Fiscal Steroids Programs Promote Risk and Carry Trades.

What happened to ‘natural organic growth without a fiscal steroids program’? Capital Markets don’t care that most of yesterday’s US GDP strength can be attributed to incentive packages. Sub-consciously, the market believes that the Fed will provide ‘ample liquidity at super-low prices for an extended period of time’. Can the US grow without aid? Next week Cbanks are held accountable, the Fed, ECB and BOE come to the policy table. Big questions will be asked, but not all will be answered! Will the Fed formulate an exit strategy in order to ‘normalize’ their monetary policy? Will the ECB hike first? What about Governor King’s quantitative easing program? Is the BOE done? If we are not satisfied with any of that we have NFP to deal with on Friday!

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

Is the US on the verge of declaring that the recession is over after yesterday’s surprisingly strong GDP headline print of +3.5%? Are these results sustainable? Some analysts will argue that it’s been the clunkers-induced surge in consumer spending that has driven 2/3rd of the overall growth in the 3rd Q. What we are looking for is ‘natural organic growth not aided by fiscal steroids’. Perhaps we will come back to earth when we get the 4th Q reports! Digging deeper, personal consumption rallied +3.4% in the Q. We should expect it to be temporary, as much of the growth came from a +22.3% surge in durable goods consumption which was supported by the cash-for-clunkers program. Now that this program has ceased, auto sales have plummeted -35% last month, with further weakness expected as many of the buyers brought forward their purchase to take advantage of the program. Non-durable consumption also expanded, erasing the decline of the 2nd Q, with services adding +0.6% to real GDP. Surprisingly, inventories were less of a drag, contributing +1% to growth. The pace of inventory liquidation remains very high. Year-to-date we have witnessed approximately $405b in inventory disinvestment, however, outside of the auto sector and similar to other economies, the US has high inventory issues. Net- exports were a drag on overall growth as exports gained, adding +1.5% to GDP, but a rise in imports subtracted -2% from growth. Gross private investment advanced +11.5%, adding +1.22% to real-GDP (first expansion in 2-years). Residential investment accounted for all of the strength, rising +23.4% during the Q, as non-residential investment continued to deteriorate. Surprisingly, Government consumption eased to +2.3% from +6.7% in 2nd Q and finally, as expected, inflation remains subdued at +1.4%!

Other US data yesterday begs the question, have the weekly total of jobless claims peaked? The ‘proof is in the pudding’, if we combine all know government programs from initial claims (+530k) through continuing (+5.797m), extended (+526k) and emergency (+3.368m), then we can say that the trend ‘may have peaked’! The million dollar question, is it because of improving jobless conditions? Not really! The pessimist would say it’s because the longest of the unemployed have moved beyond the maximum period of benefits allowed to them. They have no benefits now! It’s worth noting that the US Senate is trying to extend the jobless benefits period by 14 weeks for all states, and 6 additional weeks for states with the highest unemployment rates. This can only push the extended and emergency claimant’s trend higher!

The USD$ is currently lower against the EUR +0.01%, GBP +0.12%, CHF +0.05% and JPY +0.43%. The commodity currencies are weaker this morning, CAD -0.16% and AUD -0.31%. Yesterday’s Canadian data showed that Canadian producer prices remained on a downward trend last month (-0.5% vs. +0.5%, m/m), which is keeping pipeline inflationary pressures well contained. Falling petroleum prices accounted for most of the decline in both producer and raw materials prices (-1.1% vs. +3.8%). It’s worth noting that analysts believe that the +0.6% appreciation in the loonie did not have as large an effect on producer prices as in the past given that the exchange rate remained mostly unchanged during the month! After yesterday’s surprisingly strong US GDP number, the market has once again shifted towards risk taking and a desire to own higher yielding commodity currencies. This scenario will once again test the BOC resolve. Governor Carney is insistent that a strong loonie will damper longer term growth. In his testimony before the House of Commons Finance Committee this week, he said efforts by Cbanks to affect their currencies need monetary policy to back them up. FX intervention without complimentary policy moves is seldom effective in the long term. He has options, like credit and quantitative easing to influence the loonie and meet their 2% inflation target. Will he get to use any of them? Dealers want to see better levels to own their domestic currency. Governor Carney has got to be worried, last time they intervened was 11-years ago!

As expected RBNZ Governor Bollard kept benchmark interest rates on hold this week (2.50%). The Cbank is expected to keep rates at these levels well into next year, similar to the BOC, as the economy needs further stimulus to recover from this recession. The best performer, the AUD was little changed in the O/N session, but has managed to maintain its longest winning streak vs. the USD as the US economy return to growth has investors coveting higher yielding assets. The currency remains better bid on pullbacks (0.9144).

Crude is lower in the O/N session ($79.69 down -18c). Crude prices climbed just under 4% yesterday, the most in a month, as surprisingly strong GDP data (see above) boosted the appeal of the commodity as speculators betted that fuel demand would increase. Market actions are telling us that the recession has ended, and now they seem to be in a position to question the pace of growth of the economy. A fall in weekly unemployment claims and a floundering greenback helped to propel the commodity higher. All week crude has had issues sustaining a break of the $80 a barrel level. Prices remain robust despite this weeks EIA report, which revealed an unexpected increase in US gas stocks and crude supplies jumping to a new 2-month high. Gas inventories climbed +1.62m barrels w/w vs. an expected decline of -1m barrels. The import number for crude also advanced for the 1st- time in 5-weeks. OPEC has started to talk crude down. They implied that members will increase output production to protect the global economic recovery if oil prices continue to rise above the $80 psychological level. They indicated that both ‘producers and consumers were comfortable with oil prices between $75 and $80 per barrel and that higher price’s could put the brakes on the pace of global economic recovery’. Ideally, they want to ‘maintain balance’ and will act accordingly in Dec. depending on where crude is trading. Fuel demand fell -0.8%, w/w, to an average of +18.5m barrels a day, while gas consumption fell -1% to +8.86m barrels a day. Basically, demand destruction remains intact and excess supply an issue. Over the week, refineries operated at +81.8% of capacity, up +0.7% from the previous week. On the other hand, crude stocks rose +778k barrels vs. expectations of +1.9m to +339.9m barrels last week. This has left supplies +9.1% higher than the 5-year average. Supplies of distillate fuel (includes heating oil and diesel), declined -2.13m barrels to +167.8m. Surprisingly, inventories were +29% higher than the 5-year average for the week. Technically, prices have been aggressively mobile on pure ‘speculation’ in the face of positive overall supply fundamentals.

Gold aggressively rebounded from its 3-week lows yesterday as a weakening dollar increased the ‘yellow metals’ appeal as an alternative investment. The commodity’s rapid decline earlier this week persuaded technical investors to increase their holdings as they believed that the down move was somewhat overdone ($1,044).

The Nikkei closed at 10,034 up +143. The DAX index in Europe was at 5,581 down -5; the FTSE (UK) currently is 5,156 up +19. The early call for the open of key US indices is lower. US 10-year bonds backed up 5bp yesterday (3.47%) and are little changed in the O/N session. Surprisingly strong US GDP data coupled with the ending of the Fed’s $300b buy back program after 7-months, pressurized treasury prices. The program was initiated to help stabilize the housing market and limit an increase in borrowing costs by keeping rates low. Yesterday, the Fed bought back approximately $1.9b in debt of varying maturities. Also this week, the US government issued $128b of new debt that needed to be absorbed by the market. It’s no wonder that some analysts foresee 4% in 10-yr notes before the year-end and 4.5% by middle of next year!

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