Dean’s FX| G8 commodity and stagflation concerns

The USD$ is mixed in the O/N trading session. Currently it is higher against 9 of the 16 most actively traded currencies in a ‘subdued’ trading range ahead of the US Empire data.

On Friday, it was not surprising, but market relief that US inflation data could have been worse. Consumer prices rose more than forecasted last month (+0.6% vs. +0.2%-largest increase since Nov.) as the populace paid more for fuel, emphasizing the Fed’s concern that inflation will pick up. Core-CPI (excluding food and energy) advanced an anticipated +0.2%. Food and Energy prices have caused the Fed to be more hawkish of late encouraging investors to price in a hike of 25bp in Aug.

Last weekend the G8 meeting showed strong concern over rising commodity prices, indicating that global economies face ‘headwinds’ and that risk to growth persist with higher commodity prices posting a ‘serious challenge’. Following the script, the Finance ministers did not comment on currencies, but, US Treasury Sec. Paulson and French Minister Lagarde spoke in favor of a strong USD$ policy. Paulson said ‘a strong dollar is in our nation’s interests’.

The US $ currently is weaker against the EUR +0.18%, GBP +0.42% and higher against CHF -0.01% and JPY -0.25%. The commodity currencies are stronger this morning, CAD +0.05% and AUD +0.07%. On Friday, Canadian manufacturing shipments surged +2.0%, m/m on the back of stronger petroleum and coal shipments (in part due to higher prices and part due to more normal production levels after schedules maintenance with refinery closings earlier this year) although gains were generally broadly based. Ex-petroleum shipments managed to still climb +1.0%, m/m. On a real basis (ex-prices and shipments) it also surged ahead suggesting that the strong CAD$ is not as limiting to export growth as one would expect although most of the volume gains were in petroleum. The greenback has strengthened against most of its major trading partners due to interest rate differentials. Last week BOC governor Carney followed suit after the BOE and halted its easing cycle to ensure inflation remains contained (3.00%- despite the market anticipating a 25bp cut). Traders are speculating that surging energy and food costs will prompt the BOC to do a u-turn and raise rates by years end. Canada’s annual inflation unexpectedly accelerated in April on higher fuel and mortgage costs (+1.7% y/y-BOC target is 2% band). Most analysts believe that core inflation will remain below Carneys target right through to next year, which ponders the question why should the BOC change policies mid stream while economic data remains soft? With commodities remaining under pressure, the loonie should be able to trade back towards monthly lows north of 1.0300. Traders continue to look for better levels to sell the currency. Softer data last week has pushed the AUD$ to its quarterly lows, combine this with the Fed potentially hiking and softer commodity prices and then the currency has more slippage to achieve (0.9398).

Crude is lower O/N ($134.42 down -44c). Crude oil prices remain soft as traders speculate that Saudi Arabia will increase production, reducing risks to global growth from near-record energy prices. It is anticipated being OPEC’s largest exporter that they will announce on June 22nd an increase in production of an extra +200k barrels a day or +0.2% of world supply. Saudi oil minister al-Naimi last week described the surge in the commodity as ‘unjustified’ and called the Jeddah meeting of producers and major industrial nations to help stabilize prices. With a robust USD$ reducing the appeal of commodities as an inflation hedge, crude oil has pared some of this weeks gains. But an underlying bid tone will remain due to last weeks EIA report, which showed that US stocks declined more than expected, increasing investor concerns that inventory may come under increased pressure during the US summer driving season. Stocks fell -4.56m barrels to 302.2m last week. China have indicated that their oil imports had increased 25% last month as the country recovers from the earthquake, and geo-political tensions have heightened between Iran and the US over uranium enrichment issues (OPEC’s second-largest oil producer). To date m/m, US crude stockpiles have fallen nearly 8%. The IEA lowered its estimate for non-OPEC output this year by -300k barrels a day to +50.04m. Gold eventually ended Friday higher ($873) after erasing earlier morning losses, on speculation that food and energy costs will stimulate inflation and boost demand for the yellow metal as a hedge against inflation.

The Nikkei closed at 14,354 up +380. The DAX index in Europe was at 6,777 up +22; the FTSE (UK) currently is 5,825 up +22. The early call for the open of key US indices is mixed. Yields of the US 10-year bond backed up 2bp on Friday (4.26%) and eased 4bp O/N (4.22%). Treasury prices remained close to home despite investors booking some profits after Core-CPI came in as expected while consumer confidence took a dip. Futures traders have pared their bets that the Fed will hike as early as next month.

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