Forex markets believe ‘aid’ passing is a given and Global Recession is looming!

An inducement loaded bail-out package makes its way to the ‘House of Representatives’. Will the show of over whelming support in the Senate provide the necessary political clout to save the financial industry? ‘A week is a long time in politics’, the ‘House’ performance tomorrow afternoon could make it a nervous weekend for Capital Markets!

The US$ is stronger in the O/N trading session. Currently it is higher against 12 of the 16 most actively traded currencies, in another ‘whippy’ trading range ahead of this mornings ECB rate announcement.

FX Heatmap October 2nd, 2008

Yesterday, the US manufacturing sector contracted at a faster pace than estimated. The ISM manufacturing index unexpectedly fell to 43.5 vs. 49.9 (the lowest level in 6-years). By default, this would suggest that industrial production also declined last month. With weaker global demand for US exports and a disillusioned consumer (who has been beaten down by rising economic uncertainty, fewer jobs and softening real wages) the future for manufactured goods does not bode well. This trend is expected to continue for the remainder of the year as business investment contract, along with consumer spending. The credit crisis has spread from ‘Wall Street’ into the ‘Real Economy’. The data provides stronger evidence that US manufacturing, which had weathered a domestic slowdown because of record exports (a softer US dollar), is now starting to collapse as global expansions falter with the financial crisis. Europe’s economy is faltering at a quicker pace. Digging deeper one notice’s that ‘new’ orders fell to a 7-year low of 38.8 while production dipped to 40.8 and inventories declined to 43.4. The only two bright spots were moderating prices (which fell from 91.5 in June to 53.5), and continued expansion in ‘new export orders’ which remained tentatively above 50 (foreign demand is slowing). As expected, the employment component dropped to 41.8. This would suggest that we will see a six figure number at tomorrows NFP number.

The market has discounted yesterdays ADP employment report which showed that private sector employment only declined by -8k jobs in Sept. (and large firms only lost -6k), much less than the -50k expected. Given the recent layoff announcements, such a small decline is a large pill to swallow. With the historical divergence between the ADP report and NFP, consensus continues to seek a -150k decline in payrolls for Sept. As the US economy weakens further, one should expect bigger declines in ADP employment, especially since the financial market shake up (collapses and consolidation have occurred). It’s worth noticing that the Aug. ADP report was revised down to -37k from -33k.

Trichet has been very vocal ahead of this morning’s ECB rate decision. It is expected that they will remain on hold (4.25%) and study the ‘lay of the land’ after this weeks Bank-Bail out package vote. One cannot expect CBankers to use all their bullets in one go. He said that US lawmakers must pass the measure to shore up confidence in the global financial system. ‘It has to go, for the sake of the US and for the sake of global finance’.

The US$ currently is higher against the EUR -0.74%, GBP -0.19%, CHF -0.53% and lower against JPY +0.36%. The commodity currencies are mixed this morning, CAD -0.03% and AUD -0.31%. The loonie remained under pressure yesterday and in a well defined trading range. The market is uncertain on what the US bailout package is going to look like, if it gets passed, or when it gets voted on. With crude prices falling, it has also managed to lend a hand to the CAD$ decline. The ongoing global credit squeeze has investors shying away from riskier growth currencies like the loonie. Capital market remains focused on the US financial aid package progress through both US houses before it becomes written in law. The fear that US will enter a deep recession despite what ever aid is handed out will weigh heavily on the CAD dollar in the medium term. Canada is guilty by its proximity and association to its southern neighbor. The US remains Canada largest trading partner, 75% of all exports head south of the border, and 50% of all exports are commodity based. Loonie bulls will have to wait until the financial aid package is passed before the currency has any short term hope of appreciating. Governor Carney has indicated that any further slowdown in the US economy will affect areas that matter most to Canada. He 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. Perhaps we will see a coordinated rate ease by Cbanks sooner than expected. Expect traders to be better sellers of the CAD$ on USD$ pull backs in the short term until proven wrong.

The AUD dollar continues to remain under pressure (like most commodity currencies) as investors sell higher-yielding assets on concern that the US bail-out will not stop the world’s largest economy from sliding into a recession. The AUD has dropped more than -10% percent vs. the greenback in the past 3-months, as prices slid for commodities that Australia exports. The fear of the unknown has trader’s better sellers of the currency on rallies, and they have increased their bets that the RBA will cut O/N borrowing costs this month by 50bp (7.00%),. The main objective is to encourage banks to boost lending amid a global credit freeze rather than hoarding cash.

Crude is lower O/N ($96.47 down -206c). Crude oil remains under pressure as Capital Markets believe that the US economy will slip into a recession. And in doing so, it will curb fuel demand in the world’s largest energy consuming country. Investors remain skeptical that a ‘bank rescue plan’ will keep the US economy from slowing. Contagion is moving from ‘Wall Street’ to ‘Main Street’. This week we have seen record gains and record losses being recorded, increasing trade volatility to its highest level since the Gulf War, 17-years ago. Fundamental concerns have kept pressure on the ‘black stuff’ prices. The global economy remains very fragile, economic activity in Europe seems to be collapsing faster than in the US. The bail-out package does not guarantee that there will be no more bank runs or that the US economy will recover anytime soon. The 5-Bank bailouts this week in Europe continues to pressurize the EUR and Sterling respectively. By default, it has created a stronger USD, which makes commodities more expensive for investors outside the US, thus weakening demand. This week’s EIA report showed a bigger than forecasted increase in supplies as fuel consumption dropped to the lowest level in 7-years. Crude inventories rose +4.28m barrels to 294.5m vs. an estimated climb of +2.75m barrels. Imports and refinery operations increased after Hurricanes curtailed supplies last month. The 4-week fuel usage has averaged +19m barrels a day (lowest since 2001). Technical analysts now believe with imports remaining high (increased +26% to +8.99m barrels a day) and refinery operations back on line (+72.3% capacity, up +5.6% w/w), the $90 price level is attainable. Gold has declined this morning in London ($873) as the ‘big’ dollar gained vs. the EUR and crude-oil fell, reducing demand for the ‘yellow metal’ as a hedge against US currency weakness and inflation.

The Nikkei closed at 11,368 up +108. The DAX index in Europe was at 5,843 up +37; the FTSE (UK) currently is 5, 009 up +19. The early call for the open of key US indices is higher. 10-year Treasury yields eased 8bp yesterday (3.73%) and are little changed O/N. The Treasury prices remain better bid (especially in the front end) as traders continue to speculate that the US will enter a recession regardless of whether lawmakers approve the $700b ‘toxic waste plan’ to rescue the financial system. Capital markets are looking beyond the vote and are focusing on fundamental data which justifies the beginning of a ‘long deep recession’. Dismal US employment and manufacturing data yesterday has 38% of futures traders pricing in a 50bp ease by the Fed on Oct. 29th (2.00%). They have already priced in a 100% chance of a 25bp ease.

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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