China’s reval smokescreen for G8

Should we really be that surprised of China’s decision to allow greater flexibility of the Yuan? Its boondoggle week, everyone is off to Toronto for the G20. China had to come with a gift so as not to spoil Harper’s party. Beijing is presenting this gift as contributing to the rebalancing of the global economy. How could such a gift be refused? It would be bad manners. At least temporarily, we should witness the easing of trade tensions and of China’s need to hike rates aggressively, which obviously has worried the commodity markets of late. This gift allows China to participate in the fun and games and not answer any questions.

The US$ is mixed in the O/N trading session. Currently it is lower against 10 of the 16 most actively traded currencies in a ‘volatile’ trading range.

The dollar has come under some pressure, rightly so, as the China move has created a positive global sentiment and reduced, temporarily, the safe heaven demand for the USD, pushing equities higher and treasury prices lower. Are the moves sustainable? The subsequent appreciation of the Yuan is likely to be small, perhaps just a few percent over the remainder of the year. In the grander scheme of things, it’s not a huge deal and after all said and done, trade tensions will always return. Analysts note that a much bigger move would do nothing to boost the global economy without additional steps to increase demand ‘within’ China itself. Overall, the fundamentals for US Treasuries remain positive, perhaps China may have to buy more overseas assets to counter the increased inflows of speculative money in anticipation of further currency gains. The European fiscal crisis remains on the front burner, and is negative for the EUR. With the reduction of market short positions over the last week, this Chinese policy change provides the perfect excuse to sell into the EUR rally.

The USD$ is higher against the EUR -0.06% and JPY -0.31% and lower against the CHF +0.16% and GBP +0.30%. The commodity currencies are stronger this morning, CAD +0.41% and AUD +0.37%. The loonie ended last week recording its second consecutive weekly gain on the back of higher commodity prices and on investors paring of some of the risk-aversion trading strategies. The CAD happened to print a monthly high in the O/N trading session, as speculators continued to place bets that Governor Carney will raise interest rates faster than other country. All this despite the BOC Governor stating earlier last week that ‘the uneven global recovery and prospects of renewed weakness in Europe mean that future increases in the central bank’s benchmark interest rate are not preordained’. The loonie remained coveted as speculators increased their bets that economic growth will eventually fuel demand for commodities after the ‘flexible Yuan announcement’. Big picture, the CAD is holding its own after the BOC’s rate hike and somewhat muted and directionless communiqué earlier this month. It remains the world’s second best performer vs. its southern neighbor. Using the loonie as a safer way to play an economic recovery in the US with linkage to commodities and less banking or fiscal noise has speculators better buyers of the currency on dollar rallies. Parity is once again on the horizon.

The AUD managed to print a new month high after China indicated that they would allow the Yuan to appreciate, thus boosting demand for countries who sell products to the world’s third-largest economy. In theory, ‘commodity rich exporting countries should benefit from the increased purchasing power of Chinese manufacturers’. Earlier last week, comments from the RBA, who said that Europe’s debt crisis would ‘inevitably weigh’ on global growth, had fueled speculation that the RBA may keep rates unchanged until at least the end of the year. It seems that that ‘previous rate rises has given them flexibility to leave borrowing costs unchanged at next month’s meeting’. Last week, stronger domestic fundamentals aided the currency. Employment data added +26.9k new jobs vs. an expected +20k. It was the third consecutive month of job gains, emphasizing the RBA’s call that that economic growth will accelerate this year. This pushed dealers into increasing their bets that Governor Stevens will resume the country’s most aggressive round of monetary tightening. So far, it seems that the crisis in Europe has not had a material impact on the Australian economy. With European stress test disclosures lined up and PBOC announcement has temporarily calmed investor’s fears. Technically, the market continues to want to buy AUD on dips (0.8842).

Crude is higher in the O/N session ($78.45 up +127c). Crude prices have rallied to a six week high in the O/N session on increased confidence in the global economic recovery after China signaled an end to the Yuan’s fixed rate policy. The big dollar has pared its gains vs. the EUR, thus boosting the appeals of commodities as an alternative investment. Earlier last week, the EIA report initially gave the market its bullish sentiment, however, weaker global economic releases managed to encourage some ‘risk-off’ trading strategies. The report was dominated by the drop in refinery capacity rates. US refineries operated at +87.9%, down -1.2% from the previous week. Gas stocks declined -636k barrels to +218.3m last week with gas demand advancing +1.6% to +9.34m barrels a day (the highest level in nearly a year). Historically, gas consumption peaks sometime between US Memorial and Labor Day in Sept. (the height of the US driving season). On the flipside, crude oil rose +1.69m barrels to +363.1m vs. an expected -1m barrel decline. Inventories of distillate fuel (diesel and heating oil) increased +1.8m barrels to +156.6m vs. an expected +1m barrel gain. Direction is dictated by demand and with ample supply and growth worries to data has had speculators wanting to sell oil futures on rallies, however, confidence continues to provide the bid.

Gold continues to be a safe heaven attraction. Over the past four trading sessions all pull backs have been bought. The commodity’s prices remain robust on speculation that European’s Economic woes will be prolonged. With broader risk appetite becoming subjective, the market was capable of printing new record highs in the O/N session. Technically the ‘yellow metal’ is trading with a greater consideration of its safe heaven status. The asset class is well sought after as prices have been difficult to break down, which is, by default, technically encouraging individuals to want to own more of it for hedging purposes. Year-to-date, gold has gained +16%. Generally, it has become the benefactor when all other currencies fail. Thus far, Europeans have been content in using the commodity as a hedge against their European holdings, believing that the EUR has not bottomed out just yet. For now, buyers are waiting in the wings to purchase product on pull backs ($1,263 +480c).

The Nikkei closed at 10,238 up +242. The DAX index in Europe was at 6,299 up +82; the FTSE (UK) currently is 5,300 up +50. The early call for the open of key US indices is higher. The US 10-year backed up 2bp on Friday (3.22%) and another 7bp in the O/N session (3.29%). For most of last week, treasuries rallied on speculation that weak US employment and subdued inflation would persuade Bernanke to keep interest rates at a record low. Thursday’s weekly claims coupled with consumer prices falling reinforced that theory. Friday, the market was able to pare some of that rally as concerns eased that Europe’s debt crisis would worsen. With China stating that it will allow a more flexible Yuan has boosted confidence in the global recovery and triggered gains in global bourses, and pushing yields higher. However, rumblings that the US economy’s momentum is not being built upon could continue to provide some sort of bid on deeper pullbacks. Let’s see how North America wants to digest President Hu’s ‘flexible’ Yuan announcement over the weekend.

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