EURO Rhetoric Ticker To Dominate

Risk edged higher over the weekend, but for how long? Market expects the Eurozone to announce significant measures Wednesday at bolstering the EU bailout fund. Some of this risk has been pared back this morning by the realism of weaker Euro economic fundamentals.

The weekend meeting yielded few concrete measures to deal with the Greek solution, the EFSF or recapitalization of the banking sector, investor “hope” that a formal proposal will be presented at this Wednesday’s follow up meeting. Until then, capital markets will have to live by the Euro-rhetoric ticker tape.

This morning’s ‘second successful, and markedly sharper overall contraction in Euro-zone manufacturing this month’ (47.2 vs. 49.1), heightens fears that the region is headed for contraction in the fourth quarter and the possibility of slipping back into recession. How strong is the investor’s faith in Europe or has the Euro’s collateral damage been too great?

The dollar is higher against the EUR -0.25%, GBP -0.05%, CHF -0.38% and lower against JPY +0.16%. The commodity currencies are weaker this morning, CAD -0.04% and the AUD -0.03%.

On Friday, Canadian CPI increased +3.2% in September from a year earlier, compared with an August pace of +3.1% and a May peak of +3.7%. Posing a bit of a problem is core-inflation accelerating to +2.2%, up from August’s +1.9% pace to reach the fastest rate since in three-years. Despite inflation tapping through the BoC desired level, Governor Carney has said he has “considerable flexibility” in how fast inflation returns to the bank’s desired rate, as the country faces a weak US recovery and uncertainty over the European debt crisis that could tip the global economy into another recession. Technically and fundamentally, analysts will tell you that Carney is “looking through near-term volatility in inflation”. Investors are beginning to pare their bets that the bank’s next move will be a cut.

Ending the week on its strongest note, the loonie rallied on hope that the EU policy makers will make headway in containing the region’s debt crisis, bolstering demand for riskier assets. During last week, and similar to other growth sensitive currencies, the loonie was subjected to whiplash, all caused by the dreaded Euro headline ticker. Any time traders think the currency is gathering enough momentum to take on the stronger dollar, negative Euro rhetoric promotes risk aversion action.

The loonie, as it has done all last week, remains vulnerable to following the broader trends, especially what is transpiring in Europe on the verbal front.There’s tremendous sensitivity because of the unprecedented Euro event risk. The market remains a good buyer of dollars on dips ahead of parity (1.0056).

Anything positive about China will be positive for the AUD. The Aussie has maintained it two day gains outright, not without some volatility. Chinese manufacturing data released O/N signals that their manufacturing may expand (51.1 vs. 49.9) for the first time in four-months, boosting demand for higher yielding assets. However, AUD gains have been limited on the back of domestic data, Aussie PPI slowed in the third quarter (+0.6% vs. +0.8%) and as EU policy makers have failed somewhat to assure investors that they are nearing a solution to the euro-area debt crisis. Futures Traders are pricing in at least a 25bp cut in borrowing costs by the end of the year.

The RBA minutes last week were neutral in tone and failed to give any additional information. When it comes to cutting rates, EU holds the key and the RBA is not expected to be pro-active ahead of the G20 meeting in Caen at which Europe is due to reveal its “comprehensive policy package”.

The dollar remains susceptible to fluctuations in risk appetite, with global markets not embracing risk whole heartily, the interest to buy AUD on dips has wained, better sellers on rallies are appearing (1.0396).

Crude is higher in the O/N session ($87.68 up+$0.28c). Oil rose for the first time in three days Friday, on hope that EU policy makers will reach a deal to contain the region’s debt crisis. Positive sentiment out of Europe coupled with s surprisingly positive US earning season is providing another injection of risk appetite across the financial and commodity space. Despite fundamentals being tighter than they were four years ago, the “current geopolitical context creates significant tail risks in a world with such limited spare capacity”. Asset classes remain at the mercy of Euro rhetoric.

Last weeks EIA crude stocks fell by -4.70m barrels to +332.90m, and remain in the upper limit of the average range for this time of year. Stockpiles were forecast to climb +2m barrels. Gas was not going to be left behind, its inventory print also moved down by -3.30m barrels, a week after decreasing -4.10m. This too remains in the upper limit of the average range. Inventories of distillate fuel (heating oil and diesel), decreased -4.27m barrels to +149.7m, the biggest drop since November. Oil refinery inputs averaged +14.4m barrels per day during the week, which were +134k barrels below the previous week’s average as refineries operated at +83.10% of their operable capacity.

After this weekend’s summit release the market will begin turning its attention back to supply issue questions as Libya comes back online. Until then, expect investors to run into technical selling on some of these steeper rallies as they wait for a clearer idea of where we are going on the economic front.

The yellow metal rallied the most in a week on Friday, as a drop in the dollar and renewed optimism that Europe will act to tame the debt crisis boosted investor demand. For most of last week, the escalating worry about Europe’s inability to resolve its debt problems had precious metals trading on the back foot. The metal’s price purge earlier in the month definitely provided a better price opportunity to own the shiny metal. Gold is still seen as a safe haven or a store of value, at least in the mid to long term. For a fourth consecutive trading session, the yellow metal has been moving in tandem with riskier assets and inversely with the dollar.

Right now, we are back to the inverse dollar-gold correlation play and the belief that a larger Euro rescue package could curb the demand for the metal as a protection of wealth. It seems that the demand for ‘physical’ gold from India is providing the only support on these pullbacks. Fundamentally, the commodity is trying to find a balance ‘between the two opposing forces’, a risk investment or a safe haven play ($1,648 up+$12).

The Nikkei closed at 8,843 up+165. The DAX index in Europe was at 5,975 up+4; the FTSE (UK) currently is 5,496 up+8. The early call for the open of key US indices is higher. The US 10-year started the day backing up 3-bp on Friday morning (2.21%) and is little changed in the O/N session.

Treasury 10-year notes stopped the slide by day’s end on Friday, with prices rallying for the first time in three-weeks as concern European leaders may not agree on containing the region’s sovereign debt crisis spurred demand for the safety of US debt. Further out the curve, it was a different story. Yields on the long-bond climbed for a fourth consecutive week (longest losing streak this year), as reports showing inflation increased last month eased optimism about the Fed’s purchase of longer-maturity debt in “operation twist”.

European finance ministers began six-day’s of negotiations at the weekend, aimed at preventing a Greek default and shielding banks. Capital markets continue to be fueled by Euro-headlines. The Treasury market for the near term has become “policy-dependent, not data-dependent”.

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