EURO needs a rate hike

This weeks main event will be the ECB rate decision. Has Trichet telegraphed his hike intentions or is that too easy? The EUR price action supported by FED Dudley ‘dovish’ comments certainly has priced this scenario in and investors are ready to add to long positions on any press conference hawkish stance. The market will be in a bearish mess if no rate hike forthcoming.

After last weeks FED policy members jousting rhetoric, markets will be focusing on Bernanke’s speech this evening. He is expected to follow Dudley’s lead and stick to his dovish stance. His remarks should have little effect on treasury prices. They remain under pressure from stronger domestic data. These higher yields seem to be providing support for the dollar versus other funding currencies.

The US$ is mixed in the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in an ‘orderly’ session.

With very little data on the US data calendar, expect markets to focus on digesting last week’s strong employment data. It’s all about the language when the ECB is involved. The market has priced in an ECB repo rate +25bp hike to +1.25% this Thursday. Expect the market to focus on the press conference for guidance on further policy intentions beyond this week’s decision.

If Trichet mentions ‘monitor closely’ or ‘monitor very closely’ it’s a good bet that that he his ‘giving us the green-light’ to expect further near-term tightening, thus supporting the EUR in the month of the ‘carry’ trade.

Before the rate decision, the market will have to contend with a Portuguese bill issue on Wednesday and a Spanish bond auction on Thursday, most likely keeping peripheral funding concerns in the forefront. Analysts believe that a successful Spanish auction would likely help systemic concerns ease further even as concerns about Portugal remain elevated.

The USD is higher against the EUR -0.26%, CHF -0.11% and JPY -0.05% and lower against GBP +0.14%. The commodity currencies are weaker this morning, CAD -0.01% and AUD -0.10%.

The loonie has bettered its three year high on the back of stronger commodity prices and economic data from its largest trading partner. Everyday was a winning day for the currency outright last week, gaining +1.8%, as commodities and equities gained. Its the currency’s longest winning streak in three months after crude printed a two and a half year high.

Global economic data seems to be coming in stronger than the market initially thought, and providing renewed support for the currency. Despite a Canadian government being toppled, the ‘hawkish’ tone coming from Governor Carney about how the elevation in commodity prices generally leads to higher interest rates continues to give the loonie its bid tone as traders happily sell historical funding currencies against CAD.

With ‘carry’ historically the go to trade this month, has investors looking to buy the currency on dollar rallies. The Federal political uncertainty is expected to have a limited affect on the Canadian dollars strength. The currency will be supported in the long term by its fundamentals, a sound financial system and a strong job environment (0.9634).

It’s quarter end and the AUD is heading for a third consecutive gain outright and against the yen, boosted by last nights retail sales beating analysts expectations (+0.5% versus +0.4%).

The AUD strengthened +0.9% versus the dollar last quarter and +3% against the yen. The currency again managed to touch a record high O/N, post 1983 float, despite economists believing that Governor Stevens will keep monetary policy on hold tomorrow. Their inactivity will confirm the RBA’s longest dry spell on record. However, the country’s highs yields remain attractive to foreign investors, and the danger coming from the policy meeting would be a rate hike.

Demand for Aussie was also supported after a report showed the nation’s jobs advertised in newspapers and on the Internet advanced last month for an eleventh consecutive month. Employment ads rose +1.3%from February, when they climbed a revised +1.1%.

Appetite for growth and commodity sensitive currencies depends on the new found stamina of risk tolerance by investors. Further appreciation depends on their interpretation of global future interest rates as the ‘carry’ trade becomes in vogue again (1.0369).

Crude is higher in the O/N session ($108.76 +82c). Oil prices ended last week straddling its two and half year high on the back of stronger US data and on the belief that China’s economics will again spur the growing demand for the commodity. Prices are again marching higher on contagion fears in the Middle-East and on the back of Libyan forces renewed aggression raising concerns about oil supplies for the near-term.

Last weeks EIA report showed crude stocks climbing +2.95m barrels to +355.7m. The market had forecasted a rise of only +1.5m barrels. At the other end of the pendulum, fuel demand fell to its lowest level since November with gas softening -2.3% to +8.87m barrels a day. That is -2.1% less than a year ago. Gas inventories were down -2.7m barrels, while distillate (heating oil and diesel) were up +710k barrels.

Recent events will make it unlikely that investors will see a ‘swift normalization’ of crude-oil production in the region. On any pull backs the Middle-East and North African situation will continue to dominate in the event risk category.

Gold has found its match, the Fed. The metal declined the most in two weeks on Friday, on speculation that the Fed will tighten monetary policy, curbing demand for the yellow metals as alternative investment.

However, geopolitical reasons continue to provide support on pull backs, justifying consumers wanting to own some of the asset in their ‘own’ portfolios. Despite last weeks softening of prices, the commodity has preserved its tenth quarterly gain, its longest winning streak in over 35-years, as low interest rates, geopolitical and event risk provide support. It’s difficult to find a reason not to own some of the commodity in your portfolio.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value. However, rising interest rates increase the opportunity cost of holding non-interest-bearing bullion ($1,435 up+$6.60).

The Nikkei closed at 9,718 up +11. The DAX index in Europe was at 7,192 up+12; the FTSE (UK) currently is 6,020 up+11. The early call for the open of key US indices is higher. The US 10-year eased 1bp on Friday (3.46%) and is little changed in the O/N session.

The front end of the US yield curve took the brunt of the pressure last week. Two-year yields happened to touch a 10-month high (0.89%) after Fed officials indicated that they may need to unwind some of their stimulus measures, also providing pressure was NFP adding more jobs last month than expected. Fed Dudley ‘tenuous’ comments pared some of the losses on late Friday.

This week is an important week for yield curves around the globe as some central banks announce their interest rate policy changes, if any. It’s worth nothing that last weeks US $99b issues was not well received and required the US government to pay the highest rate in over a year.

If anything, the market remains soft, after bonds completed a second consecutive quarterly decline on concern that the Fed may end its QE2 program of debt buying earlier than planned. Investors remains reluctant to take on big bets even with event and geopolitical risk.

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