G20 Green Light for Risk and QE2

Consensus has us believing it’s ‘steady as you go’ for the FX market. The G20 finance meetings this past weekend provided some progress, but, no breakthroughs for the volatile currency markets and accompanying large trade imbalances. It seems that no country is held accountable, again. The language was vague and open to interpretation. The G20 nations will ‘move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from devaluation of currencies’. It’s worded ‘fluff’ that carries no accountability. The Chinese are following the letter of the law and ‘moving towards more market exchange rates’. Is the US refraining from ‘competitive devaluation’, of course they are…..they are bringing us QE2 are they not!

The US$ is weaker in the O/N trading session. Currently it is lower against 14 of the 16 most actively traded currencies in a ‘volatile’ trading range.

The G20 rubber stamped risk, little else was achieved. We seem to be going around in the same circle with no blame being shared. European data this morning showed that the Euro-zone industrial orders had its strongest gain in five months. Factory orders increased +5.3% in Aug. and +24.4% higher y/y. It’s the strongest gain in fourteen years. The data should go some way in appeasing the concerns of the naysayer, who believes that the Euro-zone economic recovery is slowing rapidly due to government spending cuts to reduce their own budget deficits. The market is back to selling the ‘the reserve currency’ again.

The USD$ is lower against the EUR +0.54%, GBP +0.33%, CHF +0.70% and lower against JPY +1.03%. The commodity currencies are higher this morning, CAD +0.66% and AUD +1.28%. The market should be expecting to see the loonie lag vs. the dollar, despite all the negativity surrounding the greenback.The general pledge to avoid competitive devaluation probably reduces the risk of a trade war, it should be broadly positive for risk appetite and supportive of the CAD. Last week Governor Carney stood down on hiking rates as expected, citing a softer outlook for the Canadian economy. Futures prices have priced in a ‘no-hike’ for the next six-months despite policy makers continuing to see the risk to the inflation outlook as being balanced. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way. A broadly softer dollar on QE2 pressures will prevent the loonie from losing too much ground, until at least after the FOMC meeting in Nov.

The AUD has taken further strides towards parity after data last night showed that producer prices rose faster (+1.3%) than analysts expected, adding to prospects that the RBA will raise interest rates next month. The market expects CPI to also advance later this week. There is now a +52% chance that the RBA will hike rates at its next meeting on Nov. 2nd. Last week the currency had it’s first weekly loss in six, on speculation China will announce further measures to slow growth after the nation unexpectedly raised interest rates. China is Australia’s largest trading partner. Recent reports show that China’s rate of GDP growth coupled with record inflation acceleration justifies a tighter monetary policy from the PBOC. The currency is also getting a lift from the price of commodities, with the dollar under pressure commodities are advancing. Now that the G20 has given risk ownership the green light again, investors will want to own some growth sensitive currencies. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9962).

Crude is higher in the O/N session ($82.80 +$1.11c). On Friday, Crude prices did an about turn and rallied on speculation that growing French demand for imported fuel, due to their domestic strikes, would pressure inventories elsewhere. Questionable weather patters also aided the commodity. In the O/N session, prices have maintained their momentum with the dollar remaining under pressure. Earlier last week, softer Chinese oil processing data persuaded the market to expect reduced fuel consumption from the one economy that is expected to pull us away from the global recession. The Chinese’s fuel premium was discounted somewhat, as data verifying slower domestic GDP growth, higher inflation and higher interest rates, would put a dampener on their economy.
There was other bullish variables. The weekly EIA report rose +667k barrels last week, less than half what was expected. Total crude stockpiles were to increase by +1.5m barrels. The market also focused on the drawdown at Cushing (the delivery point for New York futures). Supplies dropped -1.1m barrels to +34m, the biggest one-week drop in nine-months. Gas stockpiles rose by +1.2m barrels to +219.3m vs. a -1.3m drop. In contrast, distillate stocks (heating oil and diesel) fell by -2.2m to +170.1m barrels. Analysts had expected only a -600k barrel shortfall. The refining capacity utilization rose by +0.6% to +82.5%. Analysts were looking for a +0.1% increase. Despite all this, inventories for crude and refined products remain at unusually high levels. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. The ‘big’ dollars value continues to push prices about.

Gold happened to have its first weekly decline in over a month last week as the dollar rebounded eroding the commodity’s appeal as a haven against debasement of the US currency. Its dollar negative correlation relationship remains intact. But, in the O/N session and after the G20 meeting, the dollar has weakened, boosting the demand for commodities as an alternative investment. For most of this month investors had been seeking an alternative investment strategy to the historical reserve currency. Interest rates play an important role to the commodities advance. Rising interest rates pressurize gold prices, just look at the markets reaction to a tighter Chinese monetary policy. For most of this month the market has 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’, pushing the metal to record new record highs. With market confidence wavering in currency prices, and with cheap money, has made commodities look attractive on pull backs. To date, gold has outperformed global equities and treasuries (+20.2%), 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 had 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 ($1,345 +$20).

The Nikkei closed at 9,401 down -26. The DAX index in Europe was at 6,655 up +50; the FTSE (UK) currently is 5,784 +43. The early call for the open of key US indices is higher. The US 10-year backed up 1bp on Friday (2.54%) and is little changed in the O/N session. Treasuries prices fell, pushing the longer dated yields up as the US Treasury announced the value of this week’s supply coming to the market ($35b-2’s, $35b-5’s and $29b-7). It will be the sixth straight month that the government has lowered its offering of the three-maturities. Investor’s continue to speculate about how much US debt the Fed may buy if it resumes asset purchases to spur the economy. One gets the feeling that individuals do not have the capacity to buy any more ‘product’. The market is certainly leaning heavy to the long side and a bit of lightening up is only natural.

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