Exposed to ECB disappointment risk

Trying to keep up with this hot money movement is exhausting. US ten’s have backed up 25bp, global equities have rallied 3% and EUR two cents and this in one day. It took three and a half weeks for the EUR to shed thirteen cents last month. We all require volatility, but this is something else. Capital Markets is becoming bored with contagion, debt crisis, bailouts and are slowly wrapping their heads around fundamentals again, in case they miss the boat. Today we are exposed to ECB disappointment risk. Market is assuming that Trichet, now being elevated to a white knight, will provide us with new measures to support peripheral sovereigns and banks. The market is telling him that he has two choices, LTRO extension and bond purchases. Dealers already assume that the ECB will extend its 3-month LTRO operations into 2011. Trichet may surprise and think outside the box by announcing special facilities for weaker banks, or the banks of weaker sovereigns, separating them from the rest of the Euro system. Disappoint his audience and the EUR is back down, with us waiting for that strong NFP number, again.

The US$ is weaker in the O/N trading session. Currently, it is lower against 12 of the 16 most actively traded currencies in a ‘subdued’ trading range ahead of Trichet press conference.

The surprising private ADP release continued where UK’s and China’s PMI announcements left off yesterday, providing an up tick in risk appetite. The pace of employment is quickening, ADP jobs report in November printed the biggest monthly increase in three years. Yesterdays’ print (+93k) coupled with the backward revisions (+70k) equates to a +163k gain, twice the consensus. Digging deeper, the profile revealed small (+57k) and medium-sized firms (+37k) leading the way and large firms lagging +2k). Its worth noting that monthly changes in ADP have been weaker than the official BLS private payroll figures, with the average miss in the last three months-87k, the last six months-60k, the last twelve months-90k. Consensus believes that the pace of growth is too slow to have an impact on tomorrows unemployment rate (+9.6%).

US ISM Manufacturing continues to expand, but at a slower clip (56.6 vs. 56.9). The sub-components indices yesterday posted a mixed-to-weaker result, while all the key indices remained in expansionary territory. The losers included new orders, production, employment and exports. The winners, supplier deliveries, inventories and imports all experienced a pick up. Analysts note that a few categories should be highlighted as a concern. Production experienced the biggest slowdown, falling -7.7 points to 55.0, while inventories registered a sizable gain of nearly +3.0 points to 56.7 (highest level in twenty-six years). One month doe not make a trend, but the results could be hinting at a softer consumer sentiment and a further slowdown in industrial production over the coming months. The order backlog remains in contraction for the third consecutive month, and is becoming a negative to production, despite the partial offset of new orders. Even the prices paid index is retreating, probable proof of little pass through to the consumer. Even though the reading was strong enough to support reasonable strong expansion, it’s not as strong as the market had hoped given the strong jump in regional surveys from Philly, Kansa, Dallas and Chicago.

The USD$ is lower against the EUR +0.37%, GBP +0.16%, CHF +0.16%and JPY +0.07%. The commodity currencies are mixed this morning, CAD +0.34% and AUD -0.02%. The loonie has found support as manufacturing data from China and speculation that the ECB may signal its willingness to act to prevent the spread of the region’s debt crisis has reduced risk aversion among investors. Canadian headline 3rd Q GDP came in lower than expected earlier this week and it is this that pressurized long CAD positions to lighten up. The ‘expensive’ currency has been making it tough for exporters (-1.3% m/m) and easier on importers (+1.6%). Even with business inventories increasing, a vote of confidence by businesses that sales will be strong is certainly not being offset by stronger growth prints just yet. Slower Canadian growth points to a struggling 4th Q release. Given expected productivity improvements, the pace of growth maybe too little to reduce the unemployment rate, nor does it risk pushing future trend inflation higher. This may curb the rate of the loonies increase short term. Governor Carney may be wondering why they have been raising rates so quickly. Markets focus after Trichet’s press conference this morning will switch towards North American employment reports tomorrow. The loonie demand remains a function of investors risk desire.

The AUD is finding little love of late. In the O/N session the currency underperformed on the world stage as retail sales unexpectedly declined in October (-1.1%) and imports slumped to the lowest level in nine-months (-3%), sending the AUD lower for the fifth consecutive trading session. The data provides stronger proof for Governor Stevens to keep the overnight cash rate target unchanged next week at its last meeting of the year. Tighter monetary policy by the RBA over the last year has encouraged a +7.4% gain in the currency vs. the dollar and the second best performer among the 16 major currencies.
Futures traders are now pushing the risks of the timing of the next RBA hike even further out. Demand for Australia’s currency has also damped as signs that China’s economy is accelerating fueled speculation the PBOC will take more steps to slow it down. The Chinese have indicated that they will strengthen liquidity management and ‘normalize’ monetary conditions, damping demand for higher-yielding currencies. With them concentrating on containing strong inflation rather than boosting growth will affect commodity sensitive currencies longer term. As the leading commodity currency, the AUD is highly vulnerable to any Chinese monetary actions and risk aversion strategies (0.9679). There is stronger market interest to sell AUD on rallies.

Crude is higher in the O/N session ($87.01 +26c). Crude prices have held their gains despite the weekly EIA report showing a surprise increase in inventories, as investors instead focused on improving data for the broader US economy. Oil inventories rose +1.1m barrels last week vs. an expected decline of -1.1m. Gas stockpiles rose -600k barrels compared to expectations for no change, while stocks of distillates (heating oil and gas) fell by -200k barrels, analysts had expected a -1.1-million-barrel drop. Demand for oil and fuel products has fallen to the lowest level since mid-October. The increase follows two consecutive months of mostly steady declines after levels reached 27-year highs in September. The market continues to look past the increases and is focusing on the improving economic data in the US and China, as well as a weakening dollar. Also aiding prices is Goldman predicting that a second stage recovery in oil markets will occur next year ahead of oil prices trading above $100 in 2012. The rally is certainly an impressive response despite the stronger dollar index of late. Next stop, investors will become weather experts as European deals with an unseasonable cold snap.

The ‘yellow metal’ has limited some of its recent gains as ‘some’ appetite for risk has returned to the equity, debt and currency markets. The commodity remains supported by the persistent concerns over Euro-zone debt levels. Debt contagion has driven investors into the third ‘reservable’ currency as they seek a store of value. Despite the fear that China could tighten their monetary policy even further next month, a move to curb speculation and dampen inflation, global demand remains robust. Even though the one direction lemming trade seems to be overdone, investors continue to hold gold as a hedge against currency debasement and long-term inflation. The Euro-zone backdrop puts a floor on gold prices as these pullbacks have been somewhat supported on demand for a haven in the midst of Europe’s sovereign-debt crisis. Year-to-date, the metal is up + 23.8% and is poised to record its 10th consecutive annual gain ($1,393 +$4.80c). Even a higher dollar has been unable to push the commodity’s price lower. This would suggest that Gold is probably the primary reserve ‘currency’.

The Nikkei closed at 10,168 up+180. The DAX index in Europe was at 6,902 up+36; the FTSE (UK) currently is 5,701 up+59. The early call for the open of key US indices is higher. The US 10-year backed up 6bp yesterday (2.98%) and is little changed in the O/N session. Treasuries fell for a number of reasons yesterday, first, stronger US private employment data and secondly on speculation that the ECB may take additional steps to prevent the Euro-zone’s debt crisis from spreading. These were deemed strong enough reasons to diminish the appeal of US securities as a haven, temporarily at least. The Fed limited the declines and the 2/10’s spread from widening even further (242bp) by buying $7b of notes maturing from June 2016 to November 2017 yesterday as part of its plan to spur growth and keep longer term yields lower. Despite widening, the market wants to flatten the US 2/10’s curve and that will be down to Trichet this morning.

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