Merkel’s Europe Looks Small

Hey G20, what’s wrong with a phone call? You could have left a message “sorry we failed to agree and we will talk about it again in the New Year”. The upshot, global leaders are blinkered to domestic issues superseding currency stability and trade imbalances. They have agreed to piecemeal an ‘indicative guideline’, yet to be defined. In translation, it’s a signal to the world that a precarious economic situation is developing. Merkel continues to flex her might and insists that investors take a ‘haircut’ on periphery debt. Germany is trying to bully the Irish into submission. This can only lead to the periphery states losing their economic and political identity under the Euro-zone. Germany’s version of a stronger Europe looks very small indeed!

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range.

As expected Fridays Nov. UoM consumer index inched higher (69.3), the improvement of 1.6 pts was distributed between gains of consumers’ present assessment of the economy (79.7 vs. 76.6) and consumers’ slight optimism towards the future (expectation index advanced to 62.7 from 61.9). The minimal m/m swings remain within striking distance of the four month average (68.2). Twice as many consumers expect the economy to improve rather than worsen (+30% vs. +16%). It’s comforting for retails to note that ahead of the holiday shopping season, consumers voiced more favorable consumption attitudes. Finally, the short-term inflation expectations edged higher to +3% vs. 2.7%, while long-term expectation held steady at +2.8%.

The USD$ is higher against the EUR -0.43%, GBP -0.41%, CHF -0.04% and JPY -0.46%. The commodity currencies are mixed this morning, CAD +0.02% and AUD +0.11%. The loonie has temporarily failed on its lack of follow through parity and weakened vs. its largest trading partner on heightened risk aversion sentiment. With commodity and equity prices plummeted last week as China’s inflation numbers suggest a tighter monetary policy by the PBOC is directly affecting growth sensitive currencies. Softer trade numbers this month is strong proof that Canada cannot fundamentally rely on foreign demand to buffer the slowdown in domestic activity. For a commodity supportive currency, the loonie has only appreciated +1.5%, y/d, underperforming other growth currencies. The market is back to embracing the event risk factor and with Euro-peripheral debt problems expect investors to continue to cash in on their profitable long CAD positions.

The AUD continues its downward momentum, registering a two-week low in the O/N session, as Asian bourses declined on speculation that the Euro-zone will struggle to raise funds. Risk aversion was evident on the back of China’s pending rate hike. The slump in commodities and the general strength of the dollar has impeded the advance of growth sensitive currencies. The market is also anticipating that US retail sales climbed for a fourth consecutive month. Some softer jobs numbers last week also justified the unwinding of profitable positions. The Aussie unemployment rate jumped to +5.4% from +5.1%, a six-month high as job seekers swelled to a record, easing concern that a labor shortage will drive up wages. This months sudden jump in risk aversion over European periphery debt issues and a larger than expected Chinese monthly trade balance has again reduce the risk appetite of investors. The Chinese surplus is the second biggest this year. With Chinese authorities demanding higher bank reserves, again will restrict the flow of ‘hot’ money, indirectly and negatively affecting regional bourses and growth currencies. Market players are viewing corrective rebounds as fresh selling opportunities short term (0.9863).

Crude is higher in the O/N session ($85.30 +41c). Oil prices have been unable to sustain two-year highs as global bourses found it difficult to maintain positive traction and on fears that China may attempt to rein in inflation by raising interest rates and curb the commodity demand. The market continues to question the fundamental strength of other economies once the Chinese’s variable is erased from the global growth equation. The commodity found strength this week on the back of disappointing weekly inventory numbers. The report showed an unexpected decrease in stock as imports declined and refineries bolstered fuel production. The supplies of weekly crude fell -3.27m barrels to +364.9m. The market had anticipated inventories to climb +1.5m barrels. Aiding prices was the inventories of gas and distillate fuel (heating oil and diesel) posting bigger-than-projected declines. Gas stocks dropped -1.9m barrels, while distillates fell -5m barrels. Total oil and fuel inventories are now at their lowest levels in six-months after retreating in four of the last five weeks. Refineries operated at 82.4% of capacity, up +0.6%, w/w. Crude-oil imports tumbled -5.7% to +8.09m a day, the lowest level in eleven months. The ‘big’ dollars value will continue to influence prices despite fundamentals.

Gold prices fell last week, crystallizing a weekly loss, on speculation that China will raise interest rates to cool the economy. The stronger dollar has also curbed the demand for bullion. Speculators should expect European debt concerns to eventually provide support on these pullbacks. There were times last week that the one directional play felt so overdone and every time this has occurred, global fundamentals provided a reason to own it. The metal has advanced and fallen on speculation that European governments may struggle to pay debt. That argument depends on what direction the big dollar decides to take. With Capital Markets shifting their focus toward sovereign debt issues and away from QE2 debates, will continue to provide support for this asset class again. Year-to-date, the metal is up + 24.8% and is poised to record its 10th consecutive annual gain. For most of this year, speculators have sought an alternative investment strategy to the weaker dollar and have been using the commodity as a proxy for a ‘third reservable currency’ ($1,366 +$1.40).

The Nikkei closed at 9,827 up +102. The DAX index in Europe was at 6,732 down -2; the FTSE (UK) currently is 5,783 -14. The early call for the open of key US indices is higher. The US 10-years backed up 9bp on Friday (2.74%) and another 8bp in the O/N session (2.82%). Treasury prices have plummeted as the market is speculating that European leaders will eventually have to boost the Euro-zones most-indebted nations, reducing demand for safety. Last week the market had been lent on by dealers as they took down Treasury supply. Even the Fed buying $7.2b’s worth of product, as they embark on a second round easing to reduce unemployment and avert deflation, could not stem the rise of yield. Does this mean that Helicopter Ben theory to promote growth is broke? The market is saying so. Will we experience a whip lash effect in prices after US Retail Sales?

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