EUR crapshoot

The Chinese rate hike has been brushed aside by the lightly staffed trading desks. It was expected and mostly priced into the market. A logical reaction would have been a stampede towards safety assets, alas, this has not developed. Perhaps it will be an issue for the first week of trading in the New Year. For now, this illiquid market is trying to stay out of trouble in the holiday shortened trading week. Despite the slightly heavier volumes this morning, universally its believed that the EUR remains vulnerable when normal trading resumes next week as some currency prices are an illusion as its difficult to get size executed.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ O/N session.

Capital Markets has few reasons to want to do anything thus far in this extremely thin trading week. Light volume tends to exaggerate price movements and traders see ‘no pay from play’ until liquidity picks up. There seems to be more focus on the negative Chinese equity market. It has extended its losses after the PBOC rate hike to +5.81% at the weekend. With China implementing its proactive fiscal policy again in the New Year should eventually squeeze global bourses and commodity sensitive currencies. For now, staying out of trouble is the number one priority for most dealers.

The USD$ is lower against the EUR +0.49%, GBP +0.04%, CHF +1.32% and JPY +0.69%. The commodity currencies are stronger this morning, CAD +0.33% and AUD +0.53%. The market has strong bids all the way down to parity in this holiday shortened trading week. The loonie, if allowed at all, can only make modest gains technically until the year-end as the currency trades in this narrow range. The currency continues to modestly underperform against its major trading partners despite the stronger fundamentals out of the US. Canadian policy makers remain weary of Europe’s funding challenges, US growth risks and with benign domestic Canadian inflation worries will not pressurize the BOC to tighten monetary policy any time soon. This month the loonie has gained +1.1% outright vs. its largest trading partner. The currency has only witnessed modest strength compared to other growth sensitive currencies as Governor Carney highlights the dangers of a persistently strong domestic currency. The CAD continues to struggle within striking distance of parity because of the strong corporate interest to own dollars there. If the bids disappear it would become interesting. Overall, the market remains better buyers of dollars on dips.

The AUD extended gains to a fresh two month high in holiday thinned markets O/N. Ongoing M&A talks for Aussie companies as well as firmer commodity prices is lending the currency a hand despite the PBOC hiking rates +25bp at the weekend. A higher risk appetite is spurring a shift of money to the Aussie and other commodity sensitive currencies, temporarily at least. The currency had been trading under pressure outright as US Treasury yields climb, narrowing the yield advantage of assets down-under. Year-to-date, the currency has climbed +10.4% (second biggest winner after JPY), on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt compared with other developed markets. The market is running into offers at 1.0150(1.0112).

Crude is higher in the O/N session ($91.10 +10c). After peaking at its two-year high yesterday, oil prices have retreated as the market digests the Chinese interest rate hike which may slow economic growth in the world’s biggest energy consumer. Colder conditions along the US east coast and throughout Europe seems to be providing a bid on pull backs in this weeks thin market action. Last week’s EIA report showed that crude inventories decreased by -5.3m barrels. At +340.7m barrels analysts note that current stocks are above the upper limit of the average range for this time of year. There was a similar scenario with gas inventories, they increased +2.4m and remain in the upper half of their range. OPEC believes that supply and demand are ‘in balance,’ and expect demand growth will slow as the global economy struggles to recover, amid ample supplies. Technically, expect the market to meet resistance all the way up to the psychological $100 limit as refiner’s actions to avoid year-end tax liabilities is priced in.

Gold prices again advanced this morning on speculation that currency volatility will boost demand for a safe heaven investment. The dollar weakening has also come to the commodity’s aid. Year-to-date the commodity has gained +26% as Europe’s debt crisis and low US interest rates has encouraged global investment in precious metals. The yellow metal continues to garner ‘physical’ interest on pull backs despite China hiking interest rates by +25bp on Christmas Day. Even though the one direction trade feels overdone, investors continue to hold gold as a hedge against long-term inflation. The Euro-zone contagion issues continue to put a floor on metal prices on demand for a haven. The commodity is poised to record its tenth consecutive annual gain ($1,394 +$11.50c). Technical analysts believe that gold will outshine other precious metal in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,292 down-64. The DAX index in Europe was at 6,973 up+3; the +FTSE (UK) currently is 6,008 up+13. The early call for the open of key US indices is higher. The US 10-year eased 5bp yesterday (3.33%) and is little changed in the O/N session. Treasuries remain under pressure, heading for their biggest monthly decline in a year, as the market prepares to take down $99b of new product this week. There is speculation that the confidence print this morning will beat expectations, and with the market taking the Chinese rate hike in its stride, is pushing yields to test medium term resistance levels. Yesterday, the market took down $35b 2’s, today $35b 5’s and tomorrow $29b 7’s. The 2’s came at +0.74% vs. +0.755% WI’s. The auction did not tail and was well bid with 3.71 vs. 3.51 the four auction average.

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