0.06% and lower against JPY +0.20%. The commodity currencies are weaker this morning, CAD -0.02% and AUD -0.56%.

PM Harper got his majority with the NDP surprising at the expense of the Liberals. The loonie has underperformed against most of its major trading partners of late, except outright against the dollar. Similar to most other major currencies, it managed to print a new three-year high last week, on speculation that the Fed will trail the BoC in raising interest rates. The election is a CAD-positive result, with the probability that the loonie could revisit its multi-decade low (0.9059 in 2007) if the dollar negative sentiment persists over the next few months. Now that the event risk is out of the way there is interest to own more loonies on these dollar rallies (0.9520).

The RBA were not as hawkish as feared, but hawkish nonetheless. As expected, they left their rate policy on hold last night (+4.75%). The RBA statement was hawkish compared to the April release, but certainly caught the rate’s market on the back foot, who had pushed yields higher going into the meeting in the wake of higher than expected first quarter inflation.

Governor Stevens communiqué ran a balanced mix of downplaying first quarter inflation due to the floods, noting strength in the labor market and a pickup in corporate credit growth but weakness in household credit. However, he went on to say that ‘the marked decline in underlying inflation from the peak in 2008 has now run its course. While the rising exchange rate will be helping to hold down prices for some consumer products over the coming few quarters, over the longer term inflation can be expected to increase somewhat if economic conditions evolve broadly as expected.’ This would suggest that the exchange rate appreciation so far is not enough to keep inflation stable given the growth outlook.

Policy makers replaced the ‘stance of monetary policy remained appropriate,’ with ‘in future meetings, the Board will continue to assess carefully the evolving outlook for growth and inflation’, another nugget for possible rate hikes. Why add this warning now if you think it might only apply in 2012?

The AUD fell outright against the greenback for the fourth consecutive day on the back of some risk profit taking. The market is now pricing in a +52% chance that the RBA will raise its benchmark rate to +5% by October, down from +62% yesterday.

However, Australian 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 (1.0880).

Crude is much weaker in the O/N session ($112.75 -0.77c). If anything, the news of bin Laden’s death has only increased the volatility in the crude market. Initial reaction was dollar supportive and black-stuff negative, however, his death does not alter the facts that have pushed the buck to a three-year low against most of its major trading partners and does not end the geopolitical concerns in MENA. There were even market rumors yesterday, denied obviously, that the Israelis were amassing war planes at a US military base in Iraq for an attack on Iran. It was this alone that had crude nearly wiping out all of its initial losses.

Last weeks EIA report had inventories rising +6.16m barrels to +363.1m, the biggest one-week advance since July 2010. Crude imports rose +1.21m barrels to +9.23m. In contrast, gas inventories fell for the tenth consecutive week, -2.51m barrels to +205.59m, compared with expectations for a -1.1m drawdown. It’s worth noting that gas inventors fell in spite of domestic demand falling by -1.6% last month on a year over year basis. Finally, distillates (heating oil and diesel) dropped -1.81m barrels to +146.53m. Refinery utilization rose +0.2% to 82.7%. In reality, it looks like refiners have got to convert more of the oil into gas in the coming weeks.

The IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth. OPEC have stated that there is ‘no shortage of oil anywhere in the world’ even after supply curtailments in MENA. It’s all about the dollar’s inverse relationship with commodities. The market is back to the drawing board until we can break this volatile intraday range.

Gold have trimmed some of their bin Laden losses, unlike silver, keeping their bullish trend intact. The uncertain macro-economic and political environment continues to attract investors, 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. The precious metal has become the currency of choice as the dollar underperform against its G10 trading partners.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store-of-value ($1,547 -$9.40c).

The Nikkei closed at 10,004 up+154. The DAX index in Europe was at 7,488 down-39; the FTSE (UK) currently is 6,087 up+17. The early call for the open of key US indices is lower. The US 10-year eased 2bp yesterday (3.28%) and is little changed in the O/N session.

FI yields gave up all of their bin Laden gains with benchmark prices rallying close to their six-week high yesterday after US manufacturing grew at a slower pace than the previous month, reinforcing the concern that economic recovery will be gradual. This is very much in line with policy makers thinking and actions after last weeks rate decision. Also providing support was the Fed buying $7.24b worth of product due from May 2018 to February 2021 as part of their debt-buying program.

With the US economy losing some of its momentum and fears of a bin Laden reprisal is providing support on pull backs for the time being.

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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