Dollar Junk not EURO

We are stuck in a range being thrown around by flows while the market digs deep to justify owning their positions. The dollar has had every opportunity to outperform this week with risk subsiding. Instead, with the Fed trailing in the tightening race, has put the currency near the bottom of the G10 carry trade league. The EURO remains resilient despite the downgrades, potential debt restructuring and fears of default. It’s the hawkish nature and actions that is driving the currency forward.

A record monthly jump in Euro-zone inflation this morning unexpectedly pushed up the annual rate of inflation to a fresh 29-month high last month (+2.7%), a move that will support the ECB to tighten monetary policy even further. The market is currently pricing in a +104bp of ECB hikes over the next 12-months. Expect the EURO to grid higher.

The US$ is mixed in the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in an ‘orderly’ session.

Yesterday’s US data did the dollar no favors. The US reported disappointing claims and a mixed PPI report. The number of people filing for unemployment jumped +27k, w/w, to +412k, closer to the beginning of the year reporting when seasonal volatility impaired readings.

Analysts are explaining the unexpected rise away to the effects of adjusting to a new quarter. The four-week average remains below the +400k psychological benchmark at +396k. Continuing claims on the other hand fell further (+3.68m vs. +3.72m), although, remember that this data-set is lagged by one week. Nonetheless, the recent downward trend in continuing claims highlights continued improvements in the US labor market.

US producer prices grew at a slower pace in March (+0.7% vs. +1.6%), even the growth in core-producer prices remains relatively subdued at +0.3%, m/m, reducing upward pressure on inflation. Digging deeper, some of the major sub-components were also softer, food prices fell (-0.2%) for the first time in eight-months as did crude and energy, which were both down -0.5%, m/m.

The USD is higher against the EUR -0.13% and lower against GBP +0.00%, CHF +0.01% and JPY +0.35%. The commodity currencies are weaker this morning, CAD -0.24% and AUD -0.18%.

The loonie was back and forth yesterday, with traders acting like headless chickens looking for reasons to buy-and-sell in this range. The currency initially underperformed on fears that Europe’s most indebted nations may be forced to reorganize debt payments to bondholders, thus damping demand for currencies linked to growth. Eventually the CAD pared some of these losses on the back of oil prices getting a boost.

The focus this week has been the BoC’s MPR. The details show that policy makers expect to gradually hike interest rates through 2013, while warning that the strong CAD could hurt exports and act as a drag on growth, as well as put added downward pressure on inflation through cheaper imports. Earlier this week, Governor Carney kept rates on hold at +1%. Their new forecast for the loonie is 0.9700.

Overall, the BoC is less concerned about global and US risk as it focuses on the strong dollar. Governor Carney has been trying to talk the CAD down. The BoC statement was less hawkish than it could have been, and suggests the strong potential for policy neutrality for an extended ‘period-of-time’. It’s worth noting that with only 10% of Canadian exports going to emerging markets, Canada is not likely to benefit from the current commodity boom (0.9635).

Despite leading the G10 rally this month, the AUD fell O/N, extending a weekly drop against the dollar, as speculation that the PBoC will raise rates again to combat inflation after reports showed inflation (+5.4% March) accelerated to the fastest pace in more than two years.

Earlier this week, the MAS stepped up its fight against inflation and the BRIC leaders said rising commodity prices posed a threat to growth. The MAS, in its third tightening of policy this year, are combating inflation and their actions along with PBoC fears appears to be spurring risk-aversion and pressurizing commodity and growth sensitive currencies.

The market weakness in commodities and emerging market equities over the last two trading sessions certainly has not supported growth sensitive currencies. Depending on how risk appetite pans out, these pull backs may end up being a good buying opportunity. With Japan’s loose monetary policy, the yen is expected to continue to weaken further with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on these pullbacks (1.0524).

Crude is little changed in the O/N session ($107.79 -32c). The growing expectation among investors that the Fed will lag other Cbanks in tightening monetary policy is creating a supportive backdrop for commodities. Also aiding crude prices was the magnitude of the gasoline drawdown last week, the largest in 13-years. The shutdown of a Sunoco plant due to a fire will tighten supplies even further.

The week’s EIA report showed crude stocks climbed +1.60m barrels to +359.3m, remaining above the upper limit of the average range for this time of year. On the flip side, gas supplies plummeted-7m barrels and are near the lower limit of the average range. Oil refinery inputs averaged +14.0m barrels per day during the week, which were-354k barrels per day below the previous week’s average as refineries operated at +81.4% of capacity.

Earlier in the week the IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth based on its preliminary data for January and February. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy. Even Goldman is recommending to investors to take profit on the one directional commodity trades.

Gold prices are well supported on speculation that higher raw-material costs and record-low interest rates will encourage demand for an inflation hedge amid expectations that Bernanke and Co. will maintain its accommodative monetary policy in the medium term. Gold as a non-yielding asset has a higher opportunity cost when interest rates rise.

The commodity plunged earlier this week on the back of the reduced economic growth forecasts from the IMF and the easing of inflationary pressures. Goldman indicated that if one owned commodities, the risks outweigh any further potential gain. This had been a catalyst for some bulls to lighten up their long positions. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners is supporting commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +27% in the past year.

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 ($1,474 +$1.70).

The Nikkei closed at 9,591 down-62. The DAX index in Europe was at 7,167 up+21; the FTSE (UK) currently is 5,974 up+10. The early call for the open of key US indices is lower. The US 10-year eased 2bp yesterday (3.47%) and is little changed in the O/N session.

10-year yields touched a one-week low yesterday as US claims unexpectedly jumped, producer prices rose less than forecast and fears that Greece may need to restructure its debt, boosting investor demand for safety.

Investors are beginning to realizing that the global recovery is not necessarily a ‘one-way move up, but will remain inconsistent’. Rumors of analysts revising US GDP lower (April 28) is also providing some support.

In the last of this week’s Treasury issue, the US government sold $13b 30-year bonds. It was a strong auction, stopping at +2.4bp through the screens at 4.531%. The indirect and direct bidders took +58% of the issue, and the auction had a 2.83 bid-to-cover ratio compared to an average of 2.62 over the last six-auctions.

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