Bernanke to Support the EURO

A rally on risk related assets continues to trigger some flows out of safe heaven instruments despite weaker data out of Germany and a Chinese rate hike. Even Fed member Lacker comments yesterday stating that the Fed should reconsider its bond buying program as the economy gets stronger could not aid the dollar. With Euro-group president Juncker expecting Euro-zone leaders to have resolved a comprehensive debt plan to deal with their periphery problems by next month has even appeased the contrarian. Helicopter Ben testifies today on Capitol Hill. The near term risk for the dollar will be a material shift in rhetoric. A clouded US employment landscape and low inflation will leave the dove tone in play. The speech will reiterate the FOMC’s commitment to its $600b QE2 program. There should be limited market reaction to the speech, perhaps a relief move in US Treasuries, following this week’s selloff. Obviously, a pullback in US yields is again supportive for the EUR.

The US$ is mixed the O/N trading session. Currently, it is higher against 9 of the 16 most actively traded currencies in a ‘whippy’ O/N session.

Risk appetite remains in affect after investors downplayed the larger than expected drop in German industrial production yesterday and after the PBOC saying that they would hike deposit and lending rates by +25bps. Obviously, their aim is to curb rapid growth and inflation and prevent an asset bubble being created. Interest rate differentials continue to be the lead driver of trading this month. If China wants to slow their economy down, interest rate hikes are not the preferred tool, direct credit controls are. Tightening rates is more of a liquidity measure and something that risk investors have acknowledge by asset class movements.

The USD$ is lower against the EUR +0.14% and GBP +0.05% and higher against CHF -0.08% and JPY-0.22%. The commodity currencies are mixed this morning, CAD +0.10% and AUD -0.36%. The detail of the Canadian housing starts report yesterday (+170.4k) was weaker than the headline miss, with strength (+0.8%, m/m) being fully concentrated in the rural segment (+20.5% vs. -18.4%). Analysts note that the Canadian housing market, which happened to lead the country out of the recession, is expected to moderate throughout this year and act as a drag on the economy. It’s worth noting that last months headline was revised downwards (+169k vs. +171.5k). The loonie did not take its cue from the soft data, but from China announcing their third rate hike since October. Investors are concerned that China’s demand for oil will slow their appetite for commodity driven and interest rate sensitive currencies. The loonie has taken the path of least resistance and that’s lower, temporarily at least. This weeks buying interest, influenced by the strong jobs report last Friday, have moved up their selling interest levels as the currency underperforms against most of its major trading partners. Concerns about an over valued currency, according to Governor Carney, waning government capital spending, a cooling housing market, and moderating retail sales will eventually combine to limit overall GDP growth this year. These are all stellar reasons for BOC to be concerned, as a ‘persistent strength in the currency is a threat to economic expansion’. With strong risk appetite in vogue, the loonie continues to have cautious buyers on dollar rallies despite the Chinese effect (0.9942).

Perceptions about the health of the Chinese economy can often dictate strength in AUD because their economy and currency is heavily reliant on exporting raw materials to China. The Chinese rate hike has had the expected knee jerk effect on the currency. The AUD has come under pressure in the O/N session, with hedge fund selling being flagged as the key factor, ahead of the job’s report down-under which is expected to show the country having its longest stretch of jobs growth in three-years. Analysts expect employers to add +18k jobs last month, and the unemployment rate to remain unchanged at +5%, the lowest in two-years. The RBA has kept rates on hold the last two meetings after tightening for seven times in a calendar year. In it’s quarterly policy statement last week Governor Stevens stated the ‘the modest rate of increase in household indebtedness suggests that household behavior remains cautious’ and that ‘there are a few factors, including the recovery in household net worth over the past 18 months and the improvement in the labor market, that would suggest that growth in household consumption is unlikely to remain as low as over the past couple of years’. It’s difficult to sell AUD, but the PBOC decision to hike rates another +25bp yesterday will pressurize regional currency’s that have strong trading ties with China. Weak longs will be in trouble ahead of the jobs data (1.0114).

Crude is higher in the O/N session ($87.54 +0.50c). Oil continues to piggyback its weekly lows, as political tension in Egypt eased and on expectations that larger US stockpiles will signal that fuel demand may be faltering with the world’s biggest consumer. Now that China has raised rates again the market is questions the country future appetite for commodities. The hike is an effort to cool down the economy or putting it another way, an effort to cool down energy and industrial metal consumption. Oil’s inability to break through key technical resistance above has also provided pressure. Last weeks EIA report revealed another build up in inventory. Crude stocks grew by +2.6m to +343.2m barrels, which are +4.3% above year-ago levels. Gas grew by +6.2m barrels, or +2.7%, to +236.2m barrels. That was +3.6% above year-ago levels. The four-week gas demand was +0.6% higher than last year, averaging nearly +8.7m barrels a day. Refineries ran at +84.5% of total capacity, a rise of +2.7%. Fundamentally there is far more oil in storage, more fuel capacity and more idle oil wells to limit a much stronger market rally. The market will now focus on this morning’s inventory reports.

Despite losing some of that geopolitical risk premium support on expectations that Egypt’s president may be getting closer to his resignation, gold, the commodity that every investor hated last month has found strong support on these pull backs. Prices have climbed to a two-week high on demand for a hedge against rising consumer prices after China increased borrowing costs yesterday on expectations that their inflation has expanded at the fastest pace in two and half years. The commodity is being used as a store of value. Last year the commodity appreciated +30%. So far this year, natural physical buying has been less than modest with the commodity off to its worst start in 14-years. Has the commodity peaked or is it simply a short-term correction? The commodity is attracting technical buyers after rallying above its 20-day moving average. On deeper pullbacks, the metal should remain better bid on speculation that currency volatility will boost demand for a safe heaven investment once the Euro contagion fears raise its ugly head again over the coming weeks during the Euro-periphery refunding season ($1,363 -30c)

The Nikkei closed at 10,617 down-18. The DAX index in Europe was at 7,337 up+14; the FTSE (UK) currently is 6,071 down-19. The early call for the open of key US indices is lower. The US 10-year backed up 3bp yesterday (3.71%) and is little changed in the O/N session. Treasuries fell for a seventh consecutive day, its longest losing streak in three months, ahead of this weeks auctioned supply. Analysts note that ‘a concession has been built in and the curve is steepening very fast and all parts of the curve have seen a substantial backup since the last auctions of these issues’. Investors seek compensation for the prospect of accelerating inflation and on speculation the US may struggle to fund its deficit. Higher yields benefit the dollar but will upset Bernanke. Yesterday’s three-year $32b auction was rather soft, stopping +0.5bps back of the WI’s 1.349%. Non-dealers took just +38% (25-month low) and the auction had a 3.01 bid-to-cover ratio compared to a six-auction average of 3.12. The market will now be worried about today’s 10’s and tomorrows long-bond auction.

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