Bernanke and the Feds statement tinkering will heighten volatility

Will last Fridays headline print and payroll revisions arm twist Ben and his colleagues to re-introduce bond buying this afternoon? As late as last month, the Fed indicated that it was ‘not’ ready to take any action in the ‘near term’ to adjust its open market operations. That being said, policy makers assessment that the ‘economic outlook remains unusually uncertain’, coupled with the recent weak US data in housing and manufacturing, have fueled speculation within Capital Markets that the Fed could take steps as early as today to spur economic growth. Are they ready to hit the panic button? Any move outside of their recent norm, could be the beginning of much bigger things to come. The safer bet of course would be to see a ‘market friendly adjustment to the language of its policy statement’ rather than any structural changes to its operations. Either way, volatility will trump the day!

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

It’s all about the Fed. Guessing and second guessing by analysts is an art form and especially today, it’s taking on a life of its own. To date, helicopter Ben has already discussed additional policy options left open to him and his team to promote growth. They could extend the ‘extended period’ language, they can lower the interest rate paid on excess reserves and finally, they could buy financial assets outright (Treasuries, Fed Agencies, and/or mortgage-backed securities). Market consensus has the Fed intensifying the language and renewing their asset purchases by day’s end. Policy makers could even be more innovative and announce a few technical adjustments, whereby they could reallocate the proceeds from maturing Treasury securities into bills rather than reinvesting the proceeds into new Treasury coupons. This procedure would shorten the maturity and enhance the liquidity of its treasury holdings. Tinkering of innovation could be endless, but let’s not get ahead of ourselves as that could be an expensive exercise. Following the herd by day’s end could be just as profitable!

The USD$ is higher against the EUR -0.44%, GBP -0.65%, CHF -0.49% and lower against JPY +0.27%. The commodity currencies are weaker this morning, CAD -0.44% and AUD -0.44%. The loonie made very little noise yesterday, unlike last Friday’s movement after the Canadian jobs release. Investors continue to speculate that the Fed may consider additional stimulus for its ailing economy. If the Fed revives its quantitative easing program, it could put the dollar back on the defensive and encourage speculators to take a ‘punt’ in owning the growth and interest rate sensitive currency, the loonie. The CAD, month-to-date, has underperformed against most of its major trading partners as US economic data has been less than impressive. Thus far, the loonie has been guilty by association with its largest trading partner. That been said, on dollar rallies there are CAD buyers about. Friday’s employment data has had only a minor impact on the expectations for the BOC next month. Futures traders continue to price in a +60% chance of a Governor Carney +25bp hike before heading to the sidelines for the remainder of this year at least. A strong Canadian economy and the outlook for a ‘dovish’ Bernanke tone this week should ‘temper concern about a faltering global economic recovery’ and keep the loonie in demand on dollar rallies.

Despite remaining somewhat elevated, the AUD has managed to pare some of its recent gains, especially vs. the JPY, weakening for a 3rd-consecutive day last night, as regional bourses extended their declines, and reducing the demand for higher-yielding currencies. The AUD gravitated from its three-month high after an industry report showed that a business confidence index dropped to its lowest level in 14-months (2 vs. 4). Other data showing that Chinese imports declining and a market nervous that the Fed will today acknowledge that the US economy is cooling is dampening demand for growth currencies. In the present environment, there are only two scenarios that would give the AUD a lift. Firstly, without a sharp ‘further dip in US yields’ and secondly, a market belief that RBA rate hikes are imminent can only drive the currency higher in the short term. Demand for the AUD remains muted on speculation that the FOMC will disappoint and dampen market expectations with a second round of stimulus measures this afternoon. Any pare backs have been tempered by last weeks AUD trade surplus print unexpectedly advancing to a record high last month (+$3.54b), as Chinese demand boosted exports of coal and iron ore. Because of the equity actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.9125).

Crude is lower in the O/N session ($80.90 down -58c). Crude happened to rally for the first time in four days yesterday, as advancing global bourses boosted confidence that the economic rebound will stimulate fuel demand. The market continues to track the ‘perception of the broader economy theory’ and will hang on every word of this afternoon FOMC decision. Technically, the commodity continues to trade north of that $80 psychological level, even with prices softening after a disappointing NFP report on Friday. Not helping matters was last week’s bearish headline inventory report showing that the underlying stock sub-categories were rising. The market again is anticipating another bearish inventory report tomorrow. The steep drop in last weeks ‘headline’ oil stockpiles has thus far prevented much deeper losses. The EIA report showed that oil inventories fell -2.8m barrels, more than the -1.6m the market had been expecting. On the flipside, gas stocks again advanced by +700k barrels, compared with expectations of an -800k decline. Not to be out done, distillate inventories (heating oil and diesel) also advanced by +2.2m, doubling the expected gain. Digging deeper, the report also revealed that demand, y/y, was little changed and also too low to consume the fuel produced by refiners operating at +91.2% of capacity (highest level in 3-years). Demand is only up +0.2% from the same period last year. The recent macro-data flow indicates that the US activity has slowed down and the market should expect further price pull back as the ‘one directional upward move’ may be overdone. US fundamentals continue to show a market that is still overstocked, particularly on the product side. Speculators remain better sellers on up-ticks in the short term.

Gold prices could not make up its mind yesterday, fluctuating in and out of positive territory, despite the dollar finding some traction ahead of the FOMC meeting. The market is feeling somewhat optimistic that Bernanke and Co. will reintroduce some additional quantitative easing measures. In theory, this would be supportive for commodities. However, the ‘buck’ will continue to have the strongest influence on prices. If the dollar index remains in demand, by default, commodities will find it difficult to hold these gains. Last week, after another disappointing employment report, speculators sought sanctuary in the safer heaven asset class. The commodity also found traction on speculation that prices near its recent lows would fuel demand for the physical asset as China’s plans to relax various trading commodity rules. For most of this year, we have witnessed gold rally on the back of a weaker EUR with investors buying the asset class as a safe heaven investment. Until recently, a weaker dollar had been the biggest factor in supporting commodity prices. Since the record highs witnessed on June 21st ($1,266), the commodity has fallen -4.7%. Historically and fundamentally, this is the ‘slowest’ season for physical demand and now with China potentially changing the ground rules should temporarily drag the metal higher. Year-to-date, the commodity has gained +7.6% ($1,201 -$1.60c).

The Nikkei closed at 9,551 down -21. The DAX index in Europe was at 6,320 down -31; the FTSE (UK) currently is 5,397 down -13. The early call for the open of key US indices is lower. The US 10-year backed up 1bp yesterday (2.82%) and is little changed in the O/N session. After last weeks 10th consecutive rally, the FI asset class gave up some ground on speculation that the recent slide in yields was a tad excessive. The market is waiting for this afternoons FOMC communiqué for direction. Also putting pressure on prices will be the dealers making room to take down $74b’s worth of new debt this week (3’s, 10’s and long-bond). The average for this particular mix of securities is around $69b. With global growth concerns, the market is content in owning product on deeper pull backs, until 2.15pm at least!

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