EUR Bears hanging tough ahead of policy decisions

The market seems to be obsessed with the idea that a Fed announcement of additional stimulus measures is near. There are a few who expect them to make some minor cosmetic changes to their copy next week. In the real world, they would have to witness stronger evidence of a more ‘severe deceleration in economic growth’ before counting up the votes to implement a ‘meaningful’ expansion of QE2. Economic outlook has not deteriorated ‘appreciably’ over the past six weeks. Yes, GDP growth has slowed (+2.4%), consumption remains muted because of the job situation but, on the plus side, business investment is rising, personal incomes are higher, the EU-zone is holding its own, equities are rebounding and the dollar has been giving up some of its insurance premium. C’est tout. Certainly it’s not a recipe for disaster just yet. The market players continue to want to pick their moments of entry.

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

Yesterday’s US ADP employment report was slightly stronger than the market had anticipated (+42k). Consensus had been anticipating a headline increase of only +15k. On the face of it, the result should not have too many dealers revising their Friday’s NFP expectations (-60k, with a private payroll increase of +85k). Despite employers adding staff to meet demand as business investment picks up, it is going to take a long while to regain the jobs lost during this recession. Other data showed that the US service industries expanded last month at a faster pace than originally thought. The ISM non- manufacturing businesses (+90% of the economy) rose to 54.3 from 53.8, m/m, signifying expansion. The market had been rather cautious prior to the release, expecting a contracting headline print.

The USD$ is higher against the EUR -0.13%, GBP -0.30%, JPY -0.06% and lower against CHF +0.38%. The commodity currencies are mixed this morning, CAD +0.38% and AUD -0.27%. The loonie is back on track and gaining ground across the board on higher commodity prices and on investors slowly renewing their risk desires. The currency managed to print 3-month highs this morning as the market participants speculate that the Canadian economy will again add to the strong job scenario on Friday. If they do, it will be the 7th consecutive month of job gains. It seems that all growth and interest rate sensitive currencies are out performing the market. Earlier this week, trade data down-under has helped the AUD to gain traction on the crosses. Last month the Canadian economy added +92.3k new jobs, holding the unemployment rate steady at +7.9%. Investors will not try to get too far ahead of themselves, especially with bond yields so low. The currency month-to-date has underperformed against most of its major trading partners as US economic data has been less than impressive. Capital Markets have been questioning the rate of growth in North America. Up until yesterday, the currency had been guilty by association with its largest trading partner. That been said, on dollar rallies there are CAD buyers about.

Again the JPY is dominating the trading sessions and the higher yielding commodity currencies have managed to be included. The AUD happened to pare more of this weeks gain on future reports expected to show that China’s growth is slowing. However, it still trades near a three-month high vs. the USD as gains in Asian stocks and commodities boosted demand for higher-yielding assets. Any pare backs have been tempered by this weeks AUD trade surplus print unexpectedly advancing to a record last month (+$3.54b) as Chinese demand boosted exports of coal and iron ore. China is Australia’s largest trading partner. Overall, there is still a sign of concerns that the world economy is in a fragile recovery phase. It’s widely expected that the that the Fed may go into a new phase of asset buying, which will keep US interest rates low, equities higher and risk appetite supported’. Because of the equity actions, the market is a cautious buyer on pullbacks, wary that the recent strong rally technically may be overdone (0.9156).

Crude is lower in the O/N session ($82.18 down -29c). Crude prices have slipped since yesterday, despite the bearish headline print after the weekly inventory report showed that the underlying stock sub-categories were rising. The steep drop in the ‘headline’ oil stockpiles has 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 some price pull back as the ‘one directional’ move may be overdone. The ‘historical’ US summer driving season is over, coupled with a lack of tropical activity in the Gulf are ingredients for justifiable weaker energy prices. Speculators will be better sellers on up-ticks in the short term.

Rebounding from some very strong technical support levels last week, the ‘yellow’ metal has advanced for a sixth consecutive day, its longest winning streak in 9-months. Gold has found traction on speculation that prices near its recent lows would fuel demand for the physical asset as China’s plans to relax rules on trading and weaker equities will increase natural demand. Many believed that last week’s decline has been overdone. Mind you, a weakening dollar will always increase the demand for the commodity. For most of this year, we have witnessed gold rally on the back of a weaker EUR, for the past 6-months investors have been buying the commodity as a safe heaven asset. Until recently, a weaker dollar had been the biggest factor in supporting commodity prices again. Since the record highs witnessed on June 21st ($1,266), the commodity has fallen over -4.7%. If the EUR continues to stabilize against most of its trading partner, by default, the market will end up selling the commodity asset class on up-ticks. Historically and fundamentally, this is the ‘slowest’ season for physical demand and now with China potentially changing the ground rules will drag the metal higher. Year-to-date, the commodity has gained +7.4% ($1,199 +$3.30c). Let’s see how far the metal can travel under renewed risk aversion.

The Nikkei closed at 9,653 up +165. The DAX index in Europe was at 6,346 up +15; the FTSE (UK) currently is 5,406 up +21. The early call for the open of key US indices is slightly higher. The US 10-year backed up 6bp yesterday (2.95%) and is little changed in the O/N session. US 2-year product is gravitating towards higher yields from its record lows after the US ISM service industries expanded faster than expected last month and on the back of US companies adding more jobs than forecasted. The US treasury also announced the issuing of $74b of new debt next week (3’s, 10’s and long-bond). This is more than the $69b average for this particular mix of securities. Again, the market seems to be second guessing what the Fed will do with the proceeds from its maturities. It’s widely rumored that on Aug 10th the Fed will announce if it’s to buy more mortgage and treasury bonds. Perhaps this Friday’s employment report will finally push them over the edge in a commitment to buying product. For now, the market is content in owning product on deeper pull backs.

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