US Banks 2nd Q earning’s to be dismal!

Ten lenders have been approved by Geithner and Co. to pay back $68b’s worth of TARP monies. An encouraging sign of financial repair you say? In little over a month we will witness 2nd Q earnings. Let’s ponder this thought; historically a banks portfolio is comprised of a rather large portion of short-term US FI product. What are these financial institutions earnings going to look like given the destruction of the short end of the yield curve over the past 5-trading sessions? Do not even talk about mortgages, they have been harder hit! For instance, last Q’s 3-yr product yielded 1.11% and after yesterday’s $35b new 3’s printed 1.94%! It was only last week that BOA’s CEO Lewis said to an Oppenheimer analyst that the next couple of Q’s would be difficult for them. Let’s not put the cart before the donkey again!

The US$ is weaker in the O/N trading session. Currently it is lower against 14 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Forex heatmap

Yesterday the only bit of data that traders could chew on was US wholesale inventories. The results again exceeded analyst’s expectations. The -1.4% decline was larger than originally forecasted (-1.1%) and followed a revised -1.8% decrease in Mar. (-1.6%). The month of April was the 8th-consecutative decline as distributors continue to cut excess inventories in line with the pace of decreasing sales. Do not expect the pace of the inventory drawdown to have much of a bearing on 2nd Q GDP as they are falling at a slower rate. With sales falling -0.4%, the slowest rate in 4-years, it would take 1.31-months for distributors to deplete the amount of goods on hand, compared with 1.32-months in Mar.

The USD$ currently is lower against the EUR +0.34%, GBP +0.55%, CHF +0.34% and higher against JPY -0.25%. The commodity currencies are stronger this morning, CAD +0.48% and AUD +1.23%. The loonie rose yesterday as crude oil advanced and global equities pared some of their deeper losses on speculation the worst of the recession may be easing. Some risk related bids appeared despite the poor underlying employment report last week. Already this month, the currency has dropped -2.2% vs. its largest trading partner after advancing +9.3% in May, the most in at least 59-years! Last weeks employment report point to a moderately worse domestic environment due to the concentration on full-time job losses (-58.7k) and cooling of wages levels. Analysts expect the losses to put further downward pressure on future cash flows and disposable incomes. If there is no spending then there will be no growth! The BOC in an unprecedented fashion managed to comment on the state of the loonie by noting that ‘if the unprecedentedly rapid rise in the Loonie proves persistent, it could fully offset these positive factors’. The BOC is basically confirming that the appreciation is not linked to fundamentals. Expect the market to continue to sell CAD on USD pullbacks for now. Let’s see what this morning’s trade numbers have in store for us!

Last night, the Australian consumer confidence jumped this month by the most in 22-years (+12.7% to 100.1) after the economy unexpectedly avoided a recession. This has heightened speculation that the RBA has finished cutting interest rates (3.00). Traders continue to look favorable on the currency because of its yield advantage and its association with commodities. In the short term look for better buying opportunities on pullbacks as the currency marches upwards (0.8108).

Crude is higher in the O/N session ($71.37 up +136c). Princeton’s Nobel Prize winning economist Paul Krugman provided support for the black-stuff yesterday. He said that the US recession may end later this year and this has prompted speculation that fuel demand may increase. A weaker greenback has supported oil’s recovery of late (doubling its value since Dec.). By default, it has increased the appeal of commodities as a hedge against a drop in the USD. Oil needs to break the support price of $64 to gather any true downward momentum and $70 on the topside to get any upward movement. Fundamentals will tell you the opposite. We have had elevated prices because of a weakening USD. The world is awash with oil, demand destruction is intact and 19-year US record inventories remain. Even last weeks EIA report reveled that crude inventories climbed +2.9m barrels to +366m vs. an expected loss of -1.6m. Crude stocks gained as imports and refineries increased their operating rates to the highest level in 6-months. Refineries are operating at 86.3% of capacity, up +1.2%, w/w. The true fundamentals do not justify these elevated prices as the 4-week moving average for US consumption is +18.2m barrels a day, that’s down -7.7%, y/y. Even with both OPEC and Russia raising production last month (to capture some of their capital gains) does not support higher prices for too long. OPEC’s output climbed +1.5% to an average +28.15m barrels while Russia’s output advanced a 3rd straight month (+0.t9%). Many believe that oil has climbed too quickly as the rapid gain has been based on stronger equities and a weaker dollar. However, the frightening part is that if OPEC complied with its Sept. production cuts (currently only at 77%), this commodity would be much higher! The ‘yellow metal’ has rebounded from its lowest level in 2-weeks as the decline in the USD has increased the appeal for precious metal as an alternative investment strategy ($962).

The Nikkei closed 9,991 up +204. The DAX index in Europe was at 5,102 up +105; the FTSE (UK) currently is 4,483 up +78. The early call for the open of key US indices is higher. The 10-year Treasury’s backed up 5bp yesterday (3.87%) and are little changed in the O/N session. Treasuries advanced yesterday on speculation that yields trading at a 7-month high would encourage investor demand at the 2- remaining government debt sales this week (10’s and long bonds-$30b). However with global equities aggressively rebounding, traders have been happy in cheapening the curve to take down the remaining issues in the O/N session. Over the past 4-trading sessions the market has been prematurely pricing in a Fed tightening. Rates are expected to remain low for most of this year, unless we have any failed auctions on the horizon!

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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