EUR only spluttering as Yen loses safe heaven appeal

Everyone and their mother expect EUR to trade sub 1.20 by month end, some even by week end. It’s true the highs are getting lower, the downward trend remains intact and the risk reward of entering a short at these levels is becoming questionable. Are Capital Markets too bearish in their sentiment which is causing such intraday volatility? Yesterday, we managed to print a four year-low followed by a 250 tick bounce that squeezed out the weaker shorts. Risk on and risk off trading strategies is playing havoc with investor’s psyche. The market is getting few breaks with the political tension in Middle East, North Korea and now in Japan where Hatoyama’s resignation has damped the allure of the JPY as a safe heaven currency. Investors risk aversion trading requirements are left with little option when it wants to hide. There is the dollar and then there’s the dollar. Who thought it was going to be a non event until NFP?

The US$ is mixed in the O/N trading session. Currently it is higher against 9 of the 16 most actively traded currencies in a ‘whippy’ trading range.

After weaker manufacturing reports from Europe and China, US data happened to provide some support to equities, albeit only briefly. Yesterday’s US reports revealed a few surprises. US’s ISM headline print was moderate, but more importantly it beat expectations (59.7 vs. 59.0). Naturally, it was difficult to keep up last month’s momentum when we had a six year high print, potentially signaling a peak after a huge run-up following the recent recession. Analysts believe that the pace of gains in manufacturing activity is likely unsustainable and believe the recent headline prints were priced in long ago and that future readings may have a right to be concerned. Digging deeper, new orders remained at 65.7 signaling strong expansion, but new export orders managed to tick a tad higher (suggesting that domestic orders dipped). However, it’s to be expected that the dollar’s appreciation and the European debt issues will eventually exert pressure on the new export growth numbers. Production moderated last month to 66.6, while inventories contracted further and at a faster pace than the previous months. Employment was one of the few indicators to post a gain, rising to 59.8. Perhaps this is a good omen for this Friday’s NFP (median +750k). Finally, the prices paid component pulled back ever so slightly and still manages to grow at an exceptionally fast pace.

Other data showed that US construction posted strong gains, climbing +2.7%, m/m, vs. a flat expectation. However, the fanatic pace of growth is not expected to remain sustainable after this month. Digging deeper, residential spending was up +4.5% (strongest print in nine months) and accounted for most of the headline increase. It worth noting that the residential spending has gotten a boost from the second round of homebuyer incentives (expired on April 30th). Basically, the incentives, at a lagging pace, finally spilt over into construction.

The USD$ is higher against the EUR -0.06%, JPY -0.60% and lower against GBP +0.47% and CHF +0.15%. The commodity currencies are stronger this morning, CAD +0.04% and AUD +0.02%. The BOC raised its key overnight rate by +0.25% yesterday, making Canada the first G7 country to see a rate hike. Their actions have kept markets guessing on its next move. The tone of the statement suggests that this is not necessarily the ‘first step on a long march towards a normalization of interest rates’. This is probably the best move for Governor Carney under current market uncertainties, and signals a fairly ‘neutral bias’ that keeps the BOC’s options open going forward. With the lack of initial clarity had the loonie selling off across the board, aided by weaker commodity and global equity prices. However, stronger US data managed to convince investors to pare some of their risk aversion trading strategies, which by default aided commodity growth currencies. We are back to risk on and off again and commodity prices dominating the loonies short term direction. One should expect the currency to be well contained ahead of the North American employment numbers this Friday. Speculators seem to be better buyers on deeper pull backs until the interest premium has been priced out.

The AUD once again found temporary support from O/N data. The Australian economy expanded for a fifth straight quarter (+0.5%) as government stimuli helped boost consumer demand that weakened after the RBA’s aggressive interest-rate increases. The currency initially found support as investors bet that the RBA will resume raising rates in the coming months after pausing earlier this week and this despite policy makers have signaled that it may keep borrowing costs steady in the coming months as it assesses the impact of the most aggressive rate hike amongst the G20 members. However, the AUD may lose some support as global equity losses mount with growth currencies potentially losing their appeal as investors again seek risk aversion trading strategies. With China’s manufacturing expanding at a slower pace last month is limiting the demand for the currency. Speculators are better sellers on rallies as longer term support levels become questionable again (0.8324).

Crude is weaker in the O/N session ($71.85 down -73c). Crude prices have whipped around on the positive and negative side in a tight range after contrasting Chinese PMI numbers and US ISM data had speculators seeking value. The fear is that China’s economy is about to stall has become a thorn in the side for the bulls. Weaker European data is showing that European growth is questionable and US data last week revealed that consumer spending stalled last month, proof perhaps that their growth may be overstated. The black stuff has fallen -15.5% from last month’s high print. Last week’s EIA report had helped the market to drag crude prices away from the initial oversold lows on European fiscal issues last month. A report released from the US Energy Department showed that the total fuel demand gained +0.6% to +19.7m barrels a day. The EIA report revealed a +2.5m barrel increase in oil inventories vs. an expected +100k gain. On the flip side, gas stocks fell -200k barrels vs. an expected no change. Distillate inventories (including heating oil and diesel), fell -300k vs. an expected increase of the same amount. Interestingly, stocks at Cushing fell -300k barrels, the first loss in two months. Refinery utilization was down -0.1% to 87.8% of capacity, matching forecasts. Fundamentals are starting to provide a difference to commodity prices and not just the dollar pricing. Technicals are showing that the market is currently overbought short term. Sellers remain on upticks as the market expects tomorrow’s inventory report to be again market bearish.

Gold yesterday rose to a two week high on demand as an alternative to the EUR. The threat to global growth from Europe’s debt crisis and declining equity prices has increased the demand for the commodity as a haven. With continued currency concerns and a market that is on ‘pins and needles’ is only boosting a case for owning the yellow metal. Europeans are content in using the commodity as some sort of hedge against their European holdings, believing that the EUR will just keep on going lower. GSNY has a month-end target print of 1.1700. Also lending support is India, who’s gold import numbers have been stronger than the markets been calculating (+$6.9b vs. +0.71b, y/y) and surpassing China as the world’s largest user of the commodity. With longer term investors using the yellow metal as a ‘currency of last resort’ have the technical bulls believing that $1,400 is a possible one-year target. For now, the market is a better buyer on deeper pull backs ($1,224).

The Nikkei closed at 9,603 down -109. The DAX index in Europe was at 5,889 down -92; the FTSE (UK) currently is 5,086 down -76. The early call for the open of key US indices is lower. The US 10-year backed up 3bp yesterday (3.26%) and is little changed in the O/N session. Over all, treasury yields remain under pressure, and contained in a 10bp range ahead of NFP this Friday despite stronger US data paring their initial rally yesterday morning on speculation that the EU efforts to contain Europe’s debt crisis will slow the global economic recovery. The 2/10’s spread continues to narrow (+252bp) on concerns that there maybe a shift in the trading philosophy from inflation to deflation. Yield support remains intact and dealers remain better buyers of debt on pull backs.

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