EURO Surge no Game Changer

Being a bear, the squeeze on Euro shorts has been painful and very expensive. Little has justified holding a short position over the last two-trading session. Periphery bond issues went off without a hitch, they were well received and furthermore, who expected a Trichet hawkish rant? Perhaps we could chalk the EUR rebound this week to positioning. The market was very much over extended in the lemming one directional negative EUR trade too early in the New Year. Fundamentally, the funding results have been encouraging. In reality, they have made only a small dent in the net financing requirements of Portugal and Spain over the coming quarter. Renewed stress concerns will again be the focus before long. The bears can also rely on the Germans to drag their heels on Trichet’s view that the ‘stabilization fund (EFSF) must be improved in quality and quanity’. Collective EU support never seems to occur logically.

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

One week does not make a trend. However, yesterday’s US weekly claims numbers certainly wound back the clock to the beginning of the fourth quarter (+445k vs. +409k). The improvements we recorded last month will be hard pressed to be repeated in this month’s job report. Some analysts have tried to blame the weather, but it seems that lagged state level data does not support this theory in full. What is of greater importance is that the softening claims has occurred in the first half of January, the reference period for NFP, stronger proof that we should be expecting a weak January release? The spike is partly seasonal and partly due to the re-extension of the Emergency Unemployment Compensation program. Other data showed that US producer prices came in higher than expected (+1.1% vs. +0.8%), while the core advanced at a modest pace (+0.2%, m/m). On an annual basis, the headline and core advanced +4.0% and +1.3% respectively. Digging deeper, most of the headline gain was driven by higher food and energy prices (+3.7%) and consumer foods (+0.8%). It’s worth noting that prices received by manufacturers of intermediate goods jumped +1.0% in December for the fifth consecutive time. Analysts note that the pass through to the consumer basket remains should remain limited, until at least the labor market finds some consistency.

The USD$ is lower against the EUR +0.08%, GBP +0.02%, CHF +0.14% and higher against JPY -0.06%. The commodity currencies are weaker this morning, CAD -0.33% and AUD -0.47%. Commodity prices are trying to support the loonie outright, however, on the crosses, being long the CAD has been costly over the last 24-hours. It has been a question of coming too far too fast and any weak announcement out of the US is going to have the currency crosses underperforming short term at least. The Canadian Finance Minister believes that the strength of the loonie is occurring on the back of international capital controls, certainly a comment that will not dissuade global interest in the currency. He said that the Canadian dollar strength ‘was to be expected’ and that it was ‘wholly unreasonable for Canadians to expect the loonie to go back to days when it was significantly devalued’. It’s the result of Canada’s strong fiscal position and it’s no wonder that some analysts are calling for the BOC to aggressively tighten rates this year to fight inflation. Perhaps this will be the new global norm from Europe to Australia and Canada? Current fundamentals support the currency. Until yesterday, it had been amongst the best-performing currencies this month, as both crude and Canadian assets remain in demand for safer heaven concerns. Governor Carney cannot have any beef with the ‘orderly’ strengthening of the currency. Short term chartists continue to eye 0.9750 CAD in the first-quarter, despite the EUR currency purge yesterday. Investors continue to look for better levels to own the currency (0.9961).

The AUD is heading towards its largest weekly loss vs. most of its major trading partners, especially the JPY, as the worst domestic floods in 50-years has tempered the country’s economic outlook. Speculation that China will take further steps to curb inflation is also reducing the demand for growth and commodity sensitive currencies. Reported data already this week was soft, certainly not aiding the currency. Australian employers added fewer workers to their payrolls than anticipated (+2.3k vs. +25k), as a stronger currency and higher borrowing costs slowed the economy. The good news headline saw the unemployment rate fall two ticks to +5% as the participation rate dropped. Governor Stevens kept rates on hold last month (+4.75%) as some indicators were suggesting a ‘more moderate pace of expansion’ and this was surely one of them. The disastrous flooding in the state of Queensland is expected to slow growth this quarter and a tightening policy would not be the prudent course of action. Currently, the market pricing of rate cuts (4.75%) for the RBA February policy meeting and of rate hikes over latter half of the year remains broadly unchanged. Already, RBA members are trying to put a monetary cost to the infrastructure damage from flooding, with suggestions of approximately +1% of GDP or $13b. Any significant cost will only delay any interest rate hike by Governor Stevens. Offers continue to appear on rallies (0.9892).

Crude is lower in the O/N session ($90.57 -83c). Crude was little changed yesterday, a day after the weekly EIA data reported a larger than expected decline in oil stocks and above expectation increases for gas and distillates. Oil inventories fell -2.2m barrels vs. an expected decline of-300k barrels. In contrast, gas supplies increased +5.1m vs. an expected rise of +2.9m barrels, while distillates jumped +2.7m. Again the Alaskan pipeline leak continues to have an effect, it is threatening to curb supplies to refineries and it’s this that is providing the overall bid for the black-stuff. The system carries +15% of US output and experts are unsure when production would return to normal. Again, there are too many hurdles to overcome ahead of the psychological $100 barrel of crude. Technically, the market is not showing a tighter supply or demand balance. 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. The market expects to meet price resistance in the mid $90’s as there is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in theory. The Trans-Alaskan closure will continue to squeeze the market until production clarity reemerges.

Portugal, Spain and Italy’s successful bond issues this week have taken some of the shine off the yellow metal for safe-haven purposes. The metal’s losses may be limited on concern inflation will accelerate. This should have gold remaining bid on pullbacks. For most of this year the commodity had fallen foul on speculation that a sustainable global economic recovery would curb demand for the precious metal. Analysts expect currency volatility again to boost demand for the metal on Euro sovereignty default concerns. The commodity last year completed its tenth annual advance with bullion rallying +30%, it’s largest rally in three years. Even though the one direction trade feels overdone, investors continue to hold gold as a hedge against long-term inflation and have some strong technical support levels to breach before the markets witnesses a mass exodus. The Euro-zone contagion issues continue to put a floor on metal prices on demand for a haven. Technical analysts believe that gold ($1,370 -$16.90c) will outshine other precious metals in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,499 down-91. The DAX index in Europe was at 7,063 down-12; the FTSE (UK) currently is 6,001 down-22. The early call for the open of key US indices is lower. The US 10-year eased 4bp yesterday (3.32%) and is little changed in the O/N session. Treasury prices have risen, pushing yields towards their lowest level in nearly a month, a continuation of the up trade from this week’s 10-year auction which saw strong demand for product. It’s mostly flow driven, mixed with some weak weekly claims surety yesterday. Yesterday’s $13b long-bond auction completed this week’s $66b funding requirement and came with a 2.5bp tail. The bond yielded 4.515% compared to the 4.492 WI’s. The bid-to-cover ratio was 2.67 compared with the average of 2.57 from the past four auctions. With the lack of auctions next week, expect the market to remain robust on pullbacks.

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