EURO has nowhere to go but higher

Event risk will dominate the remainder of this trading week. The insurance premiums of the mid-term elections have been priced in. Now, it’s time to turn our focus to the remaining G8 Cbanks and the North American employment reports. Today’s FOMC announcement is expected to set the trading tone for the remainder of the year. Unless we are totally blindsided by Helicopter Ben (it’s rumored that he may hold a press conference directly after the FOMC release to explain all), capital markets focus could gravitate back towards the Euro-zone. The NFP is certainly a work in progress, but, we all know that the unemployment rate hovers close to +10%, so that’s not a game changer. The Irish situation is quickly heading towards an IMF bailout. Why not take the Fed’s lead? The Fed is expected to buy US treasuries to reduce interest rates, boost the economy and indirectly encourage weaker dollar holdings. In Europe we get the opposite effect as QE actions will only support the EUR. The biggest threat to the EUR is the risk of a breakup. When Trichet intervenes by buying Irish or Greek debt, it is EUR positive as it reduces solvency pressures. The currency has no way to go but up.

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

Forex heatmap

What can we expect from the Fed today? Consensus seems to have settled on an announcement of about $500b in purchases of longer-term US Treasury securities over the next six months. This could take the shape of a $100b per month for five to six months or perhaps it may be front loaded, either way, policy makers will make it clear that they are ready to extend these purchases if need be (LSAP-for longer-term securities purchases). Will this week’s stronger than anticipated Oct. ISM manufacturing affect today’s decision? It’s not expected to, any member with concerns will perhaps be more vocal during the meeting. Fed officials need US economic growth to perform for an ‘extended period’. One data point does not make a trend. The agreed amount will be along with the MBS reinvestment program (to remain unchanged). It’s worth noting that the Open Market desk reinvests $20-$30b each month in repayments of principal on the agency securities and the MBS’s that it bought over the past two years. Analyst’s note that they are reinvesting in Treasuries and do not see a need for change. The main advantage is probably for liquidity purposes. FI traders expect the Fed to go further out the curve. During QE1, Ben concentrated on the 2-10-year sector and potentially using the new LASP approach will require investing in duration. It’s expected that the FOMC will strengthen their rate commitment language. This will require them to tinker with the expectation language and clarify that such expectations are ‘still unrealistic’. It would be a part of the general strategy to reduce longer-term rate expectations. The masses do not see any required changes to the copy that covers recent economic and inflation developments.

The USD$ is lower against the EUR +0.03%, GBP +0.14% and higher against the CHF -0.08% and JPY -0.01%. The loonie received support from all four corners of the globe yesterday as it begrudgingly heads towards party. The currency has rallied for a fourth consecutive day, the longest winning streak in four-months, as commodities advanced and on speculation that helicopter Ben will step up QE. The loonie, along with other commodity growth sensitive currencies, have enjoyed the strongest gains vs. the dollar over the past five trading days. Speculation that Prime Minister Harper would not block a foreign takeover of Potash (fertilizer producer-by BHP Billiton) has investors keen on buying CAD on any greenback rally, as they bet that the takeover price will be increased. In reality, real money is and has been diversified ahead of the FOMC announcement. Only event risk will reverse some of these positions. Technically, the loonie has been caught in ‘the dollar debasing jet-stream’. Canadian data highlights this week see the Oct. Ivey PMI tomorrow and the employment release on Friday.

The AUD has temporarily come under pressure this morning after a sharp fall in building approvals O/N (-6.6% vs. +0.5%), a day after registering a twenty-seven year high when the RBA surprisingly hiked rates just as Japan and the US consider additional monetary stimulus, which could increase the risk of an influx of capital into both Asian-Pacific countries that might ‘exacerbate inflation’. This was the first hike since May. Governor Stevens communique emphasized both the strength of the domestic economy and signs of recovery in its main trading partner, China. Specifically, the RBA pointed to a combination of higher wages, on the back of strong terms of trade gains, strong employment and improving credit growth in an economy with already limited spare capacity. Stevens believes this will keep domestic demand ‘potent’ medium-term and that inflation is likely to rise in the coming years. Importantly, the RBA said ‘this outlook, which is largely unchanged from the Bank’s earlier forecasts, assumes some tightening in monetary policy’. Analysts now expect the strength of the commodity sector will keep spare capacity tight and the RBA to continue hiking in 2011. They are done for this year. Fundamentals warrant the currency to eventually trade at a premium vs. the dollar in the medium term (0.9983).

Crude is higher in the O/N session ($84.17 +27c). Crude prices have continued their rally, reaching its highest level in three weeks, as the dollar weakens vs. the EUR on speculation that the Fed will need to spend more to boost the US economy. This weeks early gains occurred after stronger manufacturing data in China proved that domestic economic growth is withstanding cooling efforts by the government. The market is betting that a quantitative easing announcement will support that recovery, weaken the dollar again and support commodities. The danger is that speculators may be getting ahead of themselves. 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, 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 the price about.

Gold remains coveted on speculation that steps to support growth through QE and low interest rates will boost demand for precious metals as an alternative to some currencies. A negative move for the dollar was bound to affect the yellow metal’s price. Year-to-date, there has been a strong correlation between the two asset classes. With the greenback under pressure has boosted the appeal of the metal as an alternative investment. It’s the depth of the pull back that has been testing the underlying strength of the commodity. Last month, gold rose +3.7%, printing a new record high of $1,388.10 an ounce, as the dollar fell -2.2%. QE2 chatter dominates the market and there are two trains of thought, some argue that a measured move this afternoon 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. For most of this year speculators have sought an alternative investment strategy to the historical reserve currency. The market has been using the commodity as a proxy for a ‘third reservable currency’, the reason for the record highs. The debasing fears of the dollar, coupled with the sustainable growth issues of the US economy have had investors seeking protection in an asset with a ‘store of value’. All eyes are now on Ben ($1,354 -$2.70).

The Nikkei closed at 9,159 up +5. The DAX index in Europe was at 6,655 up +1; the FTSE (UK) currently is 5,752 -5. The early call for the open of key US indices is lower. US 10-years eased 2bp yesterday (2.59%) and are little changed in the O/N session. Treasury prices remain supported ahead of the FOMC announcement this afternoon. The market certainly is on tender hooks after stronger than expected manufacturing data this week. The PMI expanded faster than forecasted last month and has dampened speculation somewhat that helicopter Ben will step up debt purchases to boost the economy. With the US economy showing signs of stability, the market should expect further position adjustments ahead of the Fed’s announcement this afternoon.

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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