EUR positions require their own Stress Tests

The thought of even being transparent with the EU Financial Stress Tests has restored some market confidence. To investors, the biggest concern is how tough are these tests? If there are shortcomings, according to Merkel, the EU has ‘taken precautions’ including a 750B EUR financial backstop. Under US stress testing, the government pledged to provide capital when need be. The EU undertaking is short on details, not even a mention of including sovereign debt exposure, hence, the concerns of its stringency. Technically, the EUR is rounding off the week on a high and chartists continue to plot more upside with a bullish close (above 1.2330). The short futures positioning and weaker cash shorts that have been selling into this rally all week will most likely want to lighten up again before day’s end as the squeeze continues towards 1.2550.

The US$ is weaker in the O/N trading session. Currently it is lower against 11 of the 16 most actively traded currencies in another ‘subdued’ trading range.

US data yesterday did not help the ‘sustainable growth camp’s’ cause. It was a mixed and worrisome bag of headline prints. The number of people filing for initial claims for UI surprisingly advanced by +12k to +472k claims. Seasonally adjusted, increases were reported in construction, manufacturing and educational services. The four-week moving average (ex-volatile components) fell by only -500 to +463.5k. Digging deeper, the number of people continuing to file UI rose by +88k to +4.57m. However, continuing claims four-week moving average fell by -21k to +4.6m. Not to be outdone, emergency unemployment compensation dropped from +4.995m to +4.804m. Overall, it was again a discouraging report adding to a long string of disappointments from the claims series dating back to the end of last year. Analysts will argue that the headline prints may be somewhat distorted by the ‘ramping up contraction of temporary Census hires’. The sluggish pace of declining claims may suggest that employers remain reluctant to hire and are relying on existing workers to fill demand. This was certainly evident in this week’s production report.

Another report showed that US consumer prices fell for a second consecutive month (-0.2%) and underlying inflation rose slowly (Core index, the Fed’s go to variable, +0.1%), giving Bernanke and Co. room to support their economy with a record low interest rate policy. Benign inflation is certainly supporting the FI asset class.

Finally, the most disappoint release yesterday was the Philly Fed Economic Index. The headline print plunged from +21.4 to +8 this month. The market had expected only a slight dip. Digging deeper, the underlying sub-components were more mixed. The forward looking new orders index rose from +6.1 to +9, shipments softened from +15.8 to +14.2, while inventories rose from -7.9 to +4.6. The prices indices fell, paid from +35.5 to +10, while received fell from +3.5 to -6.5, mostly on the back of weaker energy prices. However, the most discouraging sub-component was employment. It fell from +3.5 to -1.5, its first negative reading in 7-months.

The USD$ is lower against the EUR +0.09%, GBP +0.35%, CHF +0.11% and JPY +0.30%. The commodity currencies are mixed this morning, CAD -0.03% and AUD +0.18%. The loonie got it between the eyes yesterday, the first time in three days, as weaker equities, commodities and a surprisingly subdued wholesales sales report (-0.3%) had investors paring some of their bullish growth positions. BOC Governor Carney said earlier this week that ‘the uneven global recovery and prospects of renewed weakness in Europe mean that future increases in the central bank’s benchmark interest rate are not preordained’. Up until yesterday’s price action, the loonie remained coveted as speculators increased their bets that economic growth will eventually fuel demand for commodities. Big picture, the CAD is holding its own after the BOC’s rate hike and somewhat muted and directionless communiqué earlier this month. It remains the world’s second best performer vs. its southern neighbor. Using the loonie as a safer way to play an economic recovery in the US with linkage to commodities and less banking or fiscal noise has speculators better buyers of the currency on dollar rallies.

The AUD has retreated from its one month highs but is in pole position to record back to back weekly gains as investors risk appetite increased. Earlier this week, comments from the RBA, who said that Europe’s debt crisis would ‘inevitably weigh’ on global growth, is fueling speculation that the Cbank may keep rates unchanged until at least the end of the year. It seems that that ‘previous rate rises has given them flexibility to leave borrowing costs unchanged at next month’s meeting’. When global bourses back peddle on concerns that the world economy may falter always affects growth currencies. Last week, stronger domestic fundamentals aided the currency. Employment data added +26.9k new jobs vs. an expected +20k. It was the third consecutive month of job gains, emphasizing the RBA’s call that that economic growth will accelerate this year. This pushed dealers into increasing their bets that Governor Stevens will resume the country’s most aggressive round of monetary tightening. So far, it seems that the crisis in Europe has not had a material impact on the Australian economy. With European stress test disclosures lined up will calm investor’s fears. Technically, the market continues to want to buy AUD on dips (0.8686).

Crude is lower in the O/N session ($76.19 down -60c). Crude prices retreated from their six week high yesterday after a jump in US weekly claims and higher weekly inventories ignited fears that that global economic growth will stumble. Earlier this week, the EIA report initially gave the market its bullish sentiment, however, weaker global economic releases has encouraged ‘risk-off’ trading strategies. The report was dominated by the drop in refinery capacity rates. US refineries operated at +87.9%, down -1.2% from the previous week. Gas stocks declined -636k barrels to +218.3m last week with gas demand advancing +1.6% to +9.34m barrels a day (the highest level in nearly a year). Historically, gas consumption peaks sometime between US Memorial and Labor Day in Sept. (the height of the US driving season). On the flipside, crude oil rose +1.69m barrels to +363.1m vs. an expected -1m barrel decline. Inventories of distillate fuel (diesel and heating oil) increased +1.8m barrels to +156.6m vs. an expected +1m barrel gain. Even with demand creeping higher, there is sufficient supply and this has encouraged some profit taking after four days of consecutive gains. Direction is dictated by demand and with ample supply and growth worries has speculators selling oil futures on rallies.

Gold continues to be a safe heaven attraction. Over the past four trading sessions all pull backs have been bought. The commodity’s prices remain robust on speculation that European’s Economic woes will be prolonged. With broader risk appetite declining, the market can expect to print new record highs. Technically the ‘yellow metal’ is trading with a greater consideration of its safe heaven status. The asset class is well sought after as prices have been difficult to break down, which is, by default, technically encouraging individuals to want to own more of it for hedging purposes. Year-to-date, gold has gained +14%. Generally, it has become the benefactor when all other currencies fail. Thus far, Europeans have been content in using the commodity as a hedge against their European holdings, believing that the EUR has not bottomed out just yet. For now, buyers are waiting in the wings to purchase product on pull backs ($1,245 -280c).

The Nikkei closed at 9,995 down -5. The DAX index in Europe was at 6,233 up +10; the FTSE (UK) currently is 5,277 up +23. The early call for the open of key US indices is higher. The US 10-year eased 8bp yesterday (3.20%) and is little changed in the O/N session. Treasuries prices rallied after US data yesterday reported a rise in weekly claims, coupled with consumer prices falling reinforced speculation that Bernanke and Co. will keep rates low for an extended period of time. The slumping Philly Fed Economic Index also added its support to the FI asset class. Basically, with inflation remaining somewhat benign and no future inflation pressures on the horizon are evidence that Bernanke and Co. have no reason in thinking about moving rates. Stronger rumblings that the US economy’s momentum is not being built upon should continue to provide some sort of bid on deeper pullbacks. With no normalization of rates on the horizon, yields should remain low and test recent lows once again.

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