Worry about EURO event risk not US

Oh, the Fed is to be gradual now? What’s a couple of trillion or billion between friends? Risk deleveraging remains in play, somewhat complicated by month end requirements. The market will be happier if they can shut up shop and get helicopter Ben’s expected announcement out of the way. The swirling rumors have most asset classes losing out. Equities should plunge in the event that the stimulus policies fall short of expectations. US yields will be expected to back up further. In this scenario, the dollar gotta outperform, but, by how much? Instead of trading volatility, we should be trading on the word ‘gradual’. Gradual employment, gradual growth, gradual stimulus. Euro-zone event risk is on the rise, and Capital markets should be expecting further negative EUR headlines. It seems that investors have not digested some of the negativity over the last few trading sessions. Ireland has announced further fiscal cuts of 15b EUR’s, double the original. Greece has warned that their fiscal revenues are falling and Portugal’s political chaos has delayed the oppositions budget agreement. The PIIGS are starting to smell again.

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 ‘whippy’ trading range.

Forex heatmap

It was a day of mixed reporting yesterday. With US Durable goods orders the market managed to get the worst out of the way first. Even though the headline came in stronger than anticipated (+3.3%), the disappointing details to the report made it more bearish than expected on balance. It was the volatile Air component that certainly distorted the report. In Sept. orders came in at +117 vs. the Aug. print of +10. Digging deeper, the transportation orders climbed +15.7%, m/m, all on the back of the aerospace. If we exclude the air component, the orders were weak (-0.8%). Probably most disconcerting is that inventories of durable goods are rising again. Last year at this time, the durable inventories to shipments ratio was 1.49, and today it has edged higher to 1.59. The bookings for capital goods fell last month (ex-military, +0.6% vs. +4.8%, m/m), further proof that a slowdown in business investment gives the Fed more reason to ease policy next week. How much will helicopter Ben and his fellow policy makers pledge?

Offsetting the disappointing durables print was a mildly better than expected US new home sales release (+307k vs. +288k). Despite the stronger headline print, sales remain exceptionally weak. Analysts note that the print continues to piggyback the all time low printed five months ago (+282k). Surprisingly the median prices rose +1.5%, m/m, and it’s important to remember that they are not seasonally adjusted. Digging deeper, the supply number has fallen to eight-months for most categories. Builders seem to be successful in reducing their inventory overhang. Unfortunately, the stock levels continue to run at double the long-run average, which suggest that prices and housing starts will remain on the softer side. Waiting in the wings will be the shadow inventories, the market still has to deal with those yet.

The USD$ is lower against the EUR +0.26%, GBP +0.22%, CHF +0.54% and JPY +0.51%. The commodity currencies are stronger this morning, CAD +0.22% and AUD +0.54%. Overall, the loonie remains under pressure, finding it difficult to gain traction, as both commodities and equities struggle, curbing the demand for growth sensitive currencies, temporarily at least. Over the past month, the CAD has been one of the worst performers vs. the buck, despite all the negativity surrounding the greenback. The dollar has strengthened against all of its major counterparts on speculation that future bond buying by the Fed will be less extensive than previously priced in. Last week Governor Carney stood down on hiking rates as expected, citing a softer outlook for the Canadian economy. Futures prices have priced in a ‘no-hike’ for the next six-months despite policy makers continuing to see the risk to the inflation outlook as being balanced. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way. It’s all about next week’s pending announcement from the Fed that will again give the market nonevent risk direction.

The AUD has clawed back some of the previous day’s losses as the dollar correction seems to have temporarily overshot its target. The currency had tumbled as the inflation numbers this week disappointed hawkish speculators. Australian CPI rose +2.8% in the third quarter from a year earlier, after increasing at a +3.1% pace in the previous three month. The market was expecting a rate of around +2.9%. Futures traders have pared their bets from a +47% chance that the RBA would hike next week to a +16% chance. It’s now expected that any rate increase down-under ‘will be only gradual, even if the RBA were to resume the monetary tightening cycle next week’. With such a benign rate outlook, the market is betting that the currency will ‘struggle in extending its gains far above parity’ in the medium term. The currency had been getting a lift from the price of commodities and the dollar of late. Now that that relationship has somewhat gone ‘walkabout’, expect investors to be better sellers on rallies in the short term (0.9781).

Crude is higher in the O/N session ($82.11 +17c). Oil prices declined yesterday for the first time this week on signs that crude supplies are rising and as the dollar strengthened, curbing investor demand for commodities. Not aiding the commodity’s cause was the decline in US Capital goods orders, signaling that investment will cool. The weekly inventory reports also surprised, surging more than five times analysts expectations. Crude climbed +5.01m barrels to +366.2m last week and the biggest increase in four-months. The market had only priced in a +1m barrel gain. Offsetting the reported surplus was the plunge in Gas stocks, falling -4.39m barrels to +214.9m. Analysts were estimating an increase of +625k barrels. The net effect was a zero-sum report. Inventories for crude and refined products remain at unusually high levels. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. The ‘big’ dollars value continues to push prices about.

We all know that the yellow metal is a favorite amongst investors as a haven against the debasement of the US currency. Commodity bulls have definitely got a scare from the dollars rise this week. Yesterday, the yellow metal registered the lowest closing price in three weeks as the dollar’s rally curbed demand for commodities as an alternative investment. Giving the dollar support is market speculation is that the Fed will buy less debt than projected in their effort to revive the economy. Over the past couple of trading session investors have been happy to ‘book some deserved profits’ in this over crowded one directional trade. The dollars negative correlation relationship remains intact with commodity prices. For most of this year investors have sought an alternative investment strategy to the historical reserve currency. Investors have been using the commodity as a proxy for a ‘third reservable currency’, pushing the metal to record new record highs. To date, gold has outperformed global equities and treasuries (+20.1%), prompting record investment in gold-backed exchange-traded products. The debasing issues of the dollar, coupled with the sustainable growth issues of the US economy have investors generally seeking protection in an asset with a ‘store of value’. Everything now hinges on next weeks Fed announcement ($1,337 +$5).

The Nikkei closed at 9,366 down -21. The DAX index in Europe was at 6,597 up +30; the FTSE (UK) currently is 5,636 +41. The early call for the open of key US indices is higher. The US 10-year backed up 6bp yesterday (2.68%) and are little changed in the O/N session. It’s official, 10-year prices fell for the sixth consecutive day, the longest losing streak in 2-years, after yesterday’s data added to speculation that the Fed’s pending QE2 program to boost the economy may be gradual. Also adding pressure to the market was the sale of $35b’s worth of 5-year product. Dealers successfully cheapened up the curve to take down the second of this week’s auction. Today we get the final installment, the $29b 7-years. Yesterday’s 5-year sale was ‘so-so’ received. Indirect bidders took down 39% after taking down 50.1% in Sept. and an average of 45.7% over the last four auctions. Direct took 12% after last months 8.7% and compared to the average of 9.9%. After today’s final sale the market will turn its focus to next week’s FOMC meeting.

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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