The dollar suffers from a New Years hangover

There are many cross-border ‘potential’ deals taking copy space in most of the headlines this morning (Nestle, Kraft, Novartis and Alcon etc). Naturally, it should be a plus for equities. But what about the FX implication, are there any? Experience shows that large cross border currency moves occur before we tend to realize what it was for. To try and preempt a potential profitable move is generally impossible, unless you are the one with the ball. What’s happening to the dollar this week? Forget its +4.2% move last month, an aberration that required some balance sheet shenanigans. This year so far it looks vulnerable. This week the currency is running on fumes. The market is beginning to speculate that Friday’s NFP may produce a ‘positive’ print. This has convinced traders to treat the mighty buck as a ‘funding currency’ once again. Its déjà vu, investors want equities, commodities and higher yielding currencies. Nothing has changed except a New Year.

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.

The strong ISM Manufacturing PMI print yesterday (55.9 vs. 54.1) seems to be at ‘odds’ with other manufacturing headlines of late. Analysts are warning that we should be cautious with the inconsistencies in various data sources. From an optimistic perspective, the headline is the strongest in over three years and indicates a modest acceleration in the rate of manufacturing expansion. Digging deeper, all sub-components performed strongly. However, manufacturing margins dwindled as the prices paid component advanced sharply. Manufacturing inventories continued to decline last Q, in contrast with the factory orders report that showed a +0.4% rise in inventories during Oct. Inventories play an enormous role in GDP and to have opposing headlines one needs to analyze much deeper. Total business inventories (retailers and wholesalers) climbed in Oct. It’s worth noting that the ISM inventories gauge is not seasonally adjusted unlike other sources, therefore inconsistency may point to revision risks from one source to another. Another sub-component, following along the same theme is employment. The ISM says that jobs are rising (the reading advanced for the 3rd consecutive month) while other data, manufacturing employment in NFP, continues to show a steadily decline. The prices paid component reversed the Nov. decline largely on higher commodity prices such as oil. Finally, domestic orders drove the gain in manufacturing. New export orders remained in expansion mode, but at a slower pace than last month, as the sub-component slipped from 56.0 to 54.5. That’s despite the acceleration of growth in new orders as this subcomponent climbed from a 60.3 reading in Nov. to 65.5 in Dec.

US construction spending continues to deteriorate, with yesterday’s report coming in worse than expected (-0.6% vs. -0.5%). The downward revision to the Oct. report (-0.5% vs. 0.0%) puts construction spending on the defense for the past 7-consecutive months. Digging deeper, non-residential accounts for much of the weakness (-1.6%, m/m-low level of housing starts and weak homebuilders confidence). Not to be out done, residential construction also remains depressed (-0.2%). Within the non-residential sector, the details were mixed with seven of the sixteen major sectors posting a decline on the month. It’s worth noting that the private sector has experienced a larger deceleration in spending (-0.7% m/m), while public spending dipped -0.4% as commercial and office spending advanced. Notably, this was the first increase in these categories for a few months.

The USD$ is currently lower against the EUR +0.06%, JPY +0.72% and higher against GBP -0.35% and CHF -0.03%. The commodity currencies are stronger this morning, CAD +0.23% and AUD +0.17%. Commodity prices and the loonie go hand-in-hand. With oil prices firmly entrenched above the $80 a barrel has pushed the CAD to print its strongest level in nearly 2-months yesterday. The loonie ended last month officially posting its biggest yearly gain in 2-years vs. its southern neighbor as the Harper led country recovers from the recession pushing the currency closer to parity with the greenback. If everything remains equal, trading at a strong premium within 8-months remains a viable reality. However, expect Governor Carney to eventually to throw his weight about preventing that from happening as the BOC said last year’s currency’s gains threaten the economy. One cannot ignore that Canadian fundamentals remain strong and that emerging countries demand for commodities, which Canada has abundance of, can only support the currency in the long run. Financial and Political (for the time being) stability continue to support the currency. With a stronger risk tolerance, speculators are better buyers of the currency on any USD rallies in the short term.

The AUD has managed to crawl it way to its month highs vs. the greenback as demand for higher yielding the assets increased on optimism for a recovery in global growth. The currency has also been aided by the price of commodities, which accounts for 50% of its total exports. Global fundamentals are improving while some Cbanks like the Fed’s rhetoric remains dovish, resulting in cheap money coveting commodities. Stronger commodity prices and positive equity indices have convinced investors that the recent currency ‘softening’ was somewhat overdone. The RBA believes its monetary policy is ‘now back in the normal range’. Traders have aggressively pared bets that the RBA was in a position to hike rates for a fourth consecutive time next month (0.9148). Expect to see better buying of the currency on pull backs to remain.

Crude is higher in the O/N session ($81.89 up +38c). Oil prices continued to put the foot on the gas yesterday after closing out last year registering the largest annual gain in a dozen years aided by the North American eastern cold snap continuing. Traders anticipate weekly inventories to show that oil supplies fell for a seventh consecutive week tomorrow. Forecasts for below-normal temperatures through mid-Jan. are expected to erode fuel stockpiles. For the immediate future any pull backs in gas or oil prices remain better bid. Last week’s EIA report showed a smaller than forecasted decline in inventories. During Dec. crude prices had been rising even as the dollar climbs and as interest rates backed up. There is no correlation and it can only suggest that the market is beginning to believe that global demand is rising. Forget the dollar. The demand ‘variable’ seems to be back on the table again. Oil inventories dropped -1.54m barrels to +326m last week vs. an expected decrease of -1.85m barrels. They were +5.2% above the 5-year average, down from +5.3%last week. Despite this week’s report, the trend of demand and consumption continues to climb. Year-to-date, oil climbed +2.7% yesterday

What a difference a New Year makes. Straight out of the gate, gold rose the most in two months as a weaker greenback boosted the demand for the commodity as an alternative investment. The official reserve currency managed to appreciate +4.2% last month and in one day gave back -0.9%. In the month of Dec., the commodity depreciated approximately -12% after printing a record high of $1,227. Yesterday it rallied just under +2%. Not unlike other asset classes, last month’s holiday swings had been somewhat overly exaggerated on liquidity constraints ($1,127).

The Nikkei closed at 10, 681 up +27. The DAX index in Europe was at 6,045 down -3; the FTSE (UK) currently is 5,494 down -6. The early call for the open of key US indices is lower. The US 10-year bond eased 4bp yesterday (3.81%) and are little changed in the O/N session. Bonds pared initial losses after the stronger than anticipated ISM manufacturing headline print. Technically, it was the first trading day in two weeks that saw FI prices rise as investors believed that the recent sell off was somewhat overdone. Yesterday’s growth reports in detail were not as strong as some traders had hoped or expected. Despite economic growth, growth overall remains muted along with inflation and in the short term will provide a bid on pull backs for the asset class. 10-year product yields remain attractive at these levels with O/N funds at zero or close to it. It’s expected that the end of the Fed’s quantitative easing program will pressurize the market, and eventually investors will have to cope with more supply.

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