FED Hawk trumps Trichet

Which hawk can shout the loudest? It seems that investors are comfortable pushing European debt problems to the back burner and accept Trichet’s anti-inflationary drum beating. The market is confidently pricing in higher rates by the ECB next week. There will certainly be a few red faces at the ECB if they don’t. The EUR’s bid remains the weak side. This morning, Fed Bullard’s hawkish comments that ‘normalization cannot wait for all uncertainties to fade’ has proved that.

Today, data risk is minimal and geopolitical risk is no better or worse, so are we settling into a pre-payroll mode a little earlier than usual? These contained ranges agree. Fridays action will be fascinating if NFP delivers the ‘knock outs’ punch. Stronger data will have the remaining QE2 program wanting to be justified, put the equity market on its back legs and require some of those massive dollar shorts to be covered. That would be the logical approach, however, these market movements seem not to require logic.

The US$ is mixed in the O/N trading session. Currently, it is higher against 10 of the 16 most actively traded currencies in a somewhat ‘subdued’ session.

Forex heatmap

Do not be fooled by the US consumers contribution to the first quarter GDP yesterday. Overall, it was weak (+0.3%). Despite nominal consumer spending being a tad stronger than expected for the quarter, in inflation-adjusted terms consumer spending is putting in a weak performance. If we assume a flat March, then in inflation adjusted terms, spending will only be +0.3%, q/q. That’s very different from the +1% rise in the fourth quarter last year. The Fed will be getting worried that their ‘go-to’ variable, the consumer, is in danger of striking out.

Digging deeper, analysts note that nondurables spending was the big supporter (+3.9%, m/m), while durable spending fell (-1.4%), and remains entrenched in a downward trend. This is in contrast to service spending, which rose +1.3%, driven mostly by price effects.

Because non-inflation adjusted spending grew faster than incomes, the saving rate moderated to +5.8% from 6.1%. In real terms, real personal income ex-government transfers were up +0.4%, while real personal disposable income was down -0.1% (first decline in seven-months).  

Importantly, inflation remains subdued. The core-deflator (ex-food and energy) came in +0.17%, m/m, and well below the Fed’s target rate of +2.0%.  Headline consumer prices (ex-food and energy) rose +0.45%, its third-straight month of gains. In hindsight, the knock on effect of higher commodity prices is not being filtered into consumer prices just yet. No one seems to be mentioning deflation.

The market welcomes positive surprises and we saw that in US pending home sales. After two-months of retreat, pending home sales posted an unexpected gain of +2.1% last month. Despite beating consensus, this one positive month has failed to reverse any of January’s (-2.8%) or December’s decline (-3.2%). The market should expect to see further positive results from the weather depressed February print going forward. Imagine if a pick up in hiring was sustainable, where would the trend be then?

The USD is weaker against the EUR +0.30%, GBP +0.14% and higher against the JPY -0.01% and CHF -0.01. The commodity currencies are stronger this morning, CAD +0.29% and AUD +0.03%.

The loonie only knows one direction when global risk sentiment increases and commodity prices remain elevated, and that’s higher outright. Despite a Canadian government being toppled last week, the ‘hawkish’ tone from Governor Carney over the weekend about how the elevation in commodity prices generally leads to higher interest has given the loonie its bid tone again.

Investors should expect this political uncertainty to have a limited affect on the Canadian dollars strength. The currency will be supported in the long term by its fundamentals, a sound financial system and a strong job environment.

The market continues to focus on the global ‘big picture’. With stronger data from its largest trading partner and global hawkish rhetoric ahead of inflation will in the end benefit the CAD. Its longer term support will continue to come from commodities and increased risk tolerance.

These dollar rallies are providing an opportunity to want to own some of the commodity and growth sensitive currency (0.9751).

The AUD is again trying to march towards its 1983 float benchmark high (1.0316), as demand for the Aussie on these pullbacks is being boosted by expected government reports this week likely to signal a strengthening in the domestic economy. The currency failed on its last attempt, at the end of last week, on speculation that the Fed will end its bond-buying program, raising prospects the supply of dollars will eventually fall.

The currency has been supported by investors pricing out the possibility of a rate cut and pricing in the chance of a rate hike again next month. The probability of a reduction in Australia’s benchmark interest rate on April 5 is 13%, down from as much as 34% last week.

Appetite for growth and commodity sensitive currencies depends on the new found stamina of risk tolerance by investors. Further appreciation depends on investor’s interpretation of global future interest rates (1.0238).

Crude is lower in the O/N session ($103.38 -0.60c). Crude prices softened a tad on news that Libyan rebels have retaken some key oil towns and oil-export terminals. Also providing some price reprieve is Qatar agreeing to market crude produced from fields no longer under Gaddafi’s control.

Expect the market to remain skeptical about how soon things will return to normal because of the damage to these facilities. Libya has seen its oil exports cut off due to the month long rebellion and Western sanctions.

Market participants continue to worry about contagion, a concern that will provide a bid again at any moment. Recent events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region near term.

Crude has been able to hold onto some of its recent gains despite last weeks EIA inventories reporting the expected supply increases. Stocks of crude rose +2.1m barrels, right on estimates. Unlike gas, whose stockpiles declined -5.3m barrels versus a market drawdown of only-2m. Distillates (heating oil and diesel) were flat for the week. Analysts had anticipated a decline of -1.5m barrels.

On deeper pull backs the Middle East and North African situation will continue to dominate for now.

Gold has fallen on bets that the recent rally to a record was overdone. Commodity prices have found it difficult to create any follow through. Stronger than expected US economic data is encouraging investors to book profits after the aggressive run-up in prices earlier last week.

There are a couple of reasons that have pushed the yellow metal into uncharted territory, unrest in Libya and the Middle-East coupled with Europe’s lingering periphery debt crisis have boosted the demand for the precious metal as an alternative investment. With so much global uncertainty it’s difficult to find a reason not to own some of the commodity in your portfolio.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. These price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets and push for those new record highs.

Even hawkish global rhetoric has managed to support higher commodity prices. With the commodity being used as a store of value, the asset class is expected to remain better bid on deep pullbacks ($1,418.30 down-$3).

The Nikkei closed at 9,459 down-19. The DAX index in Europe was at 6,915 down-22; the FTSE (UK) currently is 5,902 down-2. The early call for the open of key US indices is higher. The US 10-year eased 2bp yesterday (3.45%) and is little changed in the O/N session.

Investors temporarily stopped the yield bleeding and bought product along the US curve, attracted by bonds whose yield fluttered close to their monthly highs ahead of the auctions this week.

Some of the price rebound can be attributed to bond investors believing that elevated oil prices will eventually temper economic growth. They are also speculating that recent G7 intervention (selling of yen) has members buying US debt with the proceeds this week.

Yesterday’s $35b two-year auction was not well received and came with a 1bp tail. Non-dealers took 46% of the issue. The auction had a 3.1 bid-to-cover ration compared to a 3.52 six auction average. Indirect happened to take down 33% of the issue.

In total this week the US government will offer $99b’s worth of product, today we get $35b five’s and tomorrow we finish with the $29b seven-year note sale.

Investors can expect geopolitical and event risk in the Middle-East and North Africa to continue to support FI on much deeper pull back.

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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