EUR short is a pain

Stronger growth and softer inflation numbers can be a positive combination. So far, the market seems to be focusing on China’s surprising 4th Q GDP release (+9.8%, y/y), rather than the retreating headline CPI print (+4.6% vs. +5.1%). Market positioning believes that the PBOC will have to tighten monetary policy aggressively. In reality, they are unlikely to change their policy course. Investors should expect a ‘normalization of monetary policy amid an expansionary fiscal policy’. The PBOC is likely to favor quantitative tightening through raising reserve requirements and controlling lending activities on ‘their’ time line. Before we all get too risk averse, we have this morning’s US Philly Fed manufacturing survey and weekly jobless claims to digest. Any further proof of a muted recovery in the US job market will deter the Fed from raising borrowing costs and add to this week’s dollars woes. Any surprises, and the EUR bears can breath again.

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

Nothing surprises the market any more when it comes to US housing data. Yesterday’s unexpected housing starts (+529k, down -4.3%, m/m) will end up being a bigger drag on 4th Q GDP. Similar to building permits (+635k, +16.7%, m/m), starts have been moving sideways for nearly two-years and is -80% off its peak in 2005. Digging deeper, weakness was concentrated in singles (-9%) rather than the lower value-added multiples. On the other hand, the volatile multiple segment was up +17.7%. On average during the last quarter, housing starts averaged +538k and was -8.5% lower than in the previous quarter, marking the third consecutive quarter of declines and the biggest contraction in two years. While one month does not make a trend, the glut of listed and shadow inventory is expected to keep construction muted into the future.

The USD$ is lower against the EUR +0.12%, GBP +0.01%, CHF +0.07% and higher against JPY -0.16%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.44%. Yesterday the BOC held to the same script as their October MPR release. Carney remains committed to the view that excess capacity does not get closed off until the end of next year and it will take the same amount of time for the inflation target, convergence of core and the headline, to be capable of printing its +2% mark. Reading between the lines, the market can expect the BOC to remain on hold until the fall. Digging deeper, the BOC has shifted to a consensus view on US growth (+3.2% this year), mostly on the back of Obama’s fall stimulus package. Carney believes that the loonies elevated level and Canada’s declining productivity record will limit export competitiveness and potentially nullify some of the upside for Canada stemming from the pull effect of the US recovery. The upward revisions to US growth get largely cancelled out by the policy maker’s cautious assumptions on Canadian export growth. Finally, their revised output gap estimate is little changed from the last report. It sees spare capacity standing at +1.8% of the economy (+1.9% in October) suggesting little progress in closing off spare capacity. Yesterday’s weaker manufacturing sales data (-0.8% vs. +1.5%) continue to reflect the slow recovery in manufacturing output and a gradual improvement in capacity utilization. The BOC’s dovish position has pushed the loonie to back off from its strongest level in two-years as the market digests rates being on hold and an economic recovery being threatened by a European fiscal crisis. Expect short term profit taking to remain in focus (0.9978). There is a foreign interest just above parity to buy CAD dollars.

A decline in Asian stocks has reduced the demand for higher-yielding assets. Last nights data out of China has the market convinced that the PBOC will move quickly to hike reserve rates again, this has temporarily increased the appetite for the safety of the greenback and pushed the AUD below parity after three days of gains. Tempering some of the AUD decline was the mix of the data. The strong growth point of view (GDP) and a softer CPI than some might have been expecting can be seen as support for the AUD on these deeper pullbacks. Domestically, the Queensland flood is expected to temper the country’s economic outlook. Governor Stevens kept rates on hold last month (+4.75%) as some indicators were suggesting a ‘more moderate pace of expansion’. Growth is expected to slow 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 later in the year remains broadly unchanged. Offers again appear at parity ahead of US jobless claims (0.9953).

Crude is lower in the O/N session ($90.56 -30c). Oil prices have remained close to home ahead of this weeks EIA inventory report later this morning. It’s anticipated that there will be a seventh consecutive drawdown on inventories. Despite this, prices have tentatively retreated from their 27-month high print late last week after the IEA stated that ‘supplies are ample’, with US inventories ‘well above’ the five-year average. The commodity had experienced six-consecutive winning trading sessions on stronger North American data and on a rapid increase in energy demand from China, the second-biggest user of crude. Last week’s EIA report recorded a decline in 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. 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 dollars decline is providing support for commodities as an alternative investment. Investors are relying on fundamental scraps to justify adding to already long positions. The price erosion thus far this year is again promoting physical buying, specifically in Asian and on concerns that Europe’s sovereign-debt crisis may linger, even after the Euro-finance minister’s pledge to strengthen a ‘safety net for debt-strapped countries’. Last week’s successful Euro-periphery bond issues had taken some of the shine off the yellow metal for safe-haven purposes. On a macro level, analysts expect the losses may be limited on concern that inflation will accelerate. The commodity last year completed its tenth annual advance with bullion rallying +30%. Even though the one direction trade feels overdone, there are some strong technical support levels to breach before the markets witnesses a mass exodus. Technical analysts believe that gold ($1,365 -$4.50) will outshine other precious metals in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,437 down-120. The DAX index in Europe was at 7,070 down-12; the FTSE (UK) currently is 5,933 down-43. The early call for the open of key US indices is lower. The US 10-year eased 6bp yesterday (3.33%) and is little changed in the O/N session. Softer US data yesterday mixed with market perception that the US economic recovery will remain sluggish and the fear that today’s jobless claims losses would increase has investors coveting US debt for safe heaven purposes. The lack of US product this week and the ongoing EFSF ‘replacement and replenish’ debate should provide demand for the asset class on deeper pullback in the short term. The market is caught in this tight trading range waiting for any right reason to justify higher or lower rates.

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