Germany’s Lack of Confidence not hurting EURO, Yet

The market had expected to hear something more positive this weekend, instead of the acknowledgment of the gravity of the situation that required Europe to face an attempted scolding from Geithner. Investors now seem to believe that a Greek insolvency is inevitable and Europe cannot contain the damage. However, if the ECB could come up with a more credible plan that suggests that they are being aggressive in dealing with a deteriorating financial system, then this market is going to respond very positively. European finance officials this week will examine the cost advantages of creating the rescue fund (ESM) in July 2012, a year ahead of schedule.

German business confidence deteriorated for a third consecutive month this morning (107.5) to hit a 15-month low as firms again lowered their expectations for the next six-months amid the Euro’s deepening debt crisis. On the bright side, it fell less than the market had been expecting and is providing a ray of sunshine!

The dollars is higher against the EUR -0.22% and CHF -0.18% and lower against GBP +0.33% and JPY +0.19%. The commodity currencies are weaker this morning, CAD -0.14% and AUD -0.19%.

The loonie and like minded commodity currency crashed back to earth last week, with mass portfolio liquidation pushing the CAD to revisit its 16-month low outright. The Fed’s significant risk statement has added fuel to the fire making all higher yielding currencies pay. The fear of what the Fed has left to fight ‘no growth’ with, has sent widespread panic through all asset classes.

The CAD ended the week little changed from the previous close as investors waited to see how serious and aggressive the Euro policy makers are going to become after this weekends finance ministers and IMF meetings.Year-to-date, the loonie has lost-3.9% versus its G20 partners and last week’s-5.1% drop was the biggest in three years. The IMF has stated that the global economy is entering a new “dangerous phase’. Presently Canada is experiencing the twin evils of a slowing economy and higher inflation and remains at the mercy of ‘external headwinds’.

After the meetings, Governor Carney said there had been some progress last weekend by European policy makers to stem their debt crisis, and that he believed that Canada should avoid falling back into recession as growth rebounds from a second-quarter contraction. Carney was ‘encouraged’ by euro-area policy makers’ ‘diagnosis of the seriousness of the situation’. The Governor has become more concerned about global growth, especially now that the IMF has revised their growth forecasts. Investors remain better buyers of dollars on dips (1.0307).

The AUD slipped to a nine month low ahead of a German business confidence print this morning. For the growth sensitive currency, the bias remains lower after last weeks purge as the G20 members have failed to pledge to collectively address global risks. Despite domestically having all the strong fundamentals, cash-futures are showing that traders are betting the RBA will lower its key rate by at least-75bp by the end of the year. Last week and for the first time in six-weeks, the AUD traded below parity as all commodity and interest rate sensitive currencies suffered outright. Data from Australia’s largest trading partner, China, indicates that manufacturing may contract for a third month in September is not helping the Aussie cause.

Despite Euro policy makers indicating that they are making some good progress with Greece, periphery yields remain elevated, heightening debt default uncertainty and requiring the paring of higher yielding risk portfolios. Now that the domestic data is coming out a bit negative, there will be some questions ahead on what will happen to the Aussie economy. If anything, the RBA is likely to be on hold for an extended time, allowing investors to sell higher yielding assets on rallies (0.9741).

Crude is lower in the O/N session ($79.55 down-0.30c). Oil has tumbled to a six-week low as the market continues to digest the FOMC’s ‘significant risk’ comments. Weaker manufacturing data out of China and Europe coupled with the fear of Banks having funding issues continue to weigh on commodity prices. Last week’s US inventory report, despite being bullish, had little affect on dragging prices higher. The oil market is on downside momentum now that there is a serious lack of risk appetite.

Last week’s EIA report showed that the US commercial crude oil inventories decreased by -7.3m barrels from the previous week. Analysts expected a-700k barrel decline. At +339m barrels, oil supply’s are above the upper limit of the average range for this time of year. This drawdown has left stocks at the lowest level in nine-months and was the biggest drop since December. Refineries operated at +88.3% of capacity, up +1.3% points from the prior week. On the flip side, gas inventories increased by +3.3m barrels last week and are upper limit of the average range.

Weaker growth as shown by the IMF, which points to lower oil demand, and production in Libya is coming on stream faster than expected will have investors thinking of shorting the market again. Expect investors to run into technically selling on most rallies.

Gold fell another-6% on Friday, completing the worst two days in futures trading in nearly 30-years. Ending the week with a $100 fall was the largest dollar decline on record. The dollar’s rally has cut demand for the metal as an alternative asset after the Fed said it will implement ‘Operation Twist’. The mass liquidation of commodities to raise funds for margin requirements of other assets has dissuade the implementation of any safe heaven investment strategies.

In reality, the continued concerns over euro-zone sovereign debt is likely to drive gold higher in the longer term before policy makers are forced to take more effective action. The Fed’s efforts to drive interest rates lower to support lending should, by default, eventually support commodity prices. For now, liquidation for margin requirements takes precedence ($1,624 down-$24).

The Nikkei closed at 8,374 down-186. The DAX index in Europe was at 5,311 up+115; the FTSE (UK) currently is 5,070 up+4. The early call for the open of key US indices is higher. The US 10-year backed up+7bp on Friday (1.83%) and is little changed in the o/n session.

Bernanke’s “Operation Twist” was able to flatten the curve to new records last week. Long bond prices had their biggest gain in almost three years as investors sought refuge in US debt amid concern the global economy is on the brink of a deep recession. Record low yields were established further out the curve as global policy makers worked over the weekend to curtail a possible Greek default.

The program follows two previous attempts by the Fed to jumpstart the economy by purchasing securities to reduce borrowing costs. The market is also concerned that after this ‘shock and awe’ attempt, policy makers will have little left in their arsenal to take on the ‘no growth’ economy.

It has been seen as an aggressive move by the Fed. Their communiqué last week indicated that there were ‘significant downside risks’ to the US economic outlook, which will continue to provide support for treasuries and flatten the curve even further. The Fed is ‘firing another magic bullet’ and dealers intend to keep ahead of ‘that’ curve.

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