Economics 101=the Roubini way!

Roubini said that the ‘chance of a double-dip recession is increasing because of risks related to exit strategies from global monetary and fiscal stimuli’. In an FT article penned by the man himself yesterday, he commented that ‘policy makers may undermine the recovery and tip their own economies back into stag-deflation’ (recession + deflation). This would only occur if taxes were hiked, spending cut and eliminating the excess liquidity to reduce their fiscal deficits. On the other hand, economies that maintain large budget deficits will do battle with the bond market. Inflation fears will warrant higher bond yields, eventually pushing the cost of capital higher. This will result in the first sucker-punch called ‘stagflation’. The knockout move could come from speculators pushing both food and energy prices way beyond their own fundamentals. It seems we have been there and done that already. Remember what Keynes said ‘the market can stay irrational much longer than one can stay solvent’.

The US$ is stronger in the O/N trading session. Currently it is higher against 11 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

Everything came to a head on Friday, tri-factor of events last week has managed to elevate investor moral to the point that they believe that we have seen the worst of this recession. US existing home sales managed to surprisingly advance last month (5.24m vs. 5.03m) and print the highest level in 2-years. The German service industries expanded this month for the 1st-time in a year, and the Japanese economy grew for the 1st-time in 5 Q’s. We are on a roll! Even with the ‘green shoots’ rooting, Bernanke and other global policy makers continue to apply caution. They indicated that the recovery is likely to be muted and would ‘not’ remove the entire stimulus packages that they have injected into the financial system.

The USD$ currently is higher against the EUR -0.24%, GBP -0.19%, CHF -0.38% and JPY -0.61%. The commodity currencies are mixed this morning, CAD -0.06% and AUD +0.21%. For the 1st time this month, the loonie managed to end last week on a winning note amid the resurgences of oil and equity prices. Both of theses asset classes, when positive, entice investors increase their risk profile and purchase higher yielding currencies like the loonie and the AUD. We have witnessed of late fundamental reports showing signs of recovery in Canada. Wholesale sales increased in June (+0.6%, the 1st-time in 9-months) and the index of leading economic indicators rose +0.4% last month (1st time in a year). Speculators have been betting that Canada was or is the true first to exit the recession. It was no wonder that Goldman put out a buy CAD recommendation last week. The BOC will not be happy, last month they predicted 4th Q growth, but the value of the currency was going to affect the ‘pace’ of it. If commodities remain elevated we are going to have a nervous Governor Carney again!

Temporarily at least, in the O/N session, the AUD managed to rise against both the USD and JPY, all on the back of stronger global economic data that has managed to push global equities higher and increased the demand for higher yielding assets. With growth being served at the table this will only continue to support the AUD on pull-backs (0.8401).

Crude is higher in the O/N session ($74.11 up +22c). Crude prices on Friday managed to print 10-month highs as global equities continued their advance on investors speculating that the worst of the recession is over. Stronger than expected US housing data along with Bernanke’s comments pushed crude prices +1.3% higher. This has resulted in a weaker greenback and boosting the appeal of commodities as an alternative investment. Technical analysts believe if we can make a concerted effort to trade through $74 level it will trigger more technical buying. Last weeks surprisingly poor inventory reports from both the API and EIA bodies will again come under close scrutiny this week to see if inventory levels warrant these elevated prices. The most coveted indicator, the EIA, showed that US inventories declined the most in more than a year as imports plummeted and refineries increased their operating rates. Currently, refineries are operating at 84% of capacity (up +0.5% from the week before). Inventories declined -8.4m barrels, w/w. The most eye-catching detail was that imports fell -15% to +8.53m barrels a day (the biggest drop and lowest rate in 11-months since the last hurricane season). We are now officially over the hump of the US driving season and just about to enter historically a weak demand month of Sept. Despite probably seeing the worst of the recession, global growth will remain very subdued. But remember it’s also the hurricane season! Not to be out-done, gold prices advanced the most in 4-weeks as the buck slid and increased the ‘yellow metal’s’ appeal as an alternative investment ($955).

The Nikkei closed at 10,581 up +342. The DAX index in Europe was at 5,493 up +31; the FTSE (UK) currently is 4,882 up +31. The early call for the open of key US indices is higher. The 10-year bonds backed up 12bp on Friday (3.56%) and are little changed in the O/N session. For a 2nd-consecutive week investors ended up not wanting bonds as most asset classes seem to be responding they way they should to stronger fundamentals. Of course stabilization in the US housing market coupled with Bernanke’s belief that the global economy is ‘beginning to emerge’ from the worst recession in 60-years will do this! Supply will again this week cheapen up the curve. The Treasury announced a total of +$109b of 2’s (+42b), 5’s (+39b) and 7’s (+28b) for this weeks funding requirements.

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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