Bernanke’s ‘extended period’?

This is it, finally we get to see the hyped FOMC statement and make some sense of these markets. No actions will change, borrowing cost will remain the same, and it’s the wording we are interested in. Market participants are focusing on the ‘extended period’ language. Will it change to ‘for some time’ or something even ‘more’ meaningful? The hawks will take a back seat in this decision, Bernanke will acknowledge the improved data of late, but is expected to reiterate that that ‘the output gap will keep inflation a non-issue for some time’. What ever happens, it will be a roller coaster by day’s end!

The US$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Yesterday, US factory orders gave us hope. It rose in Sept. (+0.9% vs. -0.8%), the 5th time in the past 6-months, providing us with a stronger indication that manufacturing will drive the US economic recovery. Digging deeper, ex-demand for transportation equipment, orders climbed +0.8% after a -0.3% Aug. It’s worth noting that a record plunge in stockpiles and a boost to exports means companies will be expected to ramp up production. Lofty inventory levels have been the scourge of this recession so far! Analysts believe that the acceleration in manufacturing will help the economy grow this quarter, building on the expansion that began in Aug. Durable goods, account for 50% of total factory demand, increased +1.4% after a -2.7% drop the previous month. While the figure for non-durable goods (food, petroleum and chemicals), advanced +0.6%.

Technically, the market seems positioned for an unchanged language from the Fed’s statement this afternoon. They are betting on the higher yielding currencies to once again rally and the ‘mighty’ dollar to suffer. Too many lemming positions could probably favor the contrarian’s move of the dollar reigning supreme by day’s end!

The USD$ is currently lower against the EUR +0.37%, GBP +0.60%, CHF +0.36% and higher against JPY -0.36%. The commodity currencies are stronger this morning, CAD +0.51% and AUD +0.49%. One cannot attribute the loonies’ strength to just commodities yesterday. The market was caught completely flatfooted on the 11am fix when one dealer required selling copious amounts of USD’s. Earlier in the session, the currency once again tested last week’s lows of 1.0850 as global bourses saw red on financial earning and the announcement that various UK banks required a second bailout. However, M&A activity helped to pull equities off the floor and stronger commodity prices aided the currency by day’s end. Risk aversion trading strategies has given way to increased risked appetite. Year-to-date the currency is up +14% after falling -18% vs. its southern trading partner last year. However, weaker Canadian data of late may be stronger evidence that the Canadian economy is not following its southern neighbor directly out of this recession. To date, the BOC has declared that they would use a combination of currency intervention, credit and quantitative easing options to influence the loonie and meet their 2% inflation target. Will they get to use any of these methods? Yes, over time, but not just yet. Dealers want to see better levels to own their own currency. But, let’s see what the other Cbanks policy makers want to do first!

The AUD has had a whiplash session ahead of the Fed announcement. Australian retail sales for Sept. unexpectedly fell (-0.2% vs. +0.5%). Analysts believe that weaker household spending gives the RBA latitude to keep the O/N rate unchanged in Dec. after raising it yesterday for a second straight month. Governor Stevens’s hiked rates 25bp to 3.50% as expected, but said that it was ‘prudent to lessen gradually’. The wording ‘gradually’ has prompted traders to pare bets that there will be a rate increase in Dec. The futures market is now only pricing in a 50% chance of a hike! The currency is well supported by commodity prices and by investor’s appetite for risk for a higher yielding currency. Expect dealers to remain better buyers on pullbacks (0.9082).

Crude is higher in the O/N session ($80.33 up +73c). Yesterday, crude prices managed to trade 2% higher, rising from a 2-week low as growth in US manufacturing boosted hopes of an economic recovery. Currently, oil prices have been mirroring equity prices ahead of this week’s EIA report and the Fed announcement. After plummeting nearly 4% last week when US consumer spending fell for the first time in 4-months, the commodity has managed to find some traction on the back of stronger global fundamentals (China etc.). The theory of stronger fuel demand remains a good bet. However, in reality, the commodity’s prices remain tightly entrenched in a $6 range. All last week, the black stuff has had issues sustaining a break of the $80 a barrel level. Should crude prices not be following oil fundamentals? Last weeks EIA report revealed an unexpected increase in US gas stocks, with supplies jumping to a new 2-month high. Gas inventories climbed +1.62m barrels, w/w vs. an expected decline of -1m barrels. The import number for crude also advanced for the 1st- time in 5-weeks. Its worth noting that OPEC believes that both the ‘producer and consumer are comfortable with prices between $75 and $80 per barrel and that higher price’s would only put the brakes on the pace of global economic recovery’. Ideally, they want to ‘maintain balance’ and will act accordingly at the Dec. meeting. Over the week, refineries operated at +81.8% of capacity, up +0.7% from the previous week. On the other hand, crude stocks rose +778k barrels vs. expectations of +1.9m to +339.9m barrels last week. This has left supplies +9.1% higher than the 5-year average. Supplies of distillate fuel (includes heating oil and diesel), declined -2.13m barrels to +167.8m. Surprisingly, inventories were +29% higher than the 5-year average for the week. If the USD finds any momentum ahead of NFP this Friday expect speculators to sell the commodity on upticks!

Gold prices know no bounds. In the O/N session we witnessed another rally to record heights after the IMF declared that they have been selling to the reserve Bank of India gold bullion, 200 metric tons or $6.7b of the yellow metal. Coincidentally, this is the first sale by the IMF in 9-years. Cbanks are toying with the idea that ‘the commodity is a safe store of value compared to the dollar’ and a better bet for upside potential. Year-to-date, the yellow metal has climbed +22% ($1,082). Speculators continue to be better buyers on pull backs!

The Nikkei closed at 9,844 up +41. The DAX index in Europe was at 5,432 up +80; the FTSE (UK) currently is 5,073 up +36. The early call for the open of key US indices is higher. The US 10-year bonds backed up 7bp yesterday (3.47%) and are little changed in the O/N session. With the Fed announcement this afternoon, some pundits believe that they may indicate a change to the wording that they will keep their O/N borrowing costs at a 50-year low. 2’s/10’s widened the most in 3-months yesterday (256) as investors seek higher returns as compensation against inflation. Technically, Capital Markets is betting that the Fed may begin to signal an increase in their accommodative interest rate policy. Later this morning the US Treasury is scheduled to announce how much it plans to raise in note and bond sales next week. Whatever is announced, it will be another record and a chance for dealers to cheapen up the curve even more! If equity prices continue to find resistance, then expect FI prices to look attractive at these levels.

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