EUR shorts will be squeezed

It’s a market given that helicopter Ben will not announce any new policy measures this afternoon. Mind you, we should never say never in a vulnerable environment. Today’s FOMC decision is likely to present an opportunity for US policymakers to reassert their commitment to QE2, possibly offering further clarification on the rationale behind the policy decision. US retail sales is expected to post its fifth consecutive higher print this morning. Expect this to endorse this year-end risk appetite we are currently witnessing, without necessarily exerting upward pressure on yields or the dollar. Follow the yields, its Bennankes objective to get them lower and with that the USD too.

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’ European trading range.

With the lack of US data to focus on yesterday, the market found other reasons to want to sell the dollar outright. China refraining from tightening monetary policy at the weekend after inflation surpassed +5%, y/y triggered risk appetite, curbing demand for the dollar. Moody’s warning that there is a higher chance of a negative outlook for the US following the extension of the Bush-era tax cuts has also pressurized the dollar. The EUR is also being supported by the possibility of the EU/IMF fund being extended in order for it to have enough room to accommodate Spain. Even Trichet is doing his bit by raising the Cbank’s bond buying program significantly from previous weeks. Finally, the EURO diplomats are singing the currency’s praises by stating that investors should not bet against the EU countries determination to defend their common currency. The year-end short squeeze has begun. With liquidity becoming more of a premium as the turn draws closer and with the market anticipating that helicopter Ben will defend his policy makers QE2 intentions, the dollar will continue to have choppy waters to navigate as 2010 draws to a close.

The USD$ is lower against the EUR +0.38%, GBP +0.07%, JPY +0.21% and CHF +0.40%. The commodity currencies are mixed this morning, CAD -0.05% and AUD +0.15%. Month-to-date, the loonie has gained +1.8% outright vs. its largest trading partner down south. Yesterday, the currency advanced for a fourth consecutive day, the longest winning streak in more than a month, as gains in commodities and stocks make currencies related to economic growth more attractive. The dollar index has suffered ‘across the board’ on renewed risk appetite after China refrained from hiking rates, pushing the CAD towards modest gains as it still underperformed other growth sensitive currencies. Governor Carney fired a warning shot in a prepared speech yesterday, stating that ‘the refusal by some countries to let their exchange rates float is slowing inflation in advanced economies, which may spark additional loosening of policies globally’. The loonie continues to struggle within striking distance of parity because of good corporate interest to own dollars there. The market expects support for the loonie from the Russian Cbank on dollar rallies because of their appetite to convert approximately 1-2% of their reserves into the CAD. Some of the loonies shine has been taken away with Governor Carney’s comments after the BOC kept rates on hold last week. Carney acknowledged economic growth in the second half of this year is weaker than previously anticipated and expressed concern about the expected recovery in net exports (that’s a strong loonie problem). The market has taken this as a dovish sign for rates. Corporate dollar interest near parity should provide resistance for the loonie until year-end.

Now that China has refrained, temporarily at least, from tightening monetary policy, is giving growth and interest rate sensitive currencies a helping hand. The AUD is again on course to challenge its psychological resistance level of parity today vs. the dollar outright. With China on hold, the Aussie has rallied against most of its trading partners on the back of stronger commodity and equity prices as investors close out the year embracing risk. The AUD has climbed +9.8% this year (second biggest winner after JPY), on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt compared with other developed markets. Domestic data remains strong, this months employment data blew all analysts expectations out of the water and supports the currency on pullbacks. Not aiding the currency is the concerns for long dated interest rates in the US. Analysts are beginning to agree that the tight labor market will bring the RBA back into the picture, but believe that Governor Stevens is not behind the curve just yet and will not be required to hike rates in February. With consumers boosting their savings significantly in an environment of rising job and wage growth, suggests that the RBA is still ahead of the curve. Governor Stevens has also mentioned that rates are ‘appropriate’ for the economic outlook. Investors remain better buyers on dips, planning an assault on parity again (0.9977).

Crude is lower in the O/N session ($88.47 -14c). Crude found its second wind yesterday. Reports over the weekend revealed that China’s refiners increased their processing rate last month. The worlds biggest energy consumer boosted their net imports of the black stuff by +26%, m/m, and increased their processing rates to ease a diesel shortage. Coupled with OPEC announcement to maintain their production quotas and the PBOC refraining from tightening monetary policy is supporting the market, probably to the year end at least. OPEC believes that supply and demand are ‘in balance,’ and expect demand growth will slow as the global economy struggles to recover, amid ample supplies. Recent prices have already been elevated on the back of last week’s large fundamental drawdown of inventories and not on the strength of the dollar. The EIA inventory crude headline fell -3.82m barrels to +355.9m. Supplies were forecasted to drop by -1.4m barrels. Technically, the rise in these categories confirms there is nothing wrong with supply, but the demand picture in the US is not that robust. This is certainly in contrast to the stronger fundamentals that is occurring in Asia. Technically, expect the market to meet resistance again at the $90 high printed earlier this month.

Gold prices have found support from China refraining to hike interest rates over the weekend. The muted response to the PBOC decision to raise banks reserve requirements to +18.5% gave investors the green light to strap on some risk. Market fears that China would tighten monetary policy had eroded the demand for precious metals for most of this month. Bottom feeders have managed to stem the slide, believing that the $60 fall from its highs last week was a good opportunity to own a store of value as an alternative investment. It was only natural to see some profit taking after gold surged to a new record ($1,432.50). The commodity remains supported by the persistent concern over Euro debt levels. To date, debt contagion has driven investors into the third ‘reservable’ currency as they seek a store of value. Despite the fear that China will tighten their monetary policy, most likely in the New-year, a move to curb speculation and dampen inflation, global demand remains robust. Even though the one direction trade feels overdone, investors continue to hold gold as a hedge against currency debasement and long-term inflation. The Euro-zone backdrop is trying to put a floor on metal prices on demand for a haven. Year-to-date, the metal is up + 28% and is poised to record its 10th consecutive annual gain ($1,403 +$5.20c). Technical analysts believe that gold will outshine other precious metal in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,316 up+23. The DAX index in Europe was at 7,022 down-7; the FTSE (UK) currently is 5,849 down-11. The early call for the open of key US indices is higher. The US 10-year eased 3bp yesterday (3.29%) and is little changed in the O/N session. Treasury prices rose, pushing yields down from a six-month high on a combination of factors. First, there was some natural profit taking as the US yield curve shifted aggressively higher over the past five-trading sessions. Second, a federal ruling against the Obama healthcare overhaul has eased concern that the government will struggle to tackle the US record deficit and finally on speculation that helicopter Ben and fellow policy makers could indicate that they may purchase more bonds in their QE2 program to boost the economy. The current high yields point to higher costs for consumers and certainly defeats Bernanke’s objective at the moment. With no Government supply coming down the pipe for a couple of weeks, one would expect some support for yields at these levels.

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