EUR held hostage by dollar

We have witnessed a zero-sum game after five sessions of extreme volatility for the EUR. In effect it’s been a seven-cent swing for the currency since last Fridays high recorded after helicopter Ben’s remarks. Chancellor Merkel’s comment that the EUR is ‘shielded by rescue packages’ and the fact that she is bullish on German growth negated all the PBOC tightening monetary policy effect on Tuesday. That was surely a pre-G20 placation move on their part. The maddening currency swings have been driven by the lack of detail on the QE2 front. A Medley report yesterday seems to have appeased the market somewhat. It’s anticipated that the FOMC is ‘converging upon a decision to buy Treasuries of about $500b over the next three-to-six months with an open-ended commitment to buy more assets over the following year, depending on economic developments’. The dollar is expected to be subjected to further market pressures until after the FOMC meeting and the mid-term elections.

The US$ is weaker in the O/N trading session. Currently it is lower against 10 of the 16 most actively traded currencies in another ‘volatile’ trading range.

The market held its gains after waiting most of the day yesterday for the muted Beige book release. The Fed’s economic survey brought nothing new to the table, again stating that economic growth continues to be modest with a weak housing market and tame inflation. The surprising nugget was that the districts believe that consumers are ‘slowly regaining confidence’. Across all districts it’s more of the same. Consensus has us believing that there is nothing in the report to dissuade the Fed from their expected course of action. Earlier this month helicopter Ben stated that there was a case for additional stimulus because ‘inflation is too low and unemployment is too high’. Since his remark the market has been pricing in aggressive QE2 somewhat on the lines of the yesterday’s Medley report highlighted above.

The USD$ is lower against the EUR +0.41% and JPY +0.05% and higher against GBP -0.36% and CHF -0.09%. The commodity currencies are mixed this morning, CAD +0.15% and AUD -0.05%. Yesterday, Canadian wholesale trade shot by all market expectations. The headline (nominal) wholesale print climbed +1.2%, m/m, the biggest gain in nine-months. In volume terms, wholesale trade was up +0.9%. Digging deeper, all the sub-sectors, with exception for food, drink and tobacco, managed to report gains. It’s worth noting that the machinery and equipment segment was the key contributor to growth (+3.2%). This data took a back seat to the MPR report, which reiterated what the BOC told us earlier in the week regarding a softer outlook. However, the one bright spot may be the fact that while Carney downgraded the inflation projections, policy makers still see the risk to the inflation outlook as being balanced. On Tuesday the BOC kept rates on hold (+1%). Policy makers downgraded growth (+3% vs. +3.5%, 2010) and the inflation outlook (CPI and core inflation are now expected to converge to 2% at the end of 2012). There are a number of ‘factors’ in the way for another rate hike at present. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way. A broadly softer dollar on QE2 pressures will prevent the loonie from losing too much ground, until at least after the FOMC meeting in Nov.

The AUD had a bumpy ride in the O/N session, finding it difficult to maintain traction, as reports out of China pressurized regional bourses and by default curb the demand for growth currencies. Reports show that China’s rate of GDP growth coupled with record inflation acceleration justifies a tighter monetary policy from the PBOC. The AUD fell against the greenback and the yen as Asian shares declined. This weeks RBA minutes showed that policy maker’s decision to keep interest rates unchanged this month had been ‘finely balanced’. On the other hand they did indicate that rates would have to ‘rise at some point’. From a fundamental perspective the minutes reinforced the argument that there could be another hike coming in Nov. or Dec. given that the RBA seems very comfortable with where the currency is currently. Month-to-date, the AUD has climbed +5.9% vs. the buck as data fueled bets that the RBA will raise interest rates before the year ends. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9867).

Crude is lower in the O/N session ($82.20 -34c). Crude prices climbed as the dollar tumbled across the board yesterday, erasing most of the previous day’s losses, and on the weekly inventory report showing a smaller than forecasted gain in stockpiles. The EIA report rose +667k barrels last week, less than half what was expected. That being said, the market continues to focus on the dollar’s weakness and its inverse relationship with commodity prices. Investors anticipate the currency to struggle until after the FOMC meeting and the mid-term elections in Nov. Total crude stockpiles were expected to increase by +1.5m barrels. The market is also focusing on the drawdown at Cushing (the delivery point for New York futures). Supplies dropped -1.1m barrels to +34m, the biggest one-week drop in nine-months. Gas stockpiles rose by +1.2m barrels to +219.3m vs. a -1.3m drop. In contrast, distillate stocks (heating oil and diesel) fell by -2.2m to +170.1m barrels. Analysts had expected only a -600k barrel shortfall. The refining capacity utilization rose by +0.6% to +82.5%. Analysts expected a 0.1-percentage point increase. Despite all this, inventories for crude and refined products remain at unusually high levels. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. It’s the dollars value that is pushing prices about.

What a difference a day makes. Gold rebounded from its biggest loss in three months as the dollar tumbled on QE2 rumors yesterday. Investors continue to seek an alternative investment strategy to the historical reserve currency. Interest rates play an important role to the commodities advance. Rising interest rates pressurize gold prices, just look at the markets reaction earlier in the week to China tightening their monetary policy. Year-to-date it has been a commodity in demand for alternative investment purposes. Last week, the market traded with a distrust of currencies and gold seemed to be the only solution as investors used it as a proxy for a ‘third reservable currency’, pushing the metal to record new record highs. With market confidence wavering in currency prices, and with cheap money, has made commodities look attractive on pull backs. To date, gold has outperformed global equities and treasuries (+22.3%), prompting record investment in gold-backed exchange-traded products. The debasing issues of the dollar, coupled with the sustainable growth issues of the US economy have had investors generally seeking protection in an asset with a ‘store of value’. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to low interest rates ($1,345 +$1.50c).

The Nikkei closed at 9,376 down -5. The DAX index in Europe was at 6,547 up +23; the FTSE (UK) currently is 5,754 +25. The early call for the open of key US indices is higher. The US 10-year eased 1bp yesterday (2.48%) and is little changed in the O/N session. Longer dated securities prices remain close to home as several Fed officials express the need for more policy easing. They have also indicated that it’s going to take ‘quite something to derail a second round of QE’. The open ended question remains what form will QE2 take? It’s the unknown that is keeping yields within a tight range. They market is trying to anticipate how much the Fed will buy or even whether they will give an explicit target. Never ending rumors continue to provide support on pull backs.

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