EUR relief rally on the way?

As anticipated, with the holiday shortened trading week and after a plethora of data yesterday the market is trading in a narrow range. Markets will keep one eye open on the Irish by-election results where the Governing party is likely to lose today, reducing the government’s majority. While anticipated and should not surprise the market, a low vote return could reinforce fears that the government might lose support ahead of their budget vote on 7 December. The EUR again straddles the lower end of its range on rumors that a rating agency is looking at downgrading Italy. With thin liquidity, rumors gain traction quickly. Are we close to pricing in the periphery contagion fears already? The core-Euro-zone economy still remains untouched. If true and we include seasonal patterns a EUR relief rally should be on the way. As ever, the market is waiting for the other shoe to drop.

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘subdued’ trading range.

With the holiday shorten work week it was a squeeze to get more US data reported yesterday. The results were a mixed bag and open to many interpretation. Again, the one sector not helping to restore US consumer confidence is the housing data. Yesterday, new home sales fell -8.1% (+283k vs. +311k) last month and FHFA house price index for September eased a further -0.7%. Analysts admit that this series of numbers, especially home sales, tend to be rather volatile. However, the downward trend in the housing market remains intact.

Improvements in both the current and economic outlook components of the UoM consumer sentiment happened to push this months final reading up to 71.6 vs. 69.5 and the highest reading in six months. Despite the improvement, the print remains below the 73.9 average for the first half of the year. We should take solace in the fact that the month over month 2.3 point gain could be the beginning of an upward trend as we head into the home stretch of 2010.

On an even brighter note was the personal consumption spending data for October. A nominal increase of +0.4% was translated into an increase of +0.3% in real terms. If we included the upward revision for September, this puts the October level of real spending on a +2.9% annualized growth rate. We should be cautious as the market this week has already witnessed preliminary estimates of unreliable income growth prints, the second quarter rate of disposable income was revised higher by more than +1%. On the flip-side, the price data was very much in line with expectation. The overall PCE price index rose by +0.2%, while the core remained flat month over month. When unadjusted, the overall annualized growth rate eased from +1.2% to +0.9%. The three-month series was even weaker at +0.7%. With the core somewhat deflating will again be worrisome for the Fed in the coming months.

The Durable Goods order print yesterday has gotten the final quarter off on the wrong foot. Even taking the upward revision for September into account, the -4.5% decline in orders for non-defense is a weak start. Despite corporate sentiment starting to improve somewhat does not seem to be filtering through in the final numbers. The market should be looking towards improvement in the employment numbers to eventually carry over to a more positive durable print going forward.

Finally, weekly unemployment insurance claims gave the market a much needed job optimism jab yesterday. The-34k decline (+407k vs. +441k) pushed claims down to its lowest weekly level in twenty-seven months. This should certainly be a huge plus for Decembers NFP release. Even continuing claims impressed, seasonally adjusted, it fell-142k to a two-year low of +4.182m. This may suggest that a higher percentage of workers are leaving the program before they run out of regular benefits. Even so, it may have a positive influence on next months unemployment rate as well (+9.6%).

The USD$ is higher against the EUR -0.22%, GBP -0.08%, CHF -0.48% and JPY -0.13%. The commodity currencies are weaker this morning, CAD -0.10% and AUD -0.14%. The loonie did a complete reversal yesterday and attempted to threaten new monthly gains, but alas, ran out of gas during the illiquid US holiday shortened session. The CAD strengthened the most in four-months as risk aversion declined on optimism that the country’s economic recovery will strengthen. For most of this week the currency has been subjected to the flight to quality trading activity and the demand for the traditional historical reserve currencies, the dollar and yen. Data this week showing that inflation accelerated last month and retail sales rose in September has finally started to influence the market, at least until the next contagion shoe drops in Europe. The inflation headline print certainly brings the BOC back to the table, at least in the first quarter next year. The market should expect the loonie to underperform vs. the dollar outright, but on the crosses, the CAD should fare much better, especially vs. the EUR.

China again has entered the fray and being Australia’s largest trading partner, any threat of tightening monetary policy tends to affect Australasian currencies. The AUD fell outright and against yen O/N after the PBOC said it will strengthen liquidity management and ‘normalize’ monetary conditions, damping demand for higher-yielding currencies. With China concentrating on containing strong inflation rather than boosting growth will affect commodity sensitive currencies. The AUD had found support on prospects that global growth will weather Ireland’s debt crisis and tensions in Korea. To date, the currency has climbed against all of its major counterparts in the past six months on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt over that of other developed markets. Futures traders are pricing in the RBA will raise its target rate by +35bp over the next year (4.75%). As the leading commodity currency, the AUD is highly vulnerable to any Chinese monetary actions. From a fundamental perspective, thus far, the decline has been somewhat limited after last weeks minutes indicated that Governor Steven’s decision to raise interest rates was ‘finely balanced’. Policy makers said a ‘modest tightening’ was considered prudent when they increased the benchmark rate earlier this month. Short term speculators are looking to sell AUD on rallies (0.9802).

Crude is lower in the O/N session ($83.73 -13c). Crude rallied aggressively before the holiday period as a modest rise in weekly inventories calmed worries about a much larger increase. Crude inventories rose by +1m barrels and despite expectations that stocks would decline, the increase remains slight compared to the massive decrease the previous week. It’s the steady drop over the past two months for total inventories of crude and fuel products that has created this bid to the market. Refineries are increasing runs in response to good margins. Utilization rate increased by +1.5% to 85.5% of total refining capacity, another sign that demand was improving. Gas inventories rose by +1.9m barrels, while stockpiles of distillate (heating oil and diesel), fell by-500k barrels. Analysts had expected gas stocks to fall by-900k and distillates to fall by-1.5m barrels. Technically, crude has bounced off handsomely from the psychological $80 barrel all on fundamentals despite the Euro-zones contagion fears. It’s certainly an impressive response despite the stronger dollar index.

The overweighed one-directional lemming trade, gold, is holding its own despite risk-aversion softening. On Tuesday, the yellow metal rose the most in two weeks, on demand for a haven in the midst of Europe’s sovereign-debt crisis and escalating tensions in Korea. Investors are tentatively shredding risk and seeking flight to quality assets on pullbacks. All week, despite the plummeting EUR and a dollar in demand, the commodity has held its own. Investors, for most of this year, have been using the commodity as a hedge against inflation and store of value. Speculators expect the Euro-zones debt concerns to eventually provide stronger support on pullbacks, anticipating that Capital Markets may shift their focus toward other Euro-zone debt issues. Year-to-date, the metal is up + 22.1% and is poised to record its 10th consecutive annual gain ($1,372 -$2.40c).

The Nikkei closed at 10,079 up+50. The DAX index in Europe was at 6,831 up+8; the FTSE (UK) currently is 5,672 up+16. The early call for the open of key US indices is lower. The US 10-years backed up 14bp yesterday (2.90%) and are little changed in the O/N session. Treasuries have plummeted, wiping out most of the gains posted over the past couple of trading sessions, as the refuge appeal declined and reports showing US economy is gradually strengthening reduced the demand of the $29 billion seven-year issue. The bid-to-cover ratio, 2.63, was the lowest since March. Now we have Thanksgiving.

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