EURO Jackals lie in wait

A five notch downgrade by Moody’s is not much of a surprise, however with EU policy makers being rather vocal and having serious concerns that recent Irish legislation introduced to fix its banking system threatens the ECB’s ability to run its liquidity operations will certainly have the EURO bulls questioning their current positions. Fundamentally and technically, the EUR remains under pressure after the EU summit failed to produce a breakthrough. Add a little Korean military tension into the mix, thin liquidity and some nervous traders and we have a currency that is preparing for its next downward leg, unless one of the variables change.

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

Trichet again is thinking out loud and every time this happens little develops. He believes that the EUR is not the root of all the ills and that Governments should act responsibly, manage their day to day spending. The Euro-zone members should do more individually and collectively to combat the crisis. In theory its an extremely sound thought, however, most of the periphery countries are beyond maintenance and are currently on the cusp of requiring intervention. The EUR jackals smell blood.

The USD$ is higher against the EUR -0.28% and lower against GBP +0.11%, JPY +0.21% and CHF +0.14%. The commodity currencies are stronger this morning, CAD +0.07% and AUD +0.17%. The loonie continues to modestly underperform against its major trading partners despite the stronger fundamentals out of North America. On Friday, the currency completed is second consecutive losing week as investors lost some of their appetite for risk. The positive commodity and equity markets have been trumped by EU contagion concerns and the flight to own US assets. Data in this holiday shortened week may also provide little support for the loonie. Canadian policy makers remain weary of Europe’s funding challenges, US growth risks and with benign domestic inflation worries will not pressurize the BOC to tighten monetary policy any time soon. This month the loonie has gained +1.1% outright vs. its largest trading partner. The currency has only witnessed modest strength compared to other growth sensitive currencies as Governor Carney highlights the dangers of a persistently strong domestic currency. The loonie continues to struggle within striking distance of parity because of the strong corporate interest to own dollars there. Better dollar buying remains on dips.

AUD is finding it difficult to gain traction, trading near a one-week low against JPY on concern that the Europe’s debt crisis will worsen and tensions on the Korean peninsula will intensify, again curbing demand for higher-yielding assets. The currency has been trading under pressure outright as US Treasury yields climb, narrowing the yield advantage of assets down-under and on fear that China will act in answer to slow inflation, reducing the demand for growth sensitive and higher-yielding assets. Year-to-date, the currency has climbed +9.1% (second biggest winner after JPY), on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt compared with other developed markets. Domestic data remains strong, this months employment data blew all analysts expectations out of the water and supports the currency on pullbacks. Not aiding the currency is the concerns for long dated interest rates in the US. Analysts are beginning to agree that the tight labor market will bring the RBA back into the picture, but believe that Governor Stevens is not behind the curve just yet and will not be required to hike rates in February. With consumers boosting their savings significantly in an environment of rising job and wage growth, suggests that the RBA is still ahead of that curve. Governor Stevens has also mentioned that rates are ‘appropriate’ for the economic outlook. Demand for the currency will remain limited on speculation the minutes from the RBA’s previous policy meeting will signal the central bank won’t increase rates. Investors remain better buyers on dips, planning an assault on parity again (0.9896). There has been interest to short AUD/CAD as a hedge vs. long gold trades.

Crude is higher in the O/N session ($88.08 +6c). Crude prices are being supported by positive economic US data, but with inventories remaining high there is limited top side potential ahead of year end. Last week’s EIA report showed that the category of distillate fuel (includes heating oil and diesel) increased +1.09m barrels to +161.3m. This supply print will provide some bearish proof for the report, unlike the weekly headline print showing supplies plunging the most in eight years as imports tumbled and refineries bolstered fuel output. Stocks plunged -9.85m barrels to +346m last week vs. an expected decrease of -2.5m barrels. Also aiding prices midweek was imports falling-15% to +7.69m barrels, the lowest level in two years, and refineries operating at +88% of capacity, the most in three months. It’s worth noting that inventories along the Gulf Coast (where 50% of US refiners are located) fell -9.02m to +173.4m as the region levies taxes on year end supplies. The large draw down is mostly due to end of year inventory management at refineries or in other words cooking someone’s books. The black-stuff had previously garnered support from reports revealing that China’s refiners increased their processing rate last month. The world’s biggest energy consumer boosted their net imports of the black stuff by +26%, m/m, and increased their processing rates to ease a diesel shortage. Coupled with OPEC announcement to maintain their production quotas and the PBOC refraining from tightening monetary policy is supporting the market, probably to the year end at least. OPEC believes that supply and demand are ‘in balance,’ and expect demand growth will slow as the global economy struggles to recover, amid ample supplies. Technically, expect the market to meet resistance again at the $90 high printed earlier this month.

Being long the lemming gold trade has the weaker bulls tentatively worried after last week’s price action. Gold pared some of its advances on Friday, on speculation that the dollar will extend its rally, eroding demand for the precious metal as an alternative asset. Investors are booking year end profits following a +25% rally this year. It’s speculated that the selling has been caused by ‘year-end posturing, or even movements of large funds out of the market’. The stronger US data of late points to a recovering economy with a low inflation rate. However, thus far, the commodity remains supported on deeper pull backs by the persistent concern over Euro debt levels. For most of this year, debt contagion has driven investors into the third ‘reservable’ currency as they seek a store of value. Even though the one direction trade feels overdone, investors continue to hold gold as a hedge against currency debasement and long-term inflation. The Euro-zone backdrop is trying to put a floor on metal prices on demand for a haven. The commodity is poised to record its 10th consecutive annual gain ($1,384 +$5.40c). Technical analysts believe that gold will outshine other precious metal in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,216 down-87. The DAX index in Europe was at 7,006 up+24; the FTSE (UK) currently is 5,875 up+3. The early call for the open of key US indices is higher. The US 10-year eased 16bp on Friday (3.32%) and is little changed in the O/N session. Bonds completed their third consecutive weekly drop last week. Their longest stretch of declines in three months, as evidence that the US economy is recovering reduced demand for the safety of government debt. Investors it seems are tentatively paring their holdings of US debt as risk appetite improves. Liquidity remains a premium as we enter the holiday stretch. The 2/10’s spread has widened to 278bp. The market seems cautious about anything good for bonds ‘coming out of the tax-cut extension’ , however liquidity remains a premium.

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