Hawkish drum beat points to a strong EUR

This is a busy week data wise. We have global PMI reports, the US employment report, monetary policy meetings from the ECB, RBA, BoC and Bernanke’s testimonies to both houses to overcome. On the face of it, the market anticipates the data to show that the recovery momentum remains strong. At the same time, a dovish message from Bernanke is likely to contrast with a hawkish ECB shift. Big picture, despite the Euro-region entering a new refinancing stage, especially for the peripheries, and the overwhelming Fine Gael victory on the weekend giving it a clear mandate to try to renegotiate its EU/IMF bailout package, the dollar is expected to remain on the back foot. Of course, trumping all this will be the Middle-East and North African contagion fears.

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 ‘whippy’ O/N session.

The market is preparing itself for a more hawkish tone at this week’s ECB meeting, with bullish implications for the EUR. In the past few weeks, ECB officials have surprised the markets and gone out of their way to beat the hawkish drum. A shift in Euro-policy makers assessment of inflation risk to the upside will have the futures dealers quickly pricing in the ECB’s first rate hike in June. This morning’s Euro-zones consumer prices rose less quickly last month than initially thought, as prices for less volatile ‘core’ fell sharply from December (2.3%). Not surprisingly, the headline inflation rate is being kept elevated by energy prices.

The USD$ is lower against the EUR +0.50%, GBP +0.51%, CHF +0.12% and higher against JPY -0.11%. The commodity currencies are mixed this morning, CAD +0.13% and AUD -0.22%. The loonie surged to a three-year high outright last night, on the back of commodities continuing to trade higher with the growing tensions in the Middle-East. Higher commodity prices have investors dissociating themselves away from riskier, growth linked assets and sending investors towards safer commodity linked currencies. In fact, the loonie technically straddles both trading philosophy camps. Risk aversion and not commodities had been dominating the currency’s value of late. Currencies linked to raw materials usually weaken after ‘major crude supply shocks’. This is a busy data week for the Canadian economy. This morning we get the GDP print. The only positives that are lining up for this month are coming through net trade and wholesale trade. All other influences upon December GDP growth over the prior month are negative and that include real manufacturing shipments, housing starts, and hours worked. Are we setting ourselves up for a negative print for December GDP over November? The trend is for a stronger CAD. The market is looking towards Governor Carney tomorrow and a hint when policy begin tightening again. Expect the Governor’s rhetoric to focus on the value of the loonie and its future effect on the economy. Investors will continue to look for more favorable levels to own the currency (0.9765).

The AUD weakened in the O/N session after a government report showed company profits unexpectedly fell in the 4th Q (-2.8%). Business spending last week was in line with RBA Governor Stevens’ comments and supportive of higher yields and structurally higher AUD currency. Recent strong data has encouraged traders to add to bets that the RBA will boost interest rates over the next 12-months. On pullbacks, the currency is aided by commodity prices and is having very little follow-through on risk-aversion trading strategies. Despite geopolitical uncertainties, the demand for higher yielding growth currencies remains steadfast. The RBA is expected to remain on hold this evening. Dealers are anticipating the tone of the statement to remain largely unchanged from the last meeting, with some possibility of a slightly more positive assessment acknowledging strong wage growth in 4th Q and robust investment expectations in the CAPEX survey (1.0150).

Crude is higher in the O/N session ($98.2 +74c). Crude prices remain elevated on Middle-East geopolitical concerns. Oil climbed to a 30-month high last week as violent uprising reduced supplies from Africa’s third-biggest producer. It’s been estimated that as much as +1m barrels of Libya’s daily oil production may have been shut. The IEA believes that may be a ‘bloated figure’ which has caused oil prices to back away from their recent highs. ‘While there’s a risk of contagion, of this spreading to Iran or Saudi Arabia, the market is going to see prices elevated from these levels’. The IEA’s chief economist said that ‘higher oil prices pose a danger for a global economic recovery’. Last week’s EIA report again has provided some support for the US crude market on pull backs. The report showed a smaller-than-expected increase in supplies. Crude inventories rose by +800k barrels vs. an expected increase of +1.4m. Even worse was the gas inventory headline declining -2.8m, analysts had been expecting an increase of +950k barrels. Stocks of distillates (heating oil and diesel) fell -1.3m barrels, which was very much inline with expectations. Concerns about the Middle-East and production problems in the North Sea are boosting Brent relative to WTI and pushing the spread to a record premium. With supply the number one concern, the commodity will remain bid because of the contagion concerns.

Like most commodities, gold is heading for its longest rally in six-months, as mounting tensions in North Africa and the Middle East boost demand for a ‘safe haven’. Last week the commodity was up +1%. The yellow metal continues to be supported by geopolitical factors and inflation threats. Prices have risen nearly +7% this month, as protests in favor of democratic reform in North Africa turned bloody. Investors have grown increasingly uneasy that the crisis could spread. Even hawkish global rhetoric has managed to give the yellow metal a leg up in February. Consumer prices are also boosting the demand for the precious metal as a hedge against global inflation. Last week, the market witnessed Chinese’s inflation accelerating the most in six years, and UK consumer prices the most in two years. Even US data is showing that their inflation numbers are edging higher. The commodity that is being used as a store of value. The asset class is expected to remain better bid on speculation that currency volatility will boost demand for a safe heaven investment once the Euro contagion fears raise its ugly head again over the coming weeks during the Euro-periphery refunding season ($1,412 +$3.10c).

The Nikkei closed at 10,624 up+97. The DAX index in Europe was at 7,180 down-4; the FTSE (UK) currently is 5,976 down-25. The early call for the open of key US indices is lower. The US 10-year eased 6bp on Friday (3.39%) and is little changed in the O/N session. Geopolitical pressures continue to support treasuries despite the uptick in global inflation numbers. Last week, the US benchmark 10’s gained the most in nine-months as the revolution in Libya drove investors to the safety of US product and raised concern that surging commodity prices may curtail whatever economic recovery we are currently witnessing and this despite the issue of $99b’s worth of new product. Also aiding prices is the belief that the Fed will buy between $18.5b and $26.5b in US debt this week. Month end requirements has also had portfolio managers requiring some duration. Event risk remains the order of the day.

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