No reason to sell the EUR just yet

Lack of ideas, new news and market data to focus on has the currency market well contained. Trichet had ‘nothing to add’ yesterday. The market is interpreting the ‘strong vigilance’ language as an indication that a rise in the ECB’s main policy rate is likely unless something alters the official view between now and April 7.

It will be the first tightening in nearly three-years. With some of these geopolitical concerns subsiding, the focus on interest rate differentials should remain Euro-positive. ECB President Juncker’s comments that Euro-area finance ministers have agreed on all elements of a permanent bailout fund has provided the last of the stability reason to want to own the currency. The market is failing to find fundamental reasons to want to sell it.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in a ‘subdued’ session.

Forex heatmap

The soft US housing data continues. Yesterday’s US sales of previously owned homes dropped more than forecasted last month. Even the median buying price managed to decline to its lowest level in nine-years, strong proof that the housing market is still finding it difficult to recover.

The headline print posted a drop of -9.6%, m/m, to +4.88m annualized units, its biggest correction since July.  Declines were registered in both the singles and multi-unit categories, down -9.6% and -10.0%, respectively.

The months’ supply jumped to +8.6-months of listed product on the market at current selling rates, up from +7.6 in the previous month (highest level in five-month). It’s worth noting that this does not include ‘shadow inventories’, the unlisted homes that banks are sitting on. If one included this then the market would be looking at a headline supply print of nearly double!

Digging deeper, the average and the median sales prices continue to move lower. Average prices plummeted -1.4%, m/m, to $203,700, while median prices retreated -1.1% to $156,100.

The US treasury department announced that it was selling its $142b MBS. They are beginning ‘their’ unwinding of QE1. Some will view this as a form of tightening and a supposedly positive move for the dollar. However, this is ‘NOT’ the big Fed program. This is the Treasury portfolio which is a lot smaller. It is about a tenth the size of the Fed’s portfolio. Many do not see this as having an influence on the Fed’s monetary policy. The Fed still has some ways to go before announcing its own exit strategy.

The USD is lower against the EUR +0.08%, GBP +0.22%, CHF +0.06% and higher against JPY -0.05%. The commodity currencies are stronger this morning, CAD +0.11% and AUD +0.44%.

The loonie gained the most in just under two-months yesterday outright as crude oil, the country’s biggest export, rose on renewed concern turmoil in North Africa and the Middle-East may disrupt supplies. 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 dampened 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 are improving markets risk appetite. This morning 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.

Logically, there should be a strong demand for the currency because of its fundamentals, however in this ‘fight or flight’ trading environment, logic is sometimes ignored. Expect the depth of the backup to be dictated by cross-action.

This evening the Government releases its budget, and the market currently seems to be shrugging off potential political risks on its release. 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 (0.9760).

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 investor’s 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 (1.0110)

Crude is little hanged in the O/N session ($102.19 -0.9c). 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 commodity remains better bid as NATO air strikes in Libya threaten ‘to prolong a supply outage in North Africa’s third-biggest producer and renewed concern escalating turmoil may disrupt Middle-East exports’.

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 world’s 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.

War premium has gold remaining better bid. The commodity has climbed for a fourth consecutive day after Libyan air strikes boosted investor demand for a haven. Investors continue to worry that high oil prices could end up being a drag on global economic recovery. With a weak dollar and fears that Cbanks could use the events in Japan as justification for maintaining their loose monetary policy is also supporting the yellow metal.

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 (climbing +26% in the past year). These price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets and again threaten new record prices.

Big picture, commodity prices are being supported by geopolitical factors and inflation threats. 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 ($1,430 +$3.70c).

The Nikkei closed at 9,608 up+402. The DAX index in Europe was at 6,815 down-1; the FTSE (UK) currently is 5,802 up+16. The early call for the open of key US indices is higher. The US 10-year backed up 3bp yesterday (3.33%) and are little changed in the O/N session.

Longer dated notes fell for a third consecutive day yesterday, its longest losing streak in six weeks after the US Treasury announced it plans to offload its holdings of MBS’s that it accumulated under QE1 and on signs that Japan’s nuclear crisis is easing. Last week, risk aversion trading strategies intensified as Japan’s nuclear crisis and Libyan political turmoil encouraged demand for the safety of US government debt.

Now that Prime Minister Kan can ‘see the light at the end of the tunnel’ is giving investors some confidence to unwind some of these securer trading strategies. 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%. The market remains on edge and subject to headlines at any time. 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