EUR ‘toppish’ ahead of EFSF ratification

Euro leaders will gather at the end of this week to conclude the ratification of the EFSF program that they agreed in principle a few weeks back. The market seems to have already priced in a successful decision with the EUR trading north of 1.41 and sovereign spreads stabilizing. Consensus believes that Euro-leaders will succeed in the end in ‘hashing out an agreement’ that allows for a larger EFSF and financing assistance for Portugal.

However, a week is a long time in politics, with leaders continuing to stake out negotiating positions, like Prime Minister Kenny from Ireland. The Irish continue to have a quarrel with conditions on their bail out and expect them to provide a period of anxiety over the coming days, putting pressure on the EUR more likely than further optimism and advance.

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 ‘volatile’ session.

Forex heatmap

Last weeks coordinated G7 Bank intervention seems to behaving an effect. Risk appetite is mildly higher this morning after an apparent stabilization in the Japanese nuclear crisis over the weekend.

Despite the ongoing turmoil in Libya and higher oil prices, investors seem confident enough to ‘bet’ on riskier assets first thing this week and move some of their positions out of the safe-heaven bets applied earlier in the month.

Markets remain on alert for subsequent rounds of intervention in JPY, with the BoJ potentially following up Friday’s concerted G7 effort with solo buying of dollars to ensure the currency pair remains above 80.

The USD is higher against the EUR -0.18%, CHF -0.52% and JPY -0.73% and lower against GBP +0.07%. The commodity currencies are stronger this morning, CAD +0.39% and AUD +0.77%.

On Friday, the CAD happened to pare some of its first weekly loss in over a month after G7 members intervened in the FX market to stabilize the yen. The currency’s recent moves are oblivious to stronger domestic fundamentals. Last week, the loonie lost the most in four months against its largest trading partner after Japan’s earthquake and Middle-East geopolitical events damped investor appetite for higher-yielding currencies. This week seems to be starting off on the other foot with investor’s risk appetite found wanting again.

Until now it had been a wait-and-see situation to see what comes out of Japan and whether the market has the tolerance for taking on more risk. Positive developments with Japans nuclear reactors is improving markets risk appetite. Tomorrow we have Canadian Retail Sales, and the market expects sales to have risen +1% month-over-month in January. On Friday, Core inflation data surprisingly eased in February, advancing +0.9% from a year earlier, after a +1.4% gain in January.
With risk aversion trading dominating strategies, had investors heading to the sidelines like most growth sensitive currencies. Close to parity, CAD buying interest is expected to appear again. Logically, there should be a strong demand for the currency because of its fundamentals, however in this ‘fight or flight’ trading environment, logic is mostly ignored. Expect the depth of the backup to be dictated eventually by cross-action.

These dollar rallies provide an opportunity to want to own some of the commodity and growth sensitive currency that is supported by stronger fundamentals and a sound fiscal position (0.9797).

Despite being one of the biggest currency losers last week, falling to its lowest level vs. JPY in four months, the AUD has whipped back and found favor amongst investors again. The AUD rose in the O/N session as Japanese workers made progress in getting the reactors at the nuclear power plant under control, thus giving investors confidence to buy higher-yielding assets again. The threat of further intervention by G7 members to weaken the yen again is also providing support.

The currency has extended its gains with Asian Bourses seeing black and on the back of higher commodity prices. The AUD advanced against all its major trading partners as traders cut bets that the RBA would be forced to ease rates at its next policy meeting. The market is pricing in a 13% chance that Governor Stevens will reduce borrowing costs in April, down from as much as 34% last week.

By day’s end, its all about what happens at the Fukushima nuclear plant and how the G7 members will attempt to calm the markets (1.0036)

Crude is higher in the O/N session ($102.61 +$1.54c). Big picture, oil prices remain volatile, torn between the pressure of Japan’s demand loss and the Middle-East tensions. Any uncertainty adds a premium and this despite technical analysts believing that the commodity has the potential to print $92 in the short term after registering a 29-month high earlier this month.

The turmoil in Bahrain and Libya has been providing the market with enough support to withstand the global equities slump and the nuclear concerns in Japan. Prices have also got a boost from a smaller-than-expected increase in last weeks US inventory report. Crude inventories rose +1.7m barrels last week, less than the +2.1m barrels expected. Gas supplies fared no better, declining -4.2m barrels, vs. expectations of a decline of -1.5m. Stocks of distillates (heating oil and diesel) decreased -2.6m vs. a drawdown of +1.4m barrels.

Over the past fortnight we have witnessed Middle-East potential supply constraints being cancelled out by the worlds third largest economy short term lack of demand. Japan has closed 29% of their domestic refining capacity. This has affected about +1.3m barrels of the country’s total of +4.52m barrels per day of capacity. With future consumption questionable, demand from the region is expected to remain soft in the short term.

On deeper pull backs the Middle east and North African situation will continue to dominate.

Gold remains better bid. The market believes that the recent price plummet was a ‘tad’ overdone. Investor demand the commodity as an alternative to volatile currencies. After making back all of its early losses last week, the commodity’s bull run is far from over with investors continuing to look to buy the metal on dips. This asset class has been a profitable lemming trade this year. These price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets.

Big picture, commodity prices are being supported by geopolitical factors and inflation threats. Even hawkish global rhetoric has managed to support higher commodity prices. Before last week’s unfortunate events, consumer prices were also boosting the demand for the precious metal as a hedge against global inflation. Recent data reveals that Chinese’s inflation has accelerated the most in six years, and UK consumer prices the most in two years. Even US data is showing that their inflation numbers are edging higher. With the commodity being used as a store of value, the asset class is expected to remain better bid on deep pullbacks. The metal has climbed +26% in the past year ($1,426 +$10.10c).

The Nikkei closed at 9,206 up+244. The DAX index in Europe was at 6,825 up+161; the FTSE (UK) currently is 5,789 up+71. The early call for the open of key US indices is higher. The US 10-year eased 3bp on Friday (3.26%) and backed up 5bp in the O/N session (3.32%).

Ten-year notes pushed yields to their lowest level in a year last week as risk aversion trading strategies intensified as Japan’s nuclear crisis and Libyan political turmoil encouraged demand for the safety of US government debt.

Yields on two-year notes dropped for a fifth consecutive week as a surge in the yen following Japan’s earthquake led G7 nations to intervene in currency markets. The Fed said the US recovery is gaining strength will eventually lead investors to pressurize the prices further out the curve. Investors have been speculating that Japanese insurers will need to sell the longer dated maturities to pay claims for damage.

The BOJ efforts to provide more liquidity and expand an asset-purchase program have thus far halted the sale of global equities by risk avers investors. With this risk aversion momentum easing, ten-year yields are in danger of snapping back towards their medium term highs north of 3.40%. Investors can expect geopolitical and event risk in the Middle-East to continue to support FI gains in spite of stronger economic data.

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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