EURO inflation an opportunity to Sell

Inflation still rising. Energy prices have pushed the flash Euro zone CPI to a 27-month high (+2.4%), dragging the EUR with it and making the bears nervous. Even with Trichet’s recent hawkish commentary, ECB policy makers are not expected to raise interest rates at this weeks policy meeting due to the continued fear over the ‘resilience of the Euro-zone economy’.

At the moment currency direction is dominated by Egypt’s political outlook. While Mubarak’s possible resignation might calm protestors, the uncertainty about the post-political landscape is expected to keep investors sidelined in the region. Capital markets are been driven by the concerned closure of the Suez Canal and the possibility of oil supply disruption. Rising oil prices coupled with intensifying geopolitical uncertainty may delay future investment decisions and lead to concerns about the outlook for global growth making the dollar looking a safer bet for now.

The US$ is mixed in the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in a ‘whippy’ O/N session.

Friday’s fourth quarter US growth estimates (+3.2%), though weaker than expected, continues to show some encouraging signs. The fundamental data combined with Middle-Eastern risk aversion trading strategies has been capable of pushing the dollar modestly higher. Even with US interest rates expected to remain low for an extended period, normally a negative for the currency, rise in sales and inventories supports US growth. Stagflation issues in Europe and the UK, coupled with safe heaven investment flows continue to favor the dollar on pull backs. This morning higher than expected flash Euro-CPI (+2.4%) will provide a better opportunity to sell the region on Middle-East geopolitical concerns.

The USD$ is lower against the EUR +0.21%, GBP +0.09% and higher against CHF -0.05% and JPY -0.05%. The commodity currencies are mixed this morning, CAD +0.06% and AUD -0.12%. Similar to some other G7 currencies, the loonie has found it difficult to shake the dollar from its shadow despite commodities and Canadian equities ending Friday in the black. The market strapped on risk aversion trading strategies and sought the dollar, JPY, CHF and US treasuries as safe sanctuary. Also not aiding the CAD was Governor Carney comments in Davos. Again 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. For most of the O/N session, the dollar had benefitted from a flight to safety and thinner liquidity. This morning we will get to see if the appetite remains after the Canadian GDP numbers. The Japanese downgrade saga last week also had investors willing to embrace some risk aversion and lessening their demand for higher-yielding currencies. Technically, the loonie is trading around the tone of other asset classes and on the risk aversion dollar demand. Forget this morning domestic data, investors will be driven by events in the Middle-East (1.0010).

The RBA is expected to keep rates on hold this evening (4.75%) as policy makers survey the economic damage and inflation-accelerating effects of the recent floods. Analysts anticipate that Governor Stevens is expected to ‘tolerate quicker inflation and slower growth because the economy decelerated in the second half of last year after seven rate increases from October 2009 to November 2010’. Geopolitical concerns in the Middle East is pressurizing AUD/JPY as regional bourses declined O/N on concern that the unrest in Egypt will spread, damping further the demand for higher-yielding assets. Last week, Prime Minister Gillard announced a one-off tax to fund post-floods reconstruction. The market has seemingly interpreted this as a form of fiscal tightening which eases the pressure for RBA to tighten monetary policy. Dealers have promptly lowered their bets on increases to the benchmark interest rate over the next year. Pricing over the next 12-months fell -7bp to +22bp. The credit downgrade by S&P’s of Japan is also capable of taking some ‘risk’ off the table. Offers again appear at parity (0.9928).

Crude is higher in the O/N session ($89.11 +57c). Crude oil on Friday had their largest one day rally in seven-months as consumers and investors worried that Egyptian unrest could spill over into neighboring oil-producing countries in the region. Overall, US energy fundamentals remain soft. Last week’s surprisingly higher US jobless claims bolstered concern that the US economy will be slow to recover. The weekly EIA report revealed that inventories ballooned. Stocks climbed +4.84m barrels to +340.6m vs. expectations of a +1.2m barrels rise. Not to be out done, gas supplies increased +2.4m barrels, against expectations of a +2.1m. The only negativity came with distillate supplies (heating oil and diesel) decreasing-100k, less than the expected-300k. Refinery’s in puts averaged +14.1m barrels per day, which was-212k barrels below the previous week’s average as refineries operated at +81.8% capacities. Weekly imports averaged +9.4m barrels per day, up by +386k barrels. 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 are ‘in balance’, the concern with Egypt will keep upward pressure on the commodity. The country is a significant oil producer and a rapidly growing natural-gas producer. It is also an important transit corridor for world oil markets with its proximity to the Suez canal. According to analysts, approximately +6% of global daily oil production runs through the region. If longer term disruption continued, expect rerouting of supplies around the horn of Africa. Fundamentally, there is far more oil in storage, more fuel capacity and more idle oil wells to limit a stronger market rally in the medium term. Market is looking for opportunities to sell the commodity on this aggressive rally.

Gold prices stopped the bleeding and rebounded aggressively from its three month lows on bets that low US borrowing costs will boost the demand for the yellow metal as an alternative investment. Uneasiness in the Middle-East is also providing support for commodities. For most of this month gold suffered, down -7.1%, on lackluster physical buying as the commodity’s appeal as a safe haven 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 sough ‘price appreciation’ in equities. Fundamentally, the bulls are trapped in this months price action with the trend turning rather badly against them. Expect the weak longs to sell on these upticks. 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? The metal has lost close to $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 up ticks despite what’s happening in the Middle-East ($1,335 -$6.50).

The Nikkei closed at 10,237 down-122. The DAX index in Europe was at 7,059 down-43; the FTSE (UK) currently is 5,840 down-41. The early call for the open of key US indices is lower. The US 10-year eased 6bp on Friday (3.35%) and is little changed in the O/N session. A strong GDP flash of +3.2% happened to widen the 2’s/30’s spread temporarily to a new record of +404bp. It was driven by the biggest gain in consumer spending in more than four-years and rising exports. The yield spread later narrowed as Treasuries rose amid concern that protests in Egypt are intensifying, sending investors to seek shelter in government debt. The Fed also bought $8.4b of Treasuries as part of their asset-purchase program aimed at lowering borrowing costs, stimulating economic growth and spurring employment. Rumors that Moody’s could downgrade US debt continue to hang over the asset class.

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