Forex and Equities embrace slippery Oil prices……..!

How low can we go? The dejected and somewhat poorer investor of late managed to create a brief optimistic rally in equities yesterday, and all this despite woeful US fundamentals. You think we are capable of buying into ‘Big Brothers’ plan? Perhaps OPEC will manage to put another spanner in the works!

The US$ is stronger in the O/N trading session. Currently it is higher against 12 of the 16 most actively traded currencies, in another ‘whippy’ trading range.

FX Heatmap October 17th, 2008

Equity markets are not the only record breaker of late, US fundamentals continues to weigh in on that score as well. Yesterday’s data has only added fuel to the ‘fire-sale’ we are witnessing. Headline CPI inflation is disappearing and it’s still early days in the trend. After a small -0.1% m/m decline in Aug., headline CPI followed up with a big ‘0’ change last month. Resulting in the y/y high of +5.6% we witnessed in July has now eased to +4.9%. Analysts expect it to stay the course and foresee CPI dipping below 2% in the New Year. Meanwhile Core-CPI (ex-food and energy) remains rater tight, rising only +0.1% m/m. Over the year core-CPI is +2.5% and the Fed will be happy that there is no strong evidence of a ‘pass-through’ of earlier commodity gains we experienced at the start of the summer. Digging deeper, deflation was more evident across a number of categories (apparel, vehicles, computers and energy components). Energy of course is the biggest variable for the declines. But, it’s worth nothing that the only item that is keeping the ‘core’ in positive territory is food and drink (up +0.6% m/m). Food and energy price gains have been high since June (+6% higher y/y). One should expect the consumer, whose disposable income has declined due to credit issues, near non-existent home equity withdrawals and falling real wages to withstand these high prices by replacing other items in the consumer basket in a ‘deflationary manner’.

We were somewhat lucky with initial jobless claims yesterday; it did not deteriorate as much as the market had anticipated. But, analyst point out at +461k, this equates to a 6-figure NFP reading similar to last month (-159k). It’s the continuing claims we should be focusing on as they are heavily correlated to the US unemployment rate (+6.1%). The +3.7m outstanding claimant vs. a revised +3.67m m/m is not at all comforting. But, the record breaker for the day was to be seen in US industrial production.

US industrial production fell an incredible -2.8% m/m for Sept. (the most in 34-years), and this on the heels of an already weak -1% reading in Aug. This solidifier’s a deep recession in the US manufacturing sector and could support a negative GDP reading for the 3rd Q. Despite the data taking into account both hurricanes (Gustav and Ike) and a strike at Boeing, theses numbers are difficult to stomach and one cannot put any positive spin on it. For this quarter alone, industrial production has declined a whopping -6% and the continuous weakness for certain categories provides strong evidence that the ‘cyclical manufacturing’ sector is in a deep recession. The Sept. report showed that the decline was broad based across most of the categories. It’s worth noting that a ‘small’ rebound in the reading is possible for the Oct. release when plants in the hurricane affected areas reopen. But, that may be too optimistic as activity is weak and the heightened financial turmoil will continue to weigh on consumer confidence and production.

Not to be outdone in the record breaking stakes, The Philly Fed Manufacturing Index contracted this month (-37.5 vs. +3.8) at the fastest pace in almost 2-decades, a sign the worsening credit crush is pushing the economy into a deeper slump. During all of last year the index averaged a +5.1 reading. The sub-components were not a ‘sight for sore eyes’, new orders plummeted to -30.5 (lowest in 30-years), while the shipments index decreased to -18.8 from +2.6. Being consistent with today’s disinflation theme, prices paid declined to +7.2 from last months +31.5 handle. Expectations for the next 6-months fell to -4.2 from +30.8. How can policy makers believe we are side stepping a ‘steeper’ recession? Even Bernanke said this week that the financial aid packages need ‘time’ to bear fruit. But, unfortunately time will not keep us all employed or save people from foreclosing on their homesteads. Fundamentals are painting a rater depressing picture.

The US$ currently is higher against the EUR -0.07%, GBP -0.05% and lower against CHF +0.20% and JPY +0.43%. The commodity currencies are weaker this morning, CAD -0.67% and AUD -1.76%. Yesterdays weak Canadian manufacturing shipments suggests softer production numbers will be had in the months ahead. It was a dismal report that fell over 4.5 times more than expected (-3.7% vs. +2.7%), and all of it on the volume side as prices were unchanged. This will of course cause a large drag on real GDP as future outlook looks bleak with crude oil prices continuing to fall and the US demand for Canadian goods easing (over 75% of their exports head south of the boarder and 50% of total exports are commodity based). This will result in weaker production numbers for the foreseeable future, as the economy alters activity to deal with dwindling demand. Digging deeper into the report, 18 of the 21 manufacturing industries were affected by the weakness with transportation equipment, primary metal and petroleum among the largest sectors hit. The loonie continues to make a valiant attempt to replicate last weeks trading range. The currency has been trading under pressure as crude prices maintain their downward spiral. As highlighted above, the US recession like data certainly does not help the loonies’ short term outlook. It has now deprecated 14% vs. the greenback since oil registered its record highs at the beginning of the summer. Currently one cannot rule out the market revisiting last Fridays CAD$ lows north of 1.21 again. The plunge is consistent with commodity prices and analysts are aggressively revising medium term price objectives, 6-month levels have been revised up towards the 1.2500 region. With global growth heading for a major downturn, commodities, the backbone of the Canadian economy and exports, are expected again to come under intense pressure and by default should underpin the loonie going forward. Let’s see what OPEC on Oct. 24th. Futures traders continue to price in another 25bp ease by the BOC for next week (Oct. 21st). Traders prefer to be better sellers of the currency on any USD pull backs at the moment.

The AUD$ remains under pressure as global equities and commodity prices trade in the red mostly of late. Investors remain concerned that the ‘monies’ pledged to shore up the global financial system will fail to prevent a global economic recession. The trend for the currency in a recession is always lower. Some investors have been unwinding the ‘euphoric carry’ trade that they entered after equities advanced earlier in the week. For now, expect traders to remain better sellers on upticks (0.6785).

Crude is higher O/N ($71.40 up +155c). Oil managed to penetrate the $70 a barrel for a brief spell, the first time in over a year, after yesterdays EIA report showed that crude and gas stockpiles increased more than twice as much as forecasted. The bearish report showed that crude inventories rose +5.6m barrels to 308.2m w/w. Inventories were expected to rise by +2.6m barrels. Oil remained under pressure on doubts that the bank rescue plan will boost global economic growth and increase fuel usage. This has convinced OPEC to bring forward next months ‘extraordinary’ meeting to Oct 24th in Vienna. Sluggish demand continues to be the catalyst for rising inventories. US fuel demand averaged about +18.6m barrels a day over the past month, that is the lowest reported in nearly 10-years. This week OPEC cut its world demand forecast for 2009, because of ‘dramatically worsening’ conditions in the financial markets. They supply 40% of the world’s oil and cut demand next year by -450k barrels or -0.5% to 87.21m barrels a day. They are expected to cut production because of prices falling so ‘dramatically’. The IEA has also indicated that it foresees growth advancing at its slowest pace in 15-years as global economies slip into a recession. OPEC President Chakib Khelil said that the ‘ideal’ price for crude is between $70 and $90 a barrel. Gas stockpiles climbed +6.97m barrels to +193.8m w/w, vs. an estimated rise of +3m barrels. Growth and recession will continue to be apart of the demand equation despite the economic stimulus package. The stimulus packages require time, and time is a variable that’s been in short supply of late. Gold fell to a new 1-month low yesterday and is little changed in the London session this morning ($809). Traders have sold the ‘yellow metal’ to raise cash to cover losses experienced in other asset classes. Some investors continue to fear the potential flooding of the gold market by Cbanks.

The Nikkei closed at 8,693 up +235. The DAX index in Europe was at 4,737 up +111; the FTSE (UK) currently is 3,973 up +111. The early call for the open of key US indices is higher. The 10-year Treasury yields eased 6bp yesterday (3.93%) and are little changed O/N. Weaker fundamental data yesterday overshadowed the US government’s need to raise debt to fund its rescue of the financial system. This provided a bid for the FI class for most of the trading session. Record cash infusion by governments and larger future debt issuances being tabled has investors ‘only tentatively’ buying the FI asset class at the moment. Despite the curve flattening 3bp (238), traders are putting on the 2-10’s steepener. Futures contracts continue to show a 96% chance that the Fed will cut its O/N 1.5% target rate by 25bp at the Oct. 29th meeting. The way the markets are reacting to the aid packages, expect 50bp to appear on traders radars.

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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