Bernanke and PBoC pressurize EURO

The market remains nervous. The reaction to Bernanke’s ‘neutral’ comments indicates that the market is aggressively short dollars. Last night he said that inflation was rising and must be carefully monitored. He believes the spike to be ‘transitory’, however, the market has used this as an excuse to cover some of their short dollar positions.

Stronger UK PMI data this morning (57.1) and the PBOC surprisingly hiking lending and repo rates by +25bp is also pressurizing the EUR. These nervous longs will want to pare some of their positions ahead of tomorrows Portuguese bill issue and Thursday’s Spanish bond auction. Their actions are expected to put further pressure on the EUR, triggering stop-losses down to 1.4100.

The US$ is mixed in the O/N trading session. Currently, it is higher against 10 of the 16 most actively traded currencies in another ‘orderly’ session.

The market preferred to sit on its hands yesterday and digest Friday’s NFP data’s affect. Market movements are well contained thus far ahead of the highly anticipated ECB announcement this Thursday. It’s not their action that the market waits for, but the press conference and what Trichet says. Investors seem to be nervously long.

Apart from the US doves being out in force this week, balancing the hawkish rhetoric we witnessed last week, the main event yesterday was Goldman revising down their GDP expectations for last quarter to +2.5% from +3.5% and providing a bid to the FI market. They indicated that all the other variables that are not apart of the GDP count, like business surveys and labor market indicators, continue to look solid and are probably a more accurate guide to the economy’s true strength. Their reasoning for revisions is their belief that the first quarter was held down by temporary factors, including poor weather and some ‘noisy’ data. There is always a disclaimer, the temporary factors can be reversed in the second quarter! Expect other analysts to sit up and ponder.

The USD is higher against the EUR -0.24% and JPY -0.27% and lower against GBP +0.72% and CHF +0.08%. The commodity currencies are mixed this morning, CAD +0.00% and AUD -0.33%.

BoC’s Canadian business outlook survey (13 versus 22) sees slow growth on a higher loonie and commodity prices. To date the survey has held up well to the appreciation of the currency, higher commodity prices and increased foreign competition, but, analysts note that while some moderation is expected given the stage of the economic cycle, concerns over these factors are starting to eat away at expectations. Despite being an overall positive report, there are other concerns, led by price, as inflation expectations have ticked higher and respondents now expect inflation to trend at the upper end of the BoC inflation control target.

After printing three year highs and appreciating +1.8% last week outright, it was only natural that some profit taking was required. Even news of possible M&A activity has been unable to lend the loonie a hand just yet.

The ‘hawkish’ tone coming from Governor Carney about how the elevation in commodity prices generally leads to higher interest rates will again give the loonie its bid tone with traders happy to 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 currency strength. The loonie will be supported in the long term by its fundamentals, a sound financial system and a strong job environment (0.9663).

The AUD fell for a second day after the RBA left interest rates on hold (4.75%) for a fourth meeting and after a government report showed the country posted an unexpected trade deficit ($212b versus $1.2b surplus). The Aussie has aggressively pulled back from its record high, post free float, after comments from Governor Stevens, who indicated that the currency’s recent strength was helping to control prices, damping the need for further rate increases.

Despite the market being very ‘long’, there are strong reason to want to hold the currency. Australia is running its largest trade surplus in decades on a trend basis. The ‘floods’ have taken a notch out of this, but as coal production recovers, so should the surplus. Analysts expect capital inflows into the mining sector to remain robust and even accelerate. Their level of yields are still the highest in the G10 and continue to attract regional investors en masse.

Futures traders have cut bets on rate advances to +16bp over the next 12-months, from +21bp. The country’s fundamentals remain strong and its high yields remain attractive to foreign investors, the appetite for growth and commodity sensitive currencies depends on the new found stamina of risk tolerance by investors. Appreciation depends on their interpretation of global future interest rates as the ‘carry’ trade becomes in vogue again (1.0322).

Crude is lower in the O/N session ($107.87 -60c). Oil prices continue to straddle 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 a worthy opponent, the Fed. Late last week the yellow metal fell the most in two weeks, on speculation that the Fed will tighten monetary policy, curbing demand for the yellow metals as alternative investment. However, dovish comments from Dudley, Lockhart and Bernanke have renewed the interest in wanting to own the commodity again after over extending itself.

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 ($1,436 up+$3.30).

The Nikkei closed at 9,615 down-103. The DAX index in Europe was at 7,154 down-21; the FTSE (UK) currently is 5,998 down-18. The early call for the open of key US indices is lower. The US 10-year eased 3bp yesterday (3.42%) and is little changed in the O/N session.

The US curve found a bid after Fed President Lockhart and Chair Bernanke indicated that the US economy faces headwinds, reducing speculation that they will cut the remainder of its QE2 program. Goldman revising down its GDP for last quarter is also lending support.

The Fed bought +$8.03b in Treasuries yesterday, maturing from November 2016 to March 2018 as part of the debt purchase program, again lifting the longer end of the curve.

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 is tentative and investors remain reluctant to take on big bets even with event and geopolitical risk.

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