Dollar is ‘running with the Bull’s’

The USD is ‘running with the bull’s’ this morning. Nothing ‘new’ has warranted their actions. Capital markets expected no different from the Fed, despite them being slightly more upbeat, Greece downgrade did not blindside the market (Ireland next perhaps?), but asset class prices have moved so violently and swiftly creating all sorts of havoc. The illiquid holiday season has compounded the dollar’s ‘violent’ move. Finally we have broken through some major suspect support levels for G8 currencies. Is the ‘reserve’ currency move sustainable? Are we experiencing a paradigm shift? Remember, it’s year end, month-end, holiday season, such moves, percentage wise are usually overdone!

The US$ is stronger in the O/N trading session. Currently it is higher against 15 of the 16 most actively traded currencies in a ‘volatile, yet illiquid’ trading range.

Yesterday’s US CPI headline print was rather tame (+0.4% vs. +0.4%). However, if we excluded the most volatile components, food and energy, again price issues were benign (+0.0% vs. +0.1%). Very much touted by Bernanke and Co. is the argument that current inflation remains a non-issue to the US yield curve. In fact, similar rhetoric from the Fed’s communiqué may be applied to the situation, ‘upside and downside risks are evenly balanced around a fairly tame measure going forward’. One should not get hung up on the y/y headline either. All CPI items ‘spiked’ from -0.2% to +1.8% in Nov. Analysts explain this phenomena by stating that it is purely a function of the sharp drop in oil prices this time last year which has created a very ‘soft base effect’ for inflation comparisons. So ignore it! Overall, this report provides little evidence of inflation pressures, unless one drives a car while smoking! Gas prices climbed +6.4% and tobacco another +1%. Rather than inflationary pressure existing, its nemesis was widespread, disinflation. For instance, cloth prices fell for a 2nd consecutive month as did computers and rent! Most of the other sub-components remained close to home.

US housing starts did not beat expectations, but came within walking distance of consensus (+574k vs. +551k). The headline print remains confined within a tightly defined yearly range. The results continue to hug the lower end of the spectrum. Optimistically, there are a few variables on the horizon that should solidify the ‘floor’ despite builder confidence remaining weak and even deteriorating this month. Low borrowing costs, the first-time homebuyers’ extension and small improvement in the labor market are some positives that may stop the ‘bleeding’. Realistically, growth signs in the housing sector may be solely attributed to ‘resale’s’, because of the huge amount of foreclosures hitting the markets. By default, this has managed to keep house prices and ‘new-supply’ relatively low. Digging deeper, most of the gain last month may be attributed to multi-family starts, which rose +67.3%. Not to be outdone, single-starts also improved during the month although at a more modest pace of +2.1%, m/m. If this trend carries on into this month, it may end up being a positive contributor to the 4th Q GDP. Finally, housing permits came in slightly better than expected last month, up +6% (+0.580k vs. +0.550k) on the back of gains in both the single and multi-family components!

The Fed repeated its pledge to keep interest rates ‘exceptionally low’ for ‘an extended period’ and said the economy is strengthening at the end of its two day FOMC meeting yesterday. Governors reiterated that ‘most of the Fed’s special liquidity facilities will expire on Feb. 1 2010’. They will also continue to work with other Cbanks to close temporary liquidity swap arrangements by the same date. The Fed adopted a somewhat more upbeat tone towards the economy, for instance, noting that ‘the deterioration in the labor market is abating’, and it also implied that there would ‘not’ be a further expansion of the Fed’s balance sheet or extend the array of tools for injecting liquidity into the system which had been created during the financial crisis. All seems on the up and up!

The USD$ is currently higher against the EUR -0.96%, GBP -0.69%, CHF -0.70% and JPY -0.05%. Yesterday, Canadian manufacturing doubled expectations (+2.0% vs. +1.0%). However, analysts remain vocal about the downside risks. On the face of it, the report indicates a strong start to the 4th Q, highlighted by the rise in exports. Higher prices accounted for some of the strong gains in shipments (+1.2%), and this is expected to contribute to next weeks real-GDP. There are three scenarios that could ‘throw a wrench into the works’. Firstly, analysts will tell you that the volatile Canadian aerospace sector gains will be difficult to repeat this month. Secondly, oil’s recent slide will affect the dollar value of petrochemicals shipments. And finally, new-orders are not offering much strength for shipments into the New Year. They actually fell in Oct! Yesterday, initially the loonie gained ground against most of its major trading partners as commodities managed to keep their heads above water. Since then USD bulls have gained the upper hand and the loonie is in danger of breaking some key resistance points this morning (1.0750). Expect these illiquid holiday markets to bring forth more volatility, which would take very little effort to penetrate the weak support or resistance levels. Lack of liquidity and directional play is capable, even violently so, to create a new and wide holiday trading range. Expect liquidity to become more of a concern across the board as we close out the month. Again investors continue to be a comfortable buyer of the greenback on pull backs. If one prefers being long the greenback, crossing it with a commodity sensitive currency is not the ideal answer (CAD, NZD, AUD and NOK). An investor would get more ‘bang’ for their buck if it was done out-rite with the EUR for example.

Booking profits, seeking safety, that what most of the action has been about in the O/N session. The AUD fell to its lowest level in 10-weeks as traders pared position in high yielding assets just before year end. Earlier this week, the RBA’s deputy governor Battellino said that Australia’s monetary policy is ‘now back in the normal range’ after lenders raised business and home-loan rates by more than the RBA themselves have increased (+3.75%) the overnight cash rate target. Interest rates being paid by borrowers are now ‘above their previous cyclical lows’, making it ‘reasonable to conclude that the overall stance of monetary policy is now back in the normal range’. Traders have aggressively pared bets that the Cbank was in a position to hike rates for a fourth consecutive time in Feb. (+40% chance). The currency remains under pressure despite stronger fundamentals. Investors are looking for better levels to sell it (0.8885).

Crude is lower in the O/N session ($71.71 down -95c). Crude, advanced yesterday the most in two months after the weekly inventory report dropped to its lowest level in 11-months. An insurance premium was also added after Iran tested medium-range missiles, drawing threats of sanctions. Oil advanced just under +4% after the EIA reported that inventories declined -3.69m barrels last week to +332.4m vs. expectations of a decline of only -2m barrels. Lending support, imports of crude declined -4.5% to +7.77m barrels a day (the lowest print in 14-months). Refineries operated at +80% of capacity, down -1.1%. On the flip side, US gas consumption rose +1.5% last month, y/y, as the economy recovers from the recession. Gas inventories gained +879k barrels, or +0.4%, to +217.2m barrels last week. The market was anticipating a rise of +1.25m barrels. In contrast, distillate stocks dropped -2.95m barrels to +164.4m, compared with a forecast of a -500k decline. In total, US daily fuel demand averaged +18.8m barrels over the last month, down -1.8% from a year earlier. As one analyst summed it all up, ‘if you put the response to the Iran missile test together with higher equity prices, a lower dollar, favorable chart patterns and the weekly DOE reports, and you’re looking at a buy’. There was nothing bearish about yesterday’s price action. However, this morning dollar action has naturally pared some of those gains. The reserve currency will continue to dictate the direction of commodities!

Gold advanced the most in 2-weeks yesterday as the greenback wobbled on the back of Bernanke keeping borrowing cost at historical lows for an ‘extended’ period of time. But in the O/N session the commodity managed to pare its gains and even some as the flight to safety undermined the quality of the yellow metal as an alternative investment. Even with all the noise and volatile movements in other asset classes, the ‘yellow metals’ pull backs has remained a strong buying opportunity for ‘the international currency’ ($1,121).

The Nikkei closed at 10,163 down -13. The DAX index in Europe was at 5,867 down -35; the FTSE (UK) currently is 5,278 down -42. The early call for the open of key US indices is lower. The US 10-year bond eased 3bp yesterday (3.54%) and are little changed in the O/N session. Treasuries rose, snapping a week of losses, as yields near 4-month low enticed investors to add the asset to their portfolios as Bernanke and Co. kept rates close to record lows. Yesterday’s surprising CPI headline confirms that US inflation remains rather benign and currently there is no reason for monetary authorities to tighten their policies. In fact, it’s way too early for the Fed to be worried about it.

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