Dean’s FX|Bernanke, Bonds and Beer!

The USD$ is stronger in the O/N trading session. Currently it is higher against 12 of the 16 most actively traded currencies in a ‘whippy’ trading range that has been dominated by a large potential M&A transaction (Belgian based InBev placing an offer to buy US based Anheuser-Busch).

That announcement gave renewed support to the greenback, despite less hawkish comments by Fed’s Kohn. The EUR is also being sold this morning on the back of French Finance Minister Lagarde stating that the ECB has only said that they are ‘considering’ a rate hike but ‘have not decided it’.

Hiking rates has become the new global mandate. The RBI (Reserve bank of India) took emergency measures yesterday and hiked borrowing cost by 25bp to 8%, two months before their next schedule meeting to combat the new global threat of ‘inflation’. Other emerging markets are experiencing a similar situation. New found wealth amongst an ‘emerging middle class’ continues to fan the flames of higher prices, combine this with higher fuel costs and other Cbanks in the region will shortly follow. BOC governor Carney surprisingly held steadfast this week with their rates (3.00%), citing similar problems despite weaker growth. Stagflation remains the order of the day.

Yesterday, the market waited for the US beige book all day, and no surprises were had on its release. The Fed reiterated the same story line and said that economic growth was ‘generally weak’ over the past two months as consumer spending slowed due to eroding disposable incomes and manufacturers passing on higher raw materials costs to their customers. Digging deeper, one noticed that ¾‘s of all the regions reported a ‘softer, slower or modest’ expansion. The report was not as discouraging as the last report and certainly provides some support to Bernanke and co. who has said this week that the dangers of a deeper downturn are receding. The report was very much neutral for the FI asset class, while global equities take it on the chin as investors speculate that rates will eventually rise.

The US $ currently is higher against the EUR -0.76%, GBP -0.61%, CHF -0.89% and JPY -0.48%. The commodity currencies are weaker this morning, CAD -0.38% and AUD -1.06%. With BOC governor Carney leaving O/N borrowing costs on hold at 3.00% (despite the market anticipating a cut) has helped the loonie to new found levels. Traders are speculating that surging energy and food costs will prompt the BOC to do a u-turn and raise rates by years end. Canada’s annual inflation unexpectedly accelerated in April on higher fuel and mortgage costs (+1.7% y/y-BOC target is 2% band). Most analysts believe that core inflation will remain below Carneys target right through to next year, which ponders the question why should the BOC change policies mid stream while economic data remains soft? Are they getting too far ahead of the curve? Futures traders anticipate to see the CAD$ trade back towards parity by weeks end. Already this year the currency has depreciated nearly -2.5%, mostly on the back of the manufacturing sector as consumer demand dwindles especially south of the border (>70% of exports are to the US). ‘The BOC now judges that the current stance of monetary policy is appropriately accommodative to bring aggregate demand and supply into balance and to achieve their 2% inflation target. Look for better selling of the currency once it gravitates back towards parity again. The AUD$ fell to new monthly lows (0.9362) after a government report showed that employment dropped the first time in two years (-19.7k vs. +13.5k). This has encouraged traders to reduce bets that the RBA will raise interest rates any time soon (7.25%).

Crude is lower O/N ($135.93 down -45c). Over all, Crude oil remains better bid after the weekly EIA report showed that stocks declined more than expected, thus increasing investor concerns that inventory may come under increased pressure during the US summer driving season. Stocks fell -4.56m barrels to 302.2m last week vs. an anticipated drop of -1.5m barrels. Two other variables have also contributed to prices escalating. Firstly, China said yesterday that their oil imports increased 25% last month as the country recovers from an earthquake, and secondly geo-political tensions have heightened between Iran and the US (OPEC’s second-largest oil producer), who are threatening to place more sanctions on Iran if the government continues to ignore demands to suspend uranium enrichment. To date m/m, US crude stockpiles have fallen nearly 8%. More analysts have jumped on the bandwagon and increased their price forecasts amid concern that supply from outside OPEC will not climb as fast as expected. The IEA lowered its estimate for non-OPEC output this year by -300k barrels a day to +50.04m. It seems that supply trends are growing slower than demand, which of course will push prices higher until ‘the market becomes convinced that supply and demand will be in better balance, supposedly in 2010’. Gold rallied yesterday (1st day in 5), but has give up that gain and even more as the greenback rebounds in this mornings London session, thus diminishing the yellow metal’s appeal as an alternative investment.

The Nikkei closed at 13,388 down -294. The DAX index in Europe was at 6,670 up +20; the FTSE (UK) currently is 5,761 up +38. The early call for the open of key US indices is higher. Yields of the US 10-year bond eased 3bp yesterday (4.06%) and have backed up 4bp O/N (4.10%). Yesterday, Treasuries prices rallied especially in the short end of the curve after ECB Juergen Stark damped traders speculation that the ECB would hike borrowing costs multiple of times this year to combat inflation. His comments caused European Bonds to aggressively rally dragging along treasuries. With global equities remaining under pressure, one would expect the FI class to better bid. Not so, Cbanks continue to provide sign posts that lead to higher rates!!

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