European Banks to follow Americans!

The IMF has reasons to be concerned. In an article in this mornings UK Telegraph, it has called on the Euro-zone governments to take urgent steps to clean up the banking system as losses mount, and advised the ECB to prepare ‘all unconventional options’ in case the crisis deepens. Last week we listed 5-reasons why we would ‘not’ want to own the EUR. The biggest reason was transparency or lack there of. No-one truly knows the extent of the debt load that these financial institutions are carrying. Look at Ireland, once the ‘green emerald’ in the crown of European economic growth. Yesterday, it was officially downgraded because of its financial system; it is being artificially propped up by a Government who is on the verge of financial ruin. No wonder the IMF is talking!

The US$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range.

For most of this year we have focused on the ‘once mighty greenback’ and its weakness issues and specifically the reasons for that. Despite this, the EUR/DLR is the most widely traded currency, its now time to focus on the EUR. With that being said analysts are starting to question the ‘true strength’ of European financial institutions. The currency pair is currently trading in no-mans land. Is it in a correction vs. the dollar or is this the beginning of a much bigger reversal, will we see the 1.20 handle again sooner rather than later? Most of this morning’s headlines should provide some comfort to consumers. The US is expected to approve a plan for 10-banks to repay TARP. This can only be seen as a plus for tax payers psyche! With OECD indicators pointing to the slowdown easing and German orders stabilizing, has pushed the Euro-zone investor sentiment to a 9-month high. Are these the ‘green shoots we have been waiting for? European banks not being transparent enough to prevent the beginning of the 2nd-wave!

The USD$ currently is lower against the EUR +0.23%, GBP +0.44%, CHF +0.23% and JPY +0.28%. The commodity currencies are stronger this morning, CAD +0.46% and AUD +0.70%. The loonie rose yesterday as crude oil advanced and global equities pared losses on speculation the worst of the recession may be easing. Some risk related bids appeared despite the poor underlying employment report last week. Already this month, the currency has dropped -2.2% vs. its largest trading partner after advancing in May the most in at least 59-years! The currency received support from yesterday’s housing starts. They rose in May more than expected, to a total of +128.4k units on an annualized basis vs. +117.6k last month. Last weeks employment report point to a moderately worse domestic environment due to the concentration on full-time job losses (-58.7k) and cooling of wages levels. Analysts expect the losses to put further downward pressure on future cash flows and disposable incomes. If there is no spending then there will be no growth! Last week the BOC in an unprecedented fashion managed to comment on the state of the loonie by noting that ‘if the unprecedentedly rapid rise in the Loonie proves persistent, it could fully offset these positive factors’. The BOC is basically confirming that the appreciation is not linked to fundamentals. Expect the market to continue to sell CAD on USD pullbacks for now.

After last week’s advance, the AUD remains robust with RBA governor Stevens indicating that policy makers must be cautious about lowering borrowing costs too far. At last week’s monetary policy meeting they kept rates on hold (3.00%). Traders continue to look favorable on the currency because of its yield advantage and its association with commodities. In the short term look for better buying opportunities on pullbacks as the currency marches upwards (0.7929).

Crude is higher in the O/N session ($68.98 up +78c). Princeton’s Nobel Prize winning economist Paul Krugman provided support for the black-stuff yesterday and the momentum has carried over into this morning’s session. He said that the US recession may end later this year, this has prompted speculation that fuel demand may increase. A weaker greenback has supported oil’s recovery of late (doubling its value since Dec.). By default, it has increased the appeal of commodities as a hedge against a drop in the USD. Oil needs to break the support price of $64 to gather any true downward momentum and $70 on the topside to get any upward movement. Fundamentals will tell you the opposite. We have had elevated prices because of a weakening USD. The world is awash with oil, demand destruction is intact and 19-year US record inventories remain. Even last weeks EIA report reveled that crude inventories climbed +2.9m barrels to +366m vs. an expected loss of -1.6m. Crude stocks gained as imports and refineries increased their operating rates to the highest level in 6-months. Refineries are operating at 86.3% of capacity, up +1.2%, w/w. The true fundamentals do not justify these elevated prices as the 4-week moving average for US consumption is +18.2m barrels a day, that’s down -7.7%, y/y. Even with both OPEC and Russia raising production last month (to capture some of their capital gains) does not support higher prices for too long. OPEC’s output climbed +1.5% to an average +28.15m barrels while Russia’s output advanced a 3rd straight month (+0.t9%). Many believe that oil has climbed too quickly as the rapid gain has been based on stronger equities and a weaker dollar. However, the frightening part is that if OPEC complied with its Sept. production cuts (currently only at 77%), this commodity would be much higher! The ‘yellow metal’ has rebounded from its lowest level in 2-weeks as the decline in the USD has increased the appeal for precious metal ($954).

The Nikkei closed 9,786 down -78. The DAX index in Europe was at 5,029 up +25; the FTSE (UK) currently is 4,423 up +17. The early call for the open of key US indices is lower. The 10-year Treasury’s backed up 3bp yesterday (3.87%) and eased 5bp in the O/N session (3.82%). Treasuries again fell yesterday on concerns that record US debt sales may overwhelm demand as the economy shows some signs of strengthening. After last weeks NFP report, Traders had driven yields to the highest level in 7-months. With the Treasury announcement of another $65b of 3’s (today-$35 issue) 10’s and long bonds to be issued this week also had dealer’s pre-selling the market. In the O/N session, treasuries advanced for the 1st time in 4-days on speculation that yields near a 7-month high will look attractive at this week’s sale, spur demand at three Treasury sales.

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