Holding a EUR position is playing with fire

Is it enough to convince investors? European regulators found that ‘only’ seven banks need to raise a combined EUR3.5b of capital. From all the monies that have been given out and promised by various Governments the sum sounds like pittance. Are the tests strict enough? Is it another ploy to support global confidence, to bamboozle the negativity and second guessing that is in danger of spiraling into oblivion? On the first pass, it seems that the tests were set in such a way that most of them would pass. Perhaps the regulators and governments commitments may well outweigh doubts about the stringency of the tests. Market reaction thus far is undecided.

The US$ is weaker in the O/N trading session. Currently it is lower against 12 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Initial reaction had market participants welcoming the results of the stress tests, driving appetite for higher risk in Asia. The European session, however, is questioning the ‘rigor and credibility of the tests’, specifically the worst case macro-scenario and the haircuts applied to sovereign debt. The lack of transparency and credibility in the tests is likely to limit the upside to the EUR temporarily. The latest CFTC reports show that the EUR shorts have been trimmed further, another reason not to trade much higher in the short term.

The USD$ is lower against the EUR +0.31%, GBP +0.40%, CHF +0.18% and JPY +0.58%. The commodity currencies are stronger this morning, CAD +0.18% and AUD +0.30%. The loonie got the nod from various sources last week. A strong commodity and equity market, its proxy for a reserve currency status and finally from a central bank who happened to tighten rates 25bp pushed the currency higher. The interest rate differential scenario seems to be getting the biggest support for now, despite it being a ‘dovish hike’. The currency rose again on Friday vs. its largest trading partner as most European banks that received stress tests passed. Governor Carney enforced that there was no pre-ordained path for interest rates in Canada. According to Carney’s dovish communiqué ‘the global economic recovery is proceeding, but, is not yet self-sustaining’. The 25bp hike last week will ‘leave considerable monetary stimulus in place’, with both the core and total inflation to advance at about a +2% annual rate through 2012 (within their target zone). Some will argue that with signs of a significant slowdown underway in the US, it’s possible that the BOC may be persuaded to move back to the sidelines on the Sept. go-around. Carney has given himself the latitude to step back and assess global growth for the 3rd Q. Stronger commodity and equity prices favor buying CAD on pull backs.

The AUD is encroaching on its 3-month high vs. the USD, as signs that the global economy is stabilizing is spurring investor demand for higher-yielding assets. Option barrier protection is occurring around the 0.9000 level at the moment. The currency has rallied a third straight day vs. the JPY after regional bourses advanced now that most European banks passed the stress tests and US corporate earnings surpassed market expectations. The market is also expecting a stronger CPI report this week from down-under, which again will put the RBA under the spot light to hike rates at the Aug. 3rd policy meeting. The currency gained +2.9% vs. the greenback last week after the RBA’s July minutes showed that Governor Stevens intends to use results of Europe’s stress tests and local inflation figures to decide whether to resume raising rates. The pace of CPI increased nearly doubled to +0.9% in the first quarter. Fundamental analysts believe it would take another rate hike for the currency to trade again in the 90’s and technically it’s a sell on approaching these levels. Policy makers are ‘reinstating their view that domestic growth will be about trend’ and are ‘not alarmed by the global demand backdrop’. In retrospect, policy makers remain ‘very upbeat’. Because of equities actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.8975).

Crude is softer in the O/N session ($78.52 down -46c). Crude prices fell from just under a three month high on Friday on speculation that Tropical Storm Bonnie would not be strong enough to damage production platforms in the Gulf of Mexico. Proven to be true and after last weeks strong rally, technically, the market was going to cash in somewhat on the advance. For most of last week, prices rallied as global bourses advanced on signals that economic growth will accelerate. Also supporting investors selling actions are last weeks surprising EIA report. The market had been expecting a drawdown on inventories. However, not so, stocks showed a surprise increase, reporting a rise of +400k barrels of oil for the week whilst the market had been expecting a headline decline of -1.6m. The dovish report continued with its gas inventories rising +1.1m barrels and its stockpiles of distillates (diesel and heating oil) doubling expectations to +3.9m barrels. Once again technically, the gas markets numbers show ‘lackluster demand and will put pressure on the entire energy complex’. We continue to remain range bound with the price action as the market looks for vindication.

Gold has been caught in a relatively tight trading range over the past 10-trading sessions, lacking a catalyst to carry momentum to the upside again. The commodity has been fighting its technical support 100-day moving average. Prices have found it rather difficult to gravitate too far from the $1,185-88 magnet. Dealers expect investors to dump their remaining long positions on a break of this level. Tentatively, gold futures are trying to rebound on speculation that the Fed will act to stimulate US growth. This action should drive the dollar lower and boost the appeal of the precious metal as an alternative asset. At the moment it’s has been frustrating for investors to buy into the intraday story, the ‘too and froing’ of the price action in a tight range has proven expensive. With the results of the stress tests going relatively well thus far is causing little flight to quality buying in the gold market. Bigger picture, technically, the bullish sentiment had been on hiatus with profit taking testing the medium term support levels. Fundamentally, in the short term the metal will find it difficult to rally aggressively as this is the ‘slowest’ season for physical demand. Year-to-date, the commodity has gained +8.8% and is in danger of giving up more ($1,190 +$3.00).

The Nikkei closed at 9,503 up +73. The DAX index in Europe was at 6,154 down -12; the FTSE (UK) currently is 5,313 up +2. The early call for the open of key US indices is lower. The US 10-year backed up 7bp on Friday (2.97%) and is little changed in the O/N session. After printing new record low yields, the US front-end plunged on higher earnings easing concerns that the Fed may have to consider more stimulus measures to help sustain the US economic recovery. With the Treasury planning to auction $104b of new product this week ($38b 2’s, $37b 5’s and $29b 7’s), cumulatively lower that the previous two months, will certainly have dealers wanting to cheapen the curve a tad at these technically ‘rich’ low–yields. Current market sentiment has dealers wanting to be better buyers on deeper pull backs, as the market foresees a flatter yield curve as analysts predict that 10’s will yield 2.75% by year-end.

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