US dollar sideswiped in Forex markets over ‘toxic waste’ delay!

In a US election year, exposure is a must, and everyone wants to put their finger in the pie. We have Republicans vs. Democrats, Wall Street vs. Main Street, and Nobel Laureate Economists vs. Congress, all providing their expert opinion on a ‘toxic waste disposal plan. Do they know that a Zebra was a horse designed by a committee! Their actions continue to hasten bank failures (Washington Mutual last night). Who is next?

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

FX Heatmap September 26th, 2008

After yesterday’s dismal US data, one can only say that the Fed is not getting a break on the fundamental front either. Having to sell Congress on ‘the financial aid plan’, weaker durable goods, jobless claims and New Home sales will surely have the Fed cheapening borrowing costs (2.00%) sooner rather than later. All the data provided proof of a deep recession bound US economy. The jobless claims numbers have worsened, even after controlling for hurricane effects. Despite Hurricane-distorted, last week’s initial jobless claims were ‘horrible’ (+493k) and that’s before the market can expect the peak effects of the current worsening credit crunch to hit US labor markets (due to the lagging effect). Stripping out the +50k estimated Hurricane effect; initial claims would still be hovering around the +443k mark, while the previous week was also revised higher (+461k vs. 455K). Analysts now believe that the labor market will have the momentum to penetrate the +500k barrier due to the rapidly deteriorating economic fundamentals caused by the credit debacle. Continuing claims also rose to +3.54m (a new high in the current credit crisis), by default this should push the unemployment rate higher. Capital markets cannot be surprised to see future NFP data having six figure losses. Despite a bail-out package, the US economy is very much recession bound.

US durable goods orders declined a ‘massive’ -4.5% last month, from a downward revised +0.8% increase in July (previously reported at +1.3%, m/m). The data was much weaker than the market had anticipated and the figures showed that the weakness was broad-based. Digging deeper, analysts noted that motor vehicle orders (-8.1%m/m) was consistent with the plunge in motor vehicle production registered for Aug. (-12.8% m/m). Capital goods orders fell by -5.7%, m/m. Non-defense capital goods orders (ex-aircraft) were down by -2%, offsetting the two positive reading shown in June and July. One should expect business investment in 3rd Q to continue to be a drag on growth. Computers and electronics orders were the only positive note in a very depressed report. The data suggests that we will see further contraction in factory activity and industrial production, hence the need for a financial aid package to stabilize financial markets now.

Not to be outdone, the US New Home Sales numbers for Aug. provided an additional ‘nail in the coffin’. The result was another ‘ratcheting down in activity’ after several months of comparative stability. Sales plunged -11.5%, to an annual rate of 460k (the slowest pace in 17-years). Geographically, the declines were concentrated in the northeast and west, with sales in the rest of the country virtually unchanged from Aug. It’s worth noting that they were also concentrated at the higher end of the price band (contributing to a -5.5% m/m drop in the median price, that left it with a y/y decline of -6.2%). Builders did manage to make some inroads in reducing the number of homes for sale, inventories fell -19k (down -24%, y/y). Some analysts have stuck their neck out and believe that we hit bottom last month. This is a big pill to swallow, the US credit market debacle argues against any substantial improvement in the data any time soon. Despite all of yesterday’s negative fundamental activity, both equities and the ‘big’ dollar experienced a ‘hope’ rally. One should not expect this to continue too much longer.

The US$ currently is lower against the EUR +0.02%, GBP +0.12%, CHF +0.24% and JPY +0.99%. The commodity currencies are weaker this morning, CAD -0.15% and AUD -0.86%. The loonie managed to print a 2-month high yesterday as US law makers agreed on a ‘set of principles’ for a financial rescue plan to inject fresh capital into the paralyzed credit markets. Despite the US being Canada’s largest trading partner (75% of all exports head south of the border), the currency has appreciated +1.5% this week vs. the greenback. Capital markets expect a plan to stabilize the US economy and by default can only be a plus for the loonie. But, a ‘diluted’ or delayed package should have the opposite effect for the currency. Crude appreciating +4% this week (50% of Canada’s exports are commodity based) continues to provide an undertone bid. The market will have to wait until the financial aid package is passed before the loonie can break out of its congested 1.0300-1.0400 range. Governor Carney said yesterday that any further slowdown in the US economy will affect areas that matter most for Canada. He indicated that domestic banks are ‘faring well amid the crisis’, but, expects demand for Canada’s products to drop more than anticipated and inflation to slow. This should give Governor Carney the latitude to ease O/N borrowing costs (3.00%) by year end, as the downside risks for slower growth will intensify. On a cross related basis the loonie remains sought after, as traders sell the lower yielding currencies like JPY and CHF. Expect traders to be better buyers of the CAD$ on USD$ rallies in the short term.

The AUD and Kiwi dollar have both declined this week vs. the greenback and JPY, as delays to a US banks rescue plan curbed demand for higher yielding overseas assets funded out of Japan. Investors are concerned that translation costs (FX rate) would wipe out any interest returns, thus erasing profits. Traders have increased their bets that the RBA will cut O/N borrowing costs (7.00%) next month by 50bp, to encourage banks to boost lending amid a global credit freeze rather than hoarding cash. Expect this to be the new mantra of most CBankers.

Crude is lower O/N ($106.40 down -62c). The energy market on the whole remains better bid (despite paring some of yesterday gains O/N) as Capital Markets speculated that Congress will give the seal of approval to a rescue plan for the US economy. The EIA also released a report showing that US gas inventories had dropped to its lowest level in 40-years. With Congress indicating that they agreed on a ‘set of principles’, traders bought the black-stuff because of increased optimism on both the economy and demand. Gas inventories fell -5.9m barrels to 178.7m (the lowest since 1967). One way or another the market believed a bail out has to be tabled, either ‘water-downed’ or not. With refineries operating at only 66.7% of capacity last week (lowest level in 20-years) and a bullish crude inventory report earlier on in the week, will have ‘bear’ traders running for cover. Interruptions to supplies of crude and products have also increased this week; Royal Dutch shut a gas-making unit at Europe’s largest oil refinery (due to technical problems), and Chevron faces renewed strike action in Nigeria. The highest grade of oil comes from this region and geo-political concerns have always remained an issue in the militia dominated area. Chevron produces aprox. +350k barrels a day there. With legislators debating the rescue strategy, fears that ‘when’ a finalized plan is implemented, consumers will be hit with higher energy prices. Oil has advanced +25% since US lawmakers last week pledged fast consideration of Treasury Sec. Paulson’s plan to buy devalued mortgage-related securities. Fundamentals will eventually kick in; prices are too high, it’s only a matter of time before the global economic slowdown spreads further afield (China, India) and cut consumption even more. Gold remains offered ($882) as traders believe that the ‘toxic waste’ disposal plan put forward by Paulson will finally stabilize financial markets and reduce the appeal of the ‘yellow metal’ as a safe haven asset.

The Nikkei closed at 11,893 down -113. The DAX index in Europe was at 6,080 down -92; the FTSE (UK) currently is 5,111 down -85. The early call for the open of key US indices is lower. 10-year Treasury yields backed up 1bp yesterday (3.81%) and are little changed O/N. Even though traders cheapened up the 5-yr basket for the government debt auction (24b-largest 5-yr issuance in nearly 6-years), treasury prices remained within a tight trading range after congressional leaders said they were close or not to an agreement on the $700b plan to rid banks of ‘toxic assets’. Someone spoke too soon! One has to believe that the FI market have fully priced in the aid package, maybe allowing investors to shy away from government debt as a safe heaven alternative. What will Bernanke’s next move be? Preparing the market for an interest rate cut? If so, treasuries would look mighty cheap at these or any levels!

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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