Bernanke fears encourage risk aversion

Optimism over the possible appreciation of the Yuan fading, and the ongoing concerns of the European financial sector, is again encouraging risk-aversion trading strategies across the board. The market is apprehensive over the Fed’s rate announcement this afternoon. Even though rates are not expected to change, dealers are cautious over the possibility of any indication of when the monetary policy might tighten. It seems that the market is already pricing in the likelihood that the statement ‘will sound more cautious on the economic outlook’, hence the weight on investor risk-appetite. Markets are thin, ranges are tight, and desks are monitor watching until the Fed’s communiqué.

The US$ is weaker in the O/N trading session. Currently it is lower against 9 of the 16 most actively traded currencies in a ‘subdued tight’ trading range.

All eyes yesterday were on US existing home sales. Surprisingly, they disappointed after two consecutive months of gains, falling -2.2% last month (5.66m vs. 5.79 revised upwards). The market had been expecting an upsurge in units sold (6.17m) as homebuyers were expected to ‘race to close contracts under a federal tax incentive program’. With the homebuyer tax credit potentially run its course had the market questioning the strength of the underlying fundamentals and expressing their concerns of a double-dip occurring in the housing market. The National Association of Realtors or NAR stated ‘that approximately 180k homebuyers who signed a contract in good faith to receive the tax credit may not be able to finalize by the end of June due to delays in the mortgage processes’. The data does not bode well for this morning’s US New Home Sales release. The market believes that the print could plummet to +430k from +504k in April. With the new US housing construction slumping -10% last week, has again unnerved Capital markets, and encouraged risk aversion trading strategies to be implemented.

The USD$ is lower against the EUR +0.12%, GBP +0.45%, CHF +0.05% and higher against JPY -0.10%. The commodity currencies are weaker this morning, CAD -0.23% and AUD -0.27%. Risk aversion is once again weighing on the loonie as it backed up from its 5-week intraday high print earlier this week. The commodity currency has fallen as equities and oil slump after weaker US economic reports reignited concerns that growth with Canada’s largest trading partner may stall. Domestic fundamental data shows that the Canadian economy is ‘firing on all cylinders’. The BOC’s Deputy Governor Tim Lane said ‘the country’s economic recovery has been faster than expected, and future interest-rate decisions will weigh domestic strength against the risks posed by Europe’s debt crisis’. Year-to-date the currency has appreciated 10% vs. its southern brethren. Canada’s economy expanded at a +6.1% last quarter, and policy makers predict that inflation will exceed its +2% target over the next year. Despite the countries annual inflation rate slowing to +1.4% from +1.8% in April on the back of weaker gas prices, speculators continue to place bets that Governor Carney will raise interest rates faster than other developed countries. Big picture, the CAD is holding its own after the BOC’s last rate hike (+0.5%) and somewhat muted and directionless communiqué earlier this month. Using the loonie as a safer way to play an economic recovery in the US with linkage to commodities and less banking or fiscal noise has speculators better buyers of the currency on dollar rallies. Now, with talk that the currency is being used as a Cbanks safe haven destination for capital should lend even more support to the currency. Do not be surprised to see the currency trade beyond parity in the coming months.

For a second consecutive day the AUD fell, trading near its lowest level in a week after printing a new one month high on concerns that funding trouble at various European banks will dampen global growth and reduce demand for higher yielding assets. Not helping the commodity driven currency was the Yuan falling on prospects ‘that the PBOC will intervene to limit gains after dropping its peg to the dollar’ and on the back of regional bourses continuing to see ‘red’. Earlier last week, comments from the RBA, who said that Europe’s debt crisis would ‘inevitably weigh’ on global growth, had fueled speculation that the Governor Stevens may keep rates unchanged until at least the end of the year. It seems that that ‘previous rate rises has given them flexibility to leave borrowing costs unchanged at next month’s meeting’. To date, it seems that the crisis in Europe has not had a material impact on the Australian economy, but, that’s been called into question. With European stress test disclosures lined up and PBOC announcement failing to calm investor’s fears has technical analysts wanting to sell the currency on rallies (0.8711).

Crude is lower in the O/N session ($77.37 down -48c). Crude fell for the first time in three days yesterday as sales of existing US homes unexpectedly fell -2.2% in May, signaling that the US economy is finding it difficult to sustain its economic recovery. The black-stuff extended its declines after a federal judge lifted the six-month freeze on deepwater drilling imposed by Obama. The fear that a double dip is on the cards has the bears again pressurizing prices. Analysts are adjusting down their year end prices amid concerns that growth in Europe and China will slow. The market believes that last weeks inventory report probably dropped on estimates that imports declined for the first time in three weeks. This morning we will get to see if there is any substance in that theory. Year-to-date, the commodity has appreciated +13%. Last week’s release gave the market its bullish sentiment, however, weaker global economic releases since then has managed to encourage some ‘risk-off’ trading strategies. The report was dominated by the drop in refinery capacity rates. US refineries operated at +87.9%, down -1.2% from the previous week. Gas stocks declined -636k barrels to +218.3m last week with gas demand advancing +1.6% to +9.34m barrels a day (the highest level in nearly a year). Historically, gas consumption peaks sometime between US Memorial and Labor Day in Sept. (the height of the US driving season). On the flipside, crude oil rose +1.69m barrels to +363.1m vs. an expected -1m barrel decline. Inventories of distillate fuel (diesel and heating oil) increased +1.8m barrels to +156.6m vs. an expected +1m barrel gain. Direction is dictated by demand and with ample supply and global growth worries has speculators once again wanting to sell oil futures on rallies.

Bigger picture, Gold continues to be a safe heaven attraction. The commodity rebounded yesterday as renewed credit worries and concerns about a global economic recovery triggered safe-haven demand after the metal tumbled aggressively during the previous session. Technically, all pull backs have been bought. The commodity’s prices will remain robust on speculation that European’s Economic woes will be prolonged. It will remain bid until the stronger support levels can be broken. With broader risk appetite under pressure, the market has been capable of printing new record highs already this week. The upward bias trend remains intact as the ‘yellow metal’ is trading with a greater consideration of its safe haven status. The asset class is well sought after, technically encouraging individuals to want to own more of it for hedging purposes. Year-to-date, gold has gained +15%. Generally, it has become the benefactor when all other currencies fail. Thus far, Europeans have been content in using the commodity as a hedge against their European holdings, believing that the EUR has not bottomed out just yet. For now, buyers are waiting in the wings to purchase product on all pull backs as equities remain under pressure ($1,243 +300c).

The Nikkei closed at 9,923 down -189. The DAX index in Europe was at 6,246 down -26; the FTSE (UK) currently is 5,217 down -29. The early call for the open of key US indices is higher. The US 10-year eased 8bp yesterday (3.17%) and is little changed in the O/N session. Treasury prices aggressively rose, printing a record low yield on the 2-year $40b US auction yesterday (0.738%) after a US Government industry report showed sales of existing homes unexpectedly fell last month (see above). The 4-week low yield on short end product was achieved as investors continue to speculate that the Fed will mention ‘sluggish economic growth’ when they release their statement this afternoon. The first auction of the week was very strong by all accounts. The bid-to-cover ratio was 3.45, the strongest in 8-months. The indirect bidders (including Cbanks) took down +41.4% the notes, the highest level in 4-months, while direct bidders (non- primary-dealer) purchased +21.3%, compared with +15.2% last month and an average of +13.5% over the past 10-auctions. The belief that the US economy’s momentum is not being built upon should continue to provide a better bid on deeper pullbacks. In total this week we have $108b’s worth of new US product to be auctioned off, with the 2’s completed, we have $38b 5’s today and tomorrows $30’b 7’s. Dealers will try to cheapen the curve somewhat. However, with equities under pressure and the Fed to commit to ‘extended low rates’ there should again be strong demand for product.

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