Not the data-how much QE2 needs pricing in or out?

Presently, data does not provide the same punch to currency markets. The fact that the ECB is probably closer to raising rates while the Fed is to lowering has the markets attention. Next year data releases will become more significant. This morning’s German investor confidence fell to a 21-month low (-7.2 vs. -4.3), suggesting that growth will probably slow over the coming six-months. Offsetting some of the negativity and providing support for the EUR was the Zew current situation indicator increasing to 72.6 vs. 59.9, which suggests that activity may hold up in the final quarter. Markets can go back to what they do best, create volatility by speculating how much QE2 needs to be priced in or out.

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

It does not matter how you slice and dice it, yesterday’s US industrial report was broadly negative and disappointed Capital Markets (-0.2% vs. +0.2%). Digging deeper, excluding motor vehicles (+0.5%, m/m) and high-tech products (-0.2%, m/m), the most volatile components, then core industrial production fell -0.3%. It’s noted that the loss was spread across all subcategories except one. Utilities lead the contraction (-1.9%). Manufacturing dropped -0.2%, as did both machinery (-0.7%) and electronics (-0.4%). The mining subcategory was the only winner posting a gain of +0.7%. If you broke it down into market groupings, then the results were equally disappointing. Four of the five final categories posted contractions, including consumer goods (-0.4%), defense (-0.2%), construction supply (-0.8%) and business supplies (-0.9%).  Business equipment was the only category to post an advance (+0.1%).

The Fed keenly watches the Capacity Utilization rate. It remained unchanged at 74.7% last month. This indicator coupled with the US’s soft job market will have the Fed on hold well into the end of next year. It’s also worth noting that the six-month diffusion index of industrial production (+65.1%), although well below this years highs, is much higher that the lows printed nearly 2-years ago.

US homebuilders confidence jumped +3pts to +16 yesterday, eclipsing market expectation. That was probably the most positive part of the report. Overall, confidence remains depressed, well below the 50-point break even line. The consensus view has the housing market remaining on the soft side for the future. Breaking down the report, one could say that the gains were broad based. The view on the current single-family home sales and their outlook posted gains, up +3pts to +16 and +5pts to +23, respectively (remain at historical lows). The number of ‘prospective’ home-buyers touring model homes moved up a modest +2pts to +11, while foot traffic remained weak (indicating weaker home sales). The same factors continue to depress the housing market. Anything from excess supply to job security and lack of disposable income will continue to weigh on this sector for a very long time.

The USD$ is lower against the EUR +0.06% and CHF +0.08% and higher against GBP -0.21% and JPY -0.10%. The commodity currencies are mixed this morning, CAD -0.26% and AUD +0.07%. The loonie come under renewed pressure vs. the dollar and the EUR ahead of this morning’s BOC rate announcement. At one point during the session, the CAD happened to post its biggest monthly loss against the dollar and a seven month low vs. the EUR before finding some traction in an oversold market. Technically it’s the fourth consecutive day of losses after achieving parity vs. the greenback. Capital Markets and futures traders have priced out any rate hike by Governor Carney this morning. The only surprise would be either a hike or a hawkish statement from the BOC. Last week the currency briefly found favor on the back of the MAS actions of widening their trading band, effectively tightening monetary policy. Big picture, because of the softer Canadian data this quarter and because of the strong economic ties with the US there is already much QE priced into the market. Barring any surprises from Carney, take you lead from commodities and the general direction of the dollar.

The AUD won the battle of reaching parity, albeit briefly, and aggressively fell from its twenty-seven year high on speculation that the Fed would add less monetary stimulus than expected, damping demand for higher-yielding growth assets. Analysts note that going into next months Fed meeting’s that the ‘risks are skewed towards further disappointment’ which has the market aggressively pricing out some of the QE2 premium. Last nights RBA minutes showed that policy makers decision to keep interest rates unchanged this month had been ‘finely balanced’. On the other hand they did indicate that rates would have to ‘rise at some point’. From a fundamental perspective the minutes reinforced the argument that there could be another hike coming in Nov. or Dec. given that the RBA seems very comfortable with where the currency is currently. Month-to-date, the AUD has climbed +7.1% vs. the buck as data fueled bets that the RBA will raise interest rates before the year ends. There was enough in the report to keep both the hawks and doves happy. Futures traders now see a 42% chance that the RBA will increase its target rate next month, down from 66% last week. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9887).

Crude is lower in the O/N session ($82.80 -28c). Most of yesterday’s gains can be attributed to an oversold market. The remaining price gains were due to a rebounding equity market and on data revealing that US homebuilder confidence rose this month for the first time in five-months. The black-stuff has erased most of Friday’s -1.1% decline as the dollar fell vs. the EUR, enhancing the appeal of commodities as an inflation hedge. The big picture has the commodity climbing on the back of growing speculation that the Fed will give the US economy a boost. Since the release of the FOMC minutes showing policy makers are prepared to buy more government debt, debase their currency, crude had climbed +2.3%. Interestingly, last week’s inventory report revealed a small drawdown on stocks. Crude fell by -416k barrels to +360.5m, compared with the estimated increase of +1.2m barrels. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should expect inventories to gravitate towards their highs. Not to be left in the cold, gas inventories fell -1.8m barrels to +218.2m, just above the weekly estimate of a -1.4m drawdown. Distillate stocks (heating oil and diesel), fell by -255k barrels to +172.21m. Finally, the refining capacity fell by -1.2% to 81.9%. It seems that the drop in refinery runs has probably caused the drop in fuel supplies. The market remains wary that the underlying fundamentals have not changed despite prices remaining rangebound.

Gold pared most of its European and North American losses yesterday, as the dollar lost ground after some disappointing US data. It is a commodity in demand again for alternative investment purposes. Last week, investors traded with a distrust of currencies and gold seemed to be the only solution as investors used it as a proxy for a ‘third reservable currency’. With market confidence wavering in currency prices, and with cheap money, has been making commodities look attractive on pull backs. Any time that governments are in the business of printing money then the commodity is bound to do well. To date, gold has outperformed global equities and treasuries (+23.8%), 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’. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to low interest rates ($1,370 -$1.60c).

The Nikkei closed at 9,539 up +41. The DAX index in Europe was at 6,535 up +19; the FTSE (UK) currently is 5,745 +3. The early call for the open of key US indices is lower. The US 10-year eased 2bp yesterday (2.51%) and is little changed in the O/N session. We are witnessing an about turn in the FI market, as treasuries rally after its biggest weekly drop, on speculation that the Fed will be more aggressive in its asset buying after the disappointing industrial production numbers yesterday. Various Fed speakers chimed in, stating that the ‘much more’ monetary accommodation was warranted to counter low inflation and high unemployment, a week after helicopter Ben signaled that QE2 was likely. At the moment, the market is playing hostage to any Fed rhetoric. Deeper pull back are to be bought. Buy the ‘rumor sell the fact’.

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