EURO to suffer further losses

The dollar is firmer this morning, with markets in risk averse mode, as concerns over Japan’s nuclear crisis intensifies. The continued uncertainty regarding the efforts to stabilize the nuclear facilities represents the greatest risks to the markets. The somber mood is reflected in all asset class prices with ‘historical’ risk aversion trading strategies being applied.

Recent events have had an impact on this morning’s German ZEW confidence release. Sentiment has declined after the Japanese earthquake and a hawkish ECB (14.1). There is fear that both situations could slow short term German growth. With the events in Japan continuing to unfold, the degree of uncertainty remains high and supports further risk-aversion trading strategies.

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘volatile’ session.

Other global events are been overshadowed by Japans earthquake and fears of radiation leakage from their nuclear facilities. In the mix of this crisis, European leaders are trying to coerce the Irish back in line after last weekend developments. On the face of it and after the weekends announcements, Euro-leaders and policy makers are finally getting serious about their own sovereign debt crises.

They have provided support, temporarily, for the EUR by increasing the size of EFSF fund. They have limited the purchases of sovereign debt to the primary market and not the secondary. They are also lowering the interest rate being charged to Greece’s bailout and extended the maturity of their loan. It’s the Irish situation that could burst policy makers bubble.

No change was made in the terms of Ireland’s bailout. The newly elected government has refused to cave and raise its corporate tax rate. This was the Euros demand to relaxing their bailout’s terms. It seems that the Irish will not be steamrolled by Sarkozy and Merkel. It will make the month’s end ratifying economic summit more interesting.

What can we expect from the Fed today? Last weeks US consumer sentiment index highlighted Bernanke’s dilemma. The headline decline was the deepest since the Lehman collapse and the inflation expectations was the highest since Katrina. Which of these two problems requires the most attention, especially in the wake of higher energy costs? For Ben and his policy makers, it’s a question that will not be required to be answered this afternoon.

Global mounting uncertainties could potentially undermine confidence and force the Fed to be on the alert for ‘signs of a new soft patch in the short run’, while the rise in headline inflation will make the Fed pay close attention to measures of inflation expectations in the months ahead. This will take the pressure off the Fed to declare which it considers to be the greater threat and will not require the Fed to soften the ‘extended period’ language this week.

Before Friday’s events, the market was beginning to seek a stronger commitment of an exit strategy and the omission or softening of an extended period would be the beginning of a ‘their’ soft landing from the QE2 policy. Today’s message is expected to avoid any hint that a change in the stance of monetary policy is in the works. With the respect to dissents, the market does not anticipate Fisher and Plosser to feel the need to dissent this week.

The USD is higher against the EUR -0.42%, GBP -0.60% and lower against CHF +0.29% and JPY +0.12%. The commodity currencies are weaker this morning, CAD -0.73% and AUD -1.60%.

The loonie is on the back foot against most of its major trading partners, dragged down by softer energy prices on speculation that Japans demand for oil will be reduced in the short term after last weeks earth quake and on heightened risk aversion trading strategies. The currency had been previously supported by cross action. However, tentative agreement (until ratified later in the month) by Euro leaders on a ‘retooled bailout plan for the region’s most-indebted nations’ has given the EUR some short term support. Fear of radiation leakage is currently crippling all growth and interest rate sensitive currencies.

The market has multiple reasons for wanting to own the CAD in times of stress and elation. It can be owned for risk adverse, growth and commodity reason. Fundamentally and technically the currency probably overshot it’s near term target, it is not a surprise to see the CAD backup outright. Expect the depth of the backup to be dictated eventually by cross-action.

The new reality is a Canadian dollar at or close to parity as the economy adjusts to this paradigm. Big picture, the currency’s rise remains orderly. These dollar rallies provide an opportunity to want to own some of the commodity and growth sensitive currency that is supported by stronger fundamentals and sound fiscal position. However, short term momentum will be dictated by Japanese nuclear events (0.9875).

The AUD was one of the biggest losers in the overnight session, falling to its lowest level vs. JPY in three months after another explosion at a nuclear power plant reduced the demand for higher-yielding assets. The growth sensitive currencies like AUD and SEK are leading the selloff vs. the USD, with the AUD down -1.2% to a six-week low. Last nights RBA minutes were in line with recent official rhetoric and supports markets view that the RBA is likely to sit back and assess the developments in other markets.

RBA policy makers saw the restraint in borrowing ‘as a welcome development, particularly as household debt remained at a historically high level and debt-servicing requirements had recently increased’ according to last nights released minutes. Governor Stevens and his policy members indicated that a ‘mildly restrictive stance of policy continued to be appropriate’.

The heightening risk aversion trade has sparked buying of the yen and selling of the high-yielding currencies coupled with fading expectations for rate increases down-under will likely weigh on the Aussie dollar further in the short term (0.9888)

Crude is lower again in the O/N session ($99.65 -1.54c). Oil has fallen to a two-week low, on fears that the world’s third largest economy’s demand for the black-stuff will be reduced somewhat after their unfortunate natural disaster. The short-term trend still looks to be lower and stronger support is seen around $96. It is believed that Japan has closed 29% of their domestic refining capacity. This has affected about +1.3m barrels of the country’s total of +4.52m barrels per day of capacity. With future consumption questionable, demand from the region is expected to remain soft in the short term.

Prices pared declines after Bahrain sought Saudi support yesterday. Saudi troops will be expected to protect ‘vital installations in Bahrain and maintain stability and security’. Despite the geopolitical concerns in the region appearing to be escalating, global investors will continue to focus on Japan’s affect on the commodity market.

Despite softening in the O/N market on the back of a bid dollar, gold remains in demand as Japan’s strongest earthquake on record and violence in Libya continues to support demand for a haven asset.

Commodity prices continue to be supported by geopolitical factors and inflation threats. Even hawkish global rhetoric has managed to support higher commodity prices. Before last week’s unfortunate events, consumer prices were also boosting the demand for the precious metal as a hedge against global inflation.

Recent data reveals that Chinese’s inflation has accelerated the most in six years, and UK consumer prices the most in two years. Even US data is showing that their inflation numbers are edging higher. With the commodity being used as a store of value, the asset class is expected to remain better bid on deep pullbacks. The metal has climbed +28% in the past year ($1,413 -$11.30).

The Nikkei closed at 8,605 down -10.15%. The DAX index in Europe was at 6,688 down-177; the FTSE (UK) currently is 5,690 down-84. The early call for the open of key US indices is lower. The US 10-year eased 7bp yesterday (3.28%) and is little changed in the O/N session.

The US curve is steepening, with demand for product concentrating on the front end of the US yield curve. Two-year notes pushed yields to their lowest level in five-weeks as risk aversion trading strategies intensify after last weeks Japanese earthquake. Investors are speculating that Japanese insurers will need to sell the longer dated maturities to pay claims for damage.

Japanese investors are the second-largest foreign holders of US debt and own $882b of US Treasuries. The market is expecting them to be a net seller to finance their immediate operations.

Geopolitical and event risk in the Middle-East continues to limit FI losses in spite of stronger economic data. Product should remain better bid on any pull backs until markets can get a clearer picture of the situation.

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