EUR shorts to push the currency higher

Risk is on. Markets are returning to more normal conditions in which the low-yielding, debt-laden currencies underperform their higher-yielding brethren with the USD returning to being the market’s main funding currency. Stronger global manufacturing data is encouraging risk appreciation. Currency levels are being increasingly determined by interest rate differentials, with investors buying EUR’s expecting a higher return and ignoring Europe’s still festering sovereign debt problems. The market is convinced that rising inflation in the Euro-zone will soon force the ECB’s hand. The Fed’s stance on ultra low yields will keep pressure on the dollar. The markets is waiting for confirmation from US payroll data before committing to ‘that strong US data is dollar positive’. The ADP payroll is the first of three key employment data releases this week, followed by jobless claims tomorrow and NFP on Friday. Between here and then, 1.4050 looks vulnerable.

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

US manufacturing activity blew everyone out of the water yesterday and expanded at its fastest pace in over six-years (60.8 vs. 58.5). A similar theme was also experienced in the Euro-zone with Ireland and Italy posting sharp increases, driven by strong forward looking orders components. Even the Spanish new-orders component improved, but Greece remained the weak spot with January manufacturing PMI still deep in contraction territory. US manufacturing recorded its sixth consecutive month of expansion with strong gains in both employment and inflation. It is only the third time in thirty years that the employment category registered above a 60 print (61.7). Expect this to be a risk to Friday’s employment report where consensus is expecting around +10k jobs for the sector. Fundamentally, the US economy seems to be getting strong support from its manufacturing sector, with new-orders (67.8) and production (63.5) continuing to be strong, with global demand driving commodity prices higher. Last year’s year-end momentum is being carried forward. However, consensus expects expansion to be modest with unemployment remaining on the high side (year average of +9%). Finally, rising price pressures remain a factor and beginning to trickle down, expanded by the widest margin in nearly three years (81.5). This will not influence the Fed’s stance on ultra low rates.

The USD$ is lower against the EUR +0.01%, GBP +0.43%, CHF +0.05% and higher against JPY -0.07%. The commodity currencies are stronger this morning, CAD +0.31% and AUD +0.03%. The loonie took its lead from yesterday’s strong US data and had it largest one day move in a month as investor’s embraced risk with global bourses seeing black. The CAD has lagged behind currencies from other commodity-exporting countries after comments from Finance Minister Flaherty indicated that Canada will have a ‘challenge’ with jobless numbers. Canadian employment numbers are out this Friday. The market expects the Canadian economy to add another +15k jobs after December’s stellar +34k release. While a stronger US economy will help Canadian industry in the near-term, the over valued Canadian dollar, waning government capital spending, a cooling housing market, and moderating retail sales will eventually combine to limit overall GDP growth this year. They are all stellar reasons for Carneys vocal concerns to be reiterated last weekend. He indicated that ‘persistent strength in the currency is a threat to economic expansion’. His views happened to push the currency to print three-month lows. With strong risk appetite in vogue, the loonie has cautious buyers on dollar rallies as we head towards the important data later this week (0.9871).

The Aussie dollar traded near its one month high against the greenback as stocks and commodity prices rose amid signs the global economy is picking up, increasing demand for higher-yielding assets. Through parity is a surprise with a backdrop of a flood disaster, Chinese rate hikes and a toppy equity market. However, there is a risk-on mood spreading across the markets on the back of the improving global economy. This week’s RBA rhetoric was both dovish and hawkish, something with a twist, depending on what way you want to look at it. Governor Stevens left the overnight cash rate target at 4.75% and said that policy makers will ‘look through’ the near-term affect growth and prices of flooding across the nation’s east coast will have. Stevens stated that ‘flood reconstruction doesn’t pose much inflation risk and called the global economic outlook strong for this year. He went on to say that ‘net additional demand from rebuilding is unlikely to have a major affect on the medium-term outlook for inflation’. The RBA ‘expects that inflation over the year ahead will continue to be consistent with its 2% to 3% target range’. It’s difficult to sell AUD on the back of the statement as it removes any chance whatsoever of a rate cut. The market looks for better levels to own the currency as investors look towards the ‘carry trade’ (1.0113).

Crude is higher in the O/N session ($90.84 +7c). After pushing crude prices to a 27-month high earlier this week, the rally became deflated yesterday as dealers showed relief that supplies from the Middle East so far have not been disrupted by protests in Egypt and a government shake up in Jordan. Technically and hopefully, the market in these times of uncertainty seemed to have overreacted to the geopolitical issues. Dealers have come to the realization that the Suez, even it were blocked for a period of time, would only disrupt transportation routes and have no impact on overall supply. Later this morning we will get the weekly inventory reports. Last week’s EIA release showed that US inventories ballooned. Stocks climbed +4.84m barrels, not to be out done, gas supplies increased +2.4m barrels. The only negative in the report came from distillate supplies (heating oil and diesel) decreasing-100k. Over the last four-weeks, imports have averaged +8.9m barrels, +517k barrels per day above the same four-week period last year. Despite OPEC believing that supply and demand is ‘in balance’, the unknown factor, Egypt should be providing support on deeper pullbacks. The country is a significant oil producer and a rapidly growing natural-gas producer with approximately +6% of global daily oil production running through the region. However, fundamentally there is far more oil in storage, more fuel capacity and more idle oil wells to limit a much stronger market rally. It’s fear that generally exaggerates the price.

With the lack of further escalation of unrest in Egypt, the market is pricing out some of the risk premium, which is eroding the yellow metals safe-heaven appeal. For most of this month gold has suffered, down -6.1%, on lackluster physical buying as the commodities appeal deteriorated and on hedge fund liquidation triggering vulnerable support levels. Before tensions in the Middle East, investors had been shying away from the commodity and sought ‘price appreciation’ in equities. Fundamentally, the bulls are trapped in this month’s price action with the trend turning rather badly against them. Expect the weak longs to sell on these up ticks. Natural physical buying has been less than modest with the commodity off to its worst start in 14-years. Has the gold peaked or is simply a short-term correction? Gold prices have depreciated just over $100 from its December highs. With the Euro-zone being able to sell their bonds, there’s less of a flight to quality, which could cause this asset class to be staring at a sub $1,300 a once soon. The market remains a seller on rallies despite what’s happening in the Middle-East ($1,337 -$2.80).

The Nikkei closed at 10,457 up+182. The DAX index in Europe was at 7,184 up+1; the FTSE (UK) currently is 5,995 up+38. The early call for the open of key US indices is higher. The US 10-year backed up 2bp yesterday (3.42%) and is little changed in the O/N session. A stronger US ISM manufacturing report and a military announcement that it would not fire on Egyptian protestors weighed heavily on the US curve yesterday, steepening 2/30’s to a new record (404bp). What will the curve look like if we happen to get payroll growth this Friday? The Fed stance on ultra low rates is expected to provide strong resistance for the 10’s at 3.50%. Investors continue to demand compensation for the prospect of accelerating inflation and on speculation the US may struggle to fund its deficit. The Fed pledge to its asset buyback program will support speculation that any additional rise in yields will be gradual.

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