Feds growth concerns fuel market fears

Bernanke hit the nail on the head yesterday when he said that ‘markets are less supportive of growth’. Looking for instance at this month’s US housing data, it’s proposing a second ‘double-dip’. European Governments it seems want to follow the path of fiscal conservatism by slashing spending and hiking taxes. In theory, cutting off the air supply allowing whatever growth to suffocate. Japan did this two decades ago, ‘raising consumption tax in the middle of a recession and then successfully turned it into a multi-decade depression’. Now that China has taken the political heat off itself ahead of the G20 in Toronto by its ‘quasi’ revaluation of the Renminbi, expect the newly politically correct fiscal conservatives from Europe butt heads with the US’s government spending and ‘lesser’ taxes brigade.

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’ trading range.

Forex heatmap

It was to be expected after other miserable housing data had been reported already this week, but the weak headline print took the market by surprise. Yesterday’s US New Home Sales fell last month to the lowest level on record after a tax credit expired (+300k vs. +424k). Again it proves that the market continues to depend on government incentives. Sales collapsed -33%, m/m, with previous months prints also revised downwards. The reality is that ‘the pool of home buyers is becoming smaller and smaller as more home owners find that they are technically ‘underwater’ on their mortgages’. This has many owing more than their ‘homes’ are worth and thus are unwilling or unable to sell before they can buy. This is the new reality and an ongoing vicious circle.

The main event of the day was a snooze. Universally accepted, apart from Kansas City Fed President Hoenig (the lone dissenter), the FOMC kept the funds rate unchanged within the zero to 25bp range, where it has been the past 18-months. Also, they did not change the sentence committing itself to keep this rate ‘exceptionally low for an extended period’. However, they decided to make several changes to the ‘growth’ paragraph. Analysts concur that it represents downgrades to its earlier assessment of economic conditions and the own near term outlook. Breaking it down, on the weaker side, they inserted the ‘recovery is proceeding’ instead of ‘economic activity has continued to strengthen’. They noted that ‘household spending is increasing’ instead of ‘…has picked up recently’ and finally ‘financial conditions have become less supportive of economic growth’ instead of ‘remain supportive…’ On the plus side and not negating the new weaker sentiment, its assessment of business fixed investment looked a tad stronger, with ‘investment in non-residential structures continuing to be weak’ as opposed to the earlier insertion of ‘declining’. Policy makers also took a softer tone on inflation. The previous communiqué did not comment on the direction of inflation, this time around to note that both declines in prices of energy and other commodities and that ‘underlying inflation has trended lower’.

The USD$ is higher against the EUR -0.19%, GBP -0.05%, CHF -0.10% and lower against JPY +0.23%. The commodity currencies are weaker this morning, CAD -0.22% and AUD -0.38%. Yesterday, we witnessed Canadian retail sales disappoint in Apr. (-2.0% vs. -0.4%). However, one month does not make a trend. Digging deeper, the declines can be attributed to a strong base effect and weaker auto sales. Consumer purchases happened to fall in 10 of 11 retail sub-sectors. Despite the blip, analysts expect sales to remain on the upward trend in the months ahead. The unexpected headline print dealt a body blow to the loonies’ recent rise. The CAD fell the most in three week’s after the surprising release and supported by weaker oil and equity prices. Risk aversion is once again on the table. The commodity currency has fallen as equities and oil slump after weaker US New Home Sales data reignited concerns that growth with Canada’s largest trading partner may stall. Despite domestic fundamental data showing that the Canadian economy is ‘firing on all cylinders’, the recent bid to the loonie may have been a tad overdone and a healthy purge technically was on the cards. Year-to-date the currency has appreciated 8.5% vs. its largest trading partner. Speculators continue to place bets that Governor Carney will raise interest rates faster than other developed countries. Big picture, the CAD is holding its own after the BOC’s last rate hike (+0.5%). Using the loonie as a safer way to play an economic recovery in the US with linkage to commodities and less banking or fiscal noise has speculators better buyers of the currency on dollar rallies. Now, with talk that the currency is to be used as a Cbanks safe haven destination for capital should lend even more support to the currency in the medium term. Do not be surprised to see the currency trade beyond parity in the coming months.

The AUD experienced a whiplash session O/N. Prime Minister Rudd resigned after a leadership challenge from his deputy Julia Gillard, who becomes the first female Aussi PM, after his plans to boost taxes on the mining industry affected his opinion polls. The currency had been under pressure before political risk on concerns that funding trouble at various European banks will dampen global growth and reduce demand for higher yielding assets. It’s expected that a mining tax compromise, initiated by Gillard, will end up be significantly positive for the currency. Fundamentally, pull-backs are well bid. Earlier last week, comments from the RBA, who said that Europe’s debt crisis would ‘inevitably weigh’ on global growth, had fueled speculation that the Governor Stevens may keep rates unchanged until at least the end of the year. It seems that that ‘previous rate rises has given them flexibility to leave borrowing costs unchanged at next month’s meeting’. To date, the crisis in Europe has not had a material impact on the Australian economy, but, that’s been called into question. With European stress test disclosures lined up failing to calm investor’s fears has technical analysts wanting to sell the currency on rallies (0.8701).

Crude is lower in the O/N session ($75.94 down -41c). Crude yesterday fell the most in a fortnight as the weekly EIA inventory release reported an unexpected gain in supplies and US data showed that the purchases of new homes tumbled the most on record m/m. Oil stockpiles rose +2.02m barrels to +365.1m vs. an unexpected fall of -800k barrels. On the flipside, gas supplies fell -762k barrels to +217.6m vs. an expected market decline of -180k barrels. Imports of crude oil climbed +4.3% to +10.1m barrels a day, the highest level in 18-months. The headline print certainly fly’s in the face of the ‘bulls’ way of thinking. They have been looking for demand growth to accelerate and this weeks report shows that the opposite will probably occur. Crude stocks remain well above the five-year average level, and are +3.2% above a year ago, the biggest year-on-year surplus in 6-months. Distillate stocks (diesel and heating oil) rose +297k barrels, less than expected as demand dropped to its lowest level in 7-months. Currently there are too many negative variables that support the bear’s short positions. Another factor not helping was a federal judge lifting the six-month freeze on deepwater drilling imposed by Obama. The fear that a double dip is on the cards has the speculators wanting to sell. Year-to-date, the commodity has appreciated +11%. Weaker global economic releases have managed to encourage some ‘risk-off’ trading strategies. Direction is dictated by demand and with ample supply and global growth worries has speculators once again wanting to sell any rallies.

Bigger picture, Gold continues to be a safe heaven attraction. The commodity prices remain close to home as renewed credit worries and concerns about a global economic recovery trigger a safe-haven demand for the metal. Technically, all week, pull backs have been bought. The commodity’s prices will remain robust on speculation that European’s Economic woes will be prolonged. With broader risk appetite under pressure, the market is capable of printing new record highs again. The upward bias trend remains intact as the ‘yellow metal’ is trading with a greater consideration of its safe haven status. The asset class is well sought after, technically encouraging individuals to want to own more of it for hedging purposes. Year-to-date, gold has gained +15%. Generally, it has become the benefactor when all other currencies fail. Thus far, Europeans have been content in using the commodity as a hedge against their European holdings, believing that the EUR has not bottomed out just yet. For now, buyers are waiting in the wings to purchase product on all pull backs as equities remain under pressure ($1,234 -80c).

The Nikkei closed at 9,928 up +5. The DAX index in Europe was at 6,156 down -53; the FTSE (UK) currently is 5,124 down -55. The early call for the open of key US indices is lower. The US 10-year eased 8bp yesterday (3.11%) and another 3bp in the O/N session (3.08%). Treasury prices rallied after the disappointing US New Homes Sales data. They have managed to print the lowest intraday yield in two months. Investors continue to gravitate towards the shorter end of the curve on fears of ‘sluggish economic growth’. Again and not much of a surprise was the 5-year auction being well received. The demand was less stellar than the 2-year sale, basically because yields were so low. The bid-to-cover ratio was 2.58, lower that the 2.71 at the last the sale and under the four auction average of 2.69. The belief that the US economy’s momentum is not being built upon should continue to provide a better bid on deeper pullbacks. In total this week we have $108b’s worth of new US product to be auctioned off. Now that we are two-thirds the way completed, both auctions were well received. Today is the last of the auctions where the market gets to take down $30b 7-years worth.

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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