Event risk saves the dollar

This week the dollar has got a kick in the backside as the markets begin to focus on risk aversion trading strategies. Investors are showing their willingness to escape the riskier anti-dollar bets on event risks that include more JPY intervention and on a disappointing QE2 size. The buck’s strength has not relied solely on some disappointing earnings results to pressurize equities. Investors are reducing their short dollar positions ahead of next weeks FOMC meeting and are adopting a wait-and-see attitude. This week, US data has been ‘upwardly surprising’, supporting further upward pressure on the dollar towards 1.3700, in keeping with the markets range-bound scenario.

The US$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies in a ‘volatile’ trading range.

The dollar did not get its support from yesterdays US data releases exclusively, that was provided by investor’s demand for the reserve currency for risk aversion purposes. The S&P Case-Schiller house price index for Aug. (20-city basis) was weaker than the market expected (+1.7%, y/y from 3.2% in July). Digging deeper, 17 of the 20 cities saw a weakening y/y while 15 saw a decline on the month. This can be attributed mostly to softer prices continuing their negative momentum after the lapsed tax credit program from earlier this year. Even with the surprising US home sales data earlier this week, the weak data released within that report does not bode well for Sept. index headline print. In contrast to the Index, the FHFA house price data showed a firm bounce to +0.4% from -0.7% in July, consistent with the surprising existing home sales print on Monday.

Another release showed that the Richmond’s Fed manufacturing composite index rose to 5 in Oct. from a negative -2 print last month. The manufacturing activity in the 3rd Q improved, but at the expense of the services activity. For the fist half of this year the index has averaged a 14 reading. Digging deeper, more than half of the sub-categories improved month-over-month (seasonally adjusted). The two stand out categories were order backlogs slipping to a nine-month low (-12)) and the sales lead times falling to a three-month low.

Finally, US consumer confidence print surprisingly improved and it was due in part to the expectations component (50.2 vs. 48.6). It was the six-month forward expectations component that drove most of the reports gain, despite the elevations of the present conditions also improving. It happened to outweigh increased pessimism towards the labor market. 41.9% see current business conditions as bad, down from 46% last month and 8.5% (8.1%) describe current conditions as good. However, more consumers are seeing jobs as harder to get (46.1% vs. 45.8%) and a smaller percentage (3.5%) are seeing jobs as plentiful. Within the expectations component, survey respondents put most of their faith in improving business conditions, but fewer said they expect that to translate into more jobs or higher incomes. Purchase intentions six-months forward were flat for homes and autos, but plans to purchase major appliances dipped.  It’s interesting that consumers do not see an issue with deflation as they continue to expect prices to be +5% higher in a year. Everything continues to hinge on the labor market, until we see some light at the end of the tunnel, confidence will always take a beating.

The USD$ is higher against the EUR -0.26%, GBP -0.08%, CHF -0.53% and JPY -0.41%. The commodity currencies are weaker this morning, CAD -0.56% and AUD -1.30%. The loonie remains under pressure as both commodities and equities struggle, curbing the demand for growth sensitive currencies, temporarily at least. Ever since the loonie managed to record parity twelve days ago, the currency has lost -2.1% vs. its largest trading partner. It has been well documented that the market should be expecting to see the loonie lag vs. the dollar, despite all the negativity surrounding the greenback. Last week Governor Carney stood down on hiking rates as expected, citing a softer outlook for the Canadian economy. Futures prices have priced in a ‘no-hike’ for the next six-months despite policy makers continuing to see the risk to the inflation outlook as being balanced. The BOC said that the ‘more modest growth profile reflects a more gradual global recovery and a more subdued profile for household spending’. They did not go all out neutral on future rate hikes, but noted that certain factors stand in the way. A broadly softer dollar on QE2 pressures will prevent the loonie from losing too much ground, until at least after the FOMC meeting next week.

The AUD was the big loser amongst the majors in the O/N session. The currency tumbled as inflation numbers disappointed hawkish speculators. Australian CPI rose +2.8% in the third quarter from a year earlier, after increasing at a +3.1% pace in the previous three month. The market was expecting a rate of around +2.9%. Futures traders pared their bets from a +47% chance that the RBA would hike next week to a +16% chance, pushing the AUD to underperform in the last nights session. It’s now expected that any rate increase down-under ‘will be only gradual, even if the RBA were to resume the monetary tightening cycle next week’. With such a benign rate outlook, the market is betting that the currency will ‘struggle in extending its gains far above parity’ in the medium term.
The currency had been getting a lift from the price of commodities and the dollar of late. Now that that relationship has somewhat gone ‘walkabout’, expect investors to be better sellers on rallies in the short term (0.9736).

Crude is lower in the O/N session ($81.78 -77c). Crude prices are little changed despite US consumer confidence advancing in Oct. yesterday from a seven-month low and the dollar rising against the EUR. The market expects this week’s inventory report to show an increase later this morning. Speculators are wagering that the FX market is likely to drive oil prices in the near-term, as investors look for actions by helicopter Ben as the main influence on the fate of economic recovery. Last weeks EIA report provided crude with a leg up. The headline print rose +667k barrels, less than half what was expected. The market also focused on the drawdown at Cushing (the delivery point for New York futures). Supplies dropped -1.1m barrels to +34m, the biggest one-week drop in nine-months. Gas stockpiles rose by +1.2m barrels to +219.3m vs. a -1.3m drop. In contrast, distillate stocks (heating oil and diesel) fell by -2.2m to +170.1m barrels. Analysts had expected only a -600k barrel shortfall. The refining capacity utilization rose by +0.6% to +82.5%. Analysts were looking for a +0.1% increase. Despite all this, inventories for crude and refined products remain at unusually high levels. Crude analysts note ‘this is currently a shoulder season for product demand ahead of the winter heating season’. Technically, we should see inventories gravitate towards their highs. The market remains wary that the underlying fundamentals have not changed. The ‘big’ dollars value continues to push prices about.

We all know that the yellow metal is a favorite amongst investors as a haven against the debasement of the US currency. Over the past couple of trading session and with a pause in the dollar’s slump, investors have been happy to ‘book some deserved profits’ in this over crowded one directional trade. The dollars negative correlation relationship remains intact with commodity prices. For most of this year investors have sought an alternative investment strategy to the historical reserve currency. Investors have been using the commodity as a proxy for a ‘third reservable currency’, pushing the metal to record new record highs. With market confidence wavering in currency prices, and with cheap money, has made commodities look attractive on pull backs. To date, gold has outperformed global equities and treasuries (+20.8%), prompting record investment in gold-backed exchange-traded products. The debasing issues of the dollar, coupled with the sustainable growth issues of the US economy have investors generally seeking protection in an asset with a ‘store of value’. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to low interest rates ($1,332 -$6.20c).

The Nikkei closed at 9,387 up +10. The DAX index in Europe was at 6,590 down -25; the FTSE (UK) currently is 5,676 -31. The early call for the open of key US indices is lower. The US 10-year backed up 5bp yesterday (2.63%) and another 4bp in the O/N session (2.67%). Earlier this week the US Treasury sold $10b five-year TIPS at a negative yield for the first time at a US debt auction. A negative yield suggests investors are betting that helicopter Ben will be successful in preventing ‘deflation’ or on the flip-side, capable of creating inflation. The short term scenario remains the same, investors and dealers are happy to sell into this week’s supply and then buy into month end and the pending Fed announcement next week. Yesterday, US $35b worth of 2’s was well received and on the ‘screws’ at a new record low yield of +0.40%. The bid-to-cover ratio was 3.43 compared with the average of 3.42 over the past four auctions. The indirect bid was +40% compared to the average of +35.6% for the past four auctions. The direct bid was +16% vs. the +14.4% average. Today we get $35b 5’s and tomorrow’s $29b 7’s.

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