EUR Remains Vulnerable No Matter What

The dollar has consolidated ahead of the ECB rate announcement, with the market expecting the ECB to maintain its tightening bias and raise its policy rate by +25bps. The focus will of course be on Trichet’s press conference.

Policy makers are expected to use the same language and reiterate how they will continue to monitor developments relating to price risks very closely, coupled with a continued upside risk to inflation bias as consistent with another hike in October. To date, the futures market has not fully priced in an October hike just yet. The EUR’s ability to benefit from a hawkish message remains contingent on stability in peripheral financing markets. The threat of continued tightening policy alone is not enough to support a strong rally.

What if Trichet sends another message by shifting to ‘neutral’ inflation risks or dropping the close monitoring language? The EUR’s cliff gets much steeper. Any of this rhetoric would be viewed as signaling a pause in the rate hike cycle and not be supportive for the currency.

The US$ is a stronger in the O/N trading session. Currently, it is higher against 12 of the 16 most actively traded currencies in a ‘subdued’ session ahead of Trichet’s communique.

The pace of growth in the US’s non-manufacturing services sector remained sluggish in June (53.3), with new-orders falling (53.6) and employment holding steady (54.1) last month. However, the most prominent concern remains about the volatility of prices (60.9 vs. 69.6). With energy prices continuing to fall last month has allowed cost pressures to ease. The released data did little to discourage investor’s actions. They continue to focus on renewed worries over the Euro-zone’s sovereign debt crisis and the interest rate hike from China. The report echoed data from Europe earlier this week that showed services growth slowed last month in the face of sluggish new-orders and rising interest rates.

The dollar is higher against the EUR -0.03%, GBP -0.10%, CHF -0.08% and JPY -0.02%. The commodity currencies are stronger this morning, CAD +0.03% and AUD +0.42%.

The loonie has been trading under pressure outright, touching its lowest level in almost a week yesterday, after the Chinese government increased interest rates to cool its economy, sapping demand for higher-yielding currencies. Not having any significant domestic economic data so far this week, the loonie is taking its cue from the broader market sentiment.

On the crosses, the currency is outperforming the EUR as investors worry about Euro contagion spreading to Portugal and Ireland. The potential for further loonie strength is high if data continues to surprise to the upside in a similar manner to May’s building permits release yesterday (+20.9%, m/m). It’s worth noting that the value of permits is a highly volatile data point, but the rebound in May is positive news after a weak April reading (-21.5%).

At the beginning of the week, the CAD appreciated +3%, breaking through some key support levels. Ever since the high print, investors have been booking some modest profit, trimming holdings of riskier assets after S&P’s said a debt-rollover plan for Greece may prompt a ‘selective default’ rating for the country. Expect the loonie to be subjected to the pull of either risk or risk aversion trading strategies ahead of North American employment data tomorrow (0.9650).

Boosting the AUD O/N was the employment numbers from down-under. Employment rose +23.4k in June, more than the +15k consensus. Importantly, full time employment surged +59k and the employment rate at +4.9% held at just below the full employment rate. With the strong private investment outlook pointing to still robust trend employment growth, supports Governor Carney’s concern that at some point, savings rates will fall and consumption will rise, pushing inflation above its target, allowing the RBA to be more hawkish.

Again, gains have been capped on fear that Greek austerities plan will not resolve Europe’s sovereign-debt crisis. Technically, the market is waiting for funding schedule clarity. Concerns that global growth is slowing has prompted some investors to bet that the RBA will cut interest rates some time this year.

Currently, the market is pricing a no hike in August unless both inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite. Global data needs to improve before we can embrace any rate hike policy thinking (1.0736).

Crude is higher in the O/N session ($97.39 +0.74c). Crude backed off from its three-week highs after the PBoC raised interest rates and Moody’s downgraded Portugal’s credit rating, heightening concern that slower global growth will curb future fuel consumption. China’s actions declare that their inflation fight is more important to them than growth.

Providing crude support earlier this week, after the IEA said members would release +60m barrels from strategic reserves over 30-days to make up for a supply shortfall in Libya, was Goldman Sacs cutting its estimate for the potential price effect of the release, because the actual amount sold may only be about +39m barrels, as some member countries plan to only reduce inventory requirements for refiners.

The market is concerned that the ‘tightness’ in the oil market will continue to undermine the fragile global economic recovery. This is why the IEA and its members agreed to release crude from their SPR’s to ease some of this market tension. Today’s weekly inventory report is expected to show another drawdown on stocks and provide the commodity some minor support.

This year’s energy spike is being cited ‘as the reason for the global economic slowdown. Analyst’s note, that from its peak, crude is off-20% and from the IEA announcement down -3.1%.

Gold prices hit a two-week high this morning, as a rate hike from China put inflation concerns back in the spotlight, and as worries over the Euro-zone and US debt lifted the yellow metal’s ‘safer’ haven appeal. The PBoC is clearly stating that ‘taming inflation is a top priority even when as the economy slows gently’. In real terms you are not making any money by just holding cash, so there is demand for gold as a store of wealth. The stronger dollar could stall a prospective rally if there is a persistent flight to safety or the correlation between the two asset classes becomes positive, somewhat similar to the scenario of two-years ago.

Longer term, weaker global fundamentals are expected to support this crowded trade during the second half of the year. Foe now, the metal is likely to remain range-bound ahead of tomorrow’s NFP print.

The commodities dependency on the buck and the outlook for US rates is likely to remain a supporting factor. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on these deep pullbacks until proven wrong ($1,530 +$1.10c).

The Nikkei closed at 10,071 down-11. The DAX index in Europe was at 7,464 up+34; the FTSE (UK) currently is 6,028 up+25. The early call for the open of key US indices is higher. The US 10-year eased 7bp yesterday (3.08%) and has backed up 3bp in the O/N session (+3.11%).

Yields dropped to their lowest level in a week intraday after China hiked their lending rate for the third time this year, to contain inflation, spurring concern that economic growth will slow and discouraging demand for higher-yielding assets. Any tightening by China is deemed negative for the world economy if they are trying to slow down growth.

Aiding bond prices are global equities, trading under pressure from another rating agency sovereign downgrade. Portugal’s credit rating was reduced to junk status on the back of the growing risk that the country would require a second round of official financing before it can return to the private market. A disappointing US ISM services sector does nothing to dispel the notion that the US economy has stalled with Fed rate hikes remaining perhaps further away.

A JPM survey shows no FI longs for the first time since February 2005 and only the third time in its 20-year history. Incredibly, 75% of their client base in neutral, the most since last April. The market will now wait to see what Trichet has to say for himself at this morning press conference before adding any positions ahead of tomorrows NFP.

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