Obama’s appointments are appeasing Capital Markets for now. Is Citibank to spoil the party?

Citigroup is too big to fail, or so we think. Once again the US government has come to the rescue guaranteeing $306b assistance for toxic assets. They will also get $20b in cash under TARP arrangements. In return the government will get $27b of preferred shares paying an 8% dividend. So far global equity markets have bought into this announcement, but not sure what the true economic effect will be.

The US$ is stronger in the O/N trading session. Currently it is higher against 11 of the 16 most actively traded currencies, in another ‘whippy’ trading range.

Forex heatmap

Global fundamentals remain weak as investors continue to liquidate their holdings and seek risk adverse opportunities. Citibank dominated last week’s headlines; it managed to pare 60% of its equity value. Once a mighty institution continues to be pressurized as investors wonder in what shape or form the bank will survive. Perhaps its only time that it will be nationalized? Dubai and the Middle East are beginning to show some cracks. Will this be the next white elephant project? Canada the last of the G7 members, last weekend declared that it too has entered the recession. Equities on Friday managed to advance aggressively late in the day once again as President elect Obama announced key cabinet post names that found approval with global markets. One can forget fundamental analysis for the time being, psychology and fear will dominate. With peoples livelihoods and personal wealth under constant attack, flight, anger and somewhat despair continue to influence all markets. The percolation of the financial disaster into the real economy is becoming more evident and has a long ways to go.

The US$ currently is higher against the EUR -0.10%, GBP -0.38%, CHF -0.09% and lower against JPY +0.66%. The commodity currencies are weaker this morning, CAD -0.44% and AUD -1.09%. Risk aversion trading strategies and weak commodity prices have impeded the loonie advance recently. The late optimistic surge of the equity market on Friday managed to put the ‘big dollar’ under pressure and by default the loonie found some traction. But, the overall sentiment has the CAD once gain retreating as commodities come under assault with the reality of a deeper recession taking hold. The loonie this quarter alone has lost 15% to its southern neighbor as investors have sought sanctuary in the greenback. The black stuff accounts for approximately 10% of all of Canada’s export revenues. Mathematically and technically the loonie has further to fall. The loonie remains vulnerable as oil is finding it rather difficult to advance from its new 20-month lows. Governor Carney last week said ‘that the risks to the country’s economy from a global credit crisis and recession have increased in the last month and will probably lead to a further reduction in interest rates’. Traders have priced in another 50bp ease next month, this will push borrowing costs below the psychological 2% mark as further monetary stimulus will be required to achieve the banks 2% inflation target over the medium term (2.25%).

This week has started where we left off with investor’s continuing to unwind the ‘carry trade’ and dumping higher yielding currencies. Despite the Citigroup ‘bailout’, risk aversion strategies continue, as uncertainty and fear dominate. For now traders continue to be better sellers on rallies (0.6304).

Crude is lower O/N ($49.63 down -30c). Crude prices managed on Friday to rise for the first time in a week as OPEC members cut production and governments step up efforts to revive economic growth. Reports show that OPEC members are adhering to quotas that were agreed on last month. The members are expected to meet in Cairo next week; last month they set quotas to 30.98m barrels a day for this month compared with 32.2m a day in Oct. Analysts that were bullish less than two months ago (2009 target of $150 a barrel) have aggressively revised next years targets to $80. Already oil has lost close to $100 from its record high prints witnessed at the beginning of the summer. Crudes continuing slide will add to concern that the global economy faces deflation, threatening investment in oil and gas production projects around the world. Technically we overshot prices on the way up (Chinese Olympics) and we will definitely overshoot on the way down (some analysts are looking for $40 a barrel 1st Q 2009). Fear is destroying future demand at the moment. Last weeks IEA report showed that inventories climbed more than forecasted as fuel demand dropped. Stocks climbed +1.6m barrels to 313.5m w/w vs. an expected jump of +1m barrels. Not surprising, US fuel demand over the past month has averaged +19.1m barrels a day, that is down -7% from a year ago (where is the cold weather). Gas inventories rose +539k barrels to 198.6m w/w. US fundamental data has done little to support the black stuff. Speculation that the recession will further curb demand will help send prices lower. To date, crude prices are down 65% from their summer highs and down 45% y/y. This scenario will back OPEC further into a corner. Every time they cut production they are building up spare capacity. Similar to the last cut, there is also a risk that they may make further cuts (rumored for next month) and prices still will not rebound. The erosion of future demand continues to be a ‘big’ question mark for global economies. Gold has advanced as traders speculate that the Fed will lower interest rates soon to stimulate the economy, thus boosting the appeal of the ‘yellow metal’ as an alternative investment ($804).

The Nikkei closed 7,910 up +207 (bank holiday). The DAX index in Europe was at 4,281 up +154; the FTSE (UK) currently is 3,962 up +181. The early call for the open of key US indices is higher. The 10-year Treasury yields backed up 3bp on Friday (3.21%) and are little changed O/N. Last week Treasury yields managed to print record lows, forcing 2-year notes to print below the 1% mark for the first time as investors pared equity positions and sought the sanctuary of Government debt. Traders once again raised their bets that Bernanke and Co. will cut interest rates next month to boost the US economy (1.00%). Deflation remains the biggest fear, which has US T-bills offering practically no yield as investors seek to protect their principle.

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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