Investors seek a credible Trichet

The ECB’s independence and credibility has been called into question since Trichet’s last press conference a month ago. Bond repurchases supposedly were not discussed and since then they have bought 41b’s worth. After this morning’s expected ‘no hike’ announcement and in his following communiqué he will be under pressure to explain how far European policy makers are prepared to go into the government bond markets. To date, policy makers are split on this procedure. There is a visible rift as Weber has openly criticized the bond buying move and said that it creates ‘serious stability risks’ despite borrowing costs in some countries continuing to climb. The bond purchases equate to bailing out governments and could lead to inflation, resulting in the ‘breaching of two of the ECB’s founding principles and undermining its credibility’. Investors seek convincing answers.

The US$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range.

Ben Bernanke’s testimony yesterday emphasized the need for fiscal restraint in the medium term, but was notably silent on the question of monetary restraint. Although his speech did not break any new ground, he did commit to ‘take the actions necessary’ to support dollar funding needs in Europe and the recovery more generally. He noted that the FOMC’s forecasts implied a large degree of economic slack through the end of next year where ‘inflation is likely to remain subdued’. Notably, Helicopter Ben made no mention of the Fed’s exit strategy. He acknowledged the European Sovereign Debt crisis as a new source of uncertainty in the outlook, and promised that the Fed will be ‘highly attentive’ to developments abroad and to the potential fallout for the US economy. In effect, the Fed’s primary concern remains ‘nurturing the recovery’. His somewhat optimistic slant gave the ‘risk-on traders’ some breathing space, but, for how long?

So far this week we have witnessed Australasia economically distancing itself from Europe’s debt crisis. Last night’s economic data shows China’s export numbers skyrocketing (rose +48.5% in May y/y), coupled with recent employment reports from Korea and Australia is proof that theses economies are best situated in weathering the EURO storm. Again the old arguments and questions have to be recycled. The speed of the recovery in China’s exports and by default its massive trade surplus will support the global arguments that the country should allow its currency to appreciate. A matter of week’s ago Geithner postponed a report that was expected to call out China as a currency ‘manipulator’. Technically, Europe is China largest export market. Can the EU rely on the weak EUR to outmuscle Asian domestic demand to rebalance the balance of trade somehow? Or are we to see Congress lead the way and step up their Yuan appreciation policy rhetoric? It all comes down to the ‘fine balancing act’ and how much of the pie we get. It will be interesting to see if the questions gets front and center at this months G20 meeting in Toronto.

The USD$ is lower against the EUR +0.22%, GBP +0.29%, CHF +0.05% and JPY +0.26%. The commodity currencies are stronger this morning, CAD +0.35% and AUD +1.04%. The loonie managed to record its longest winning streak in over a month yesterday, three consecutive days, as crude and equities increased, fueling demand for assets linked to economic growth. For most of this week, the CAD has got a leg up as fundamentals have persuaded investors to shy away from ‘higher-yielding assets and toward those of nations with strong balance sheets’. When it comes to risk aversion and questionable growth, it’s the commodity currencies that are normally the most affected, but on the whole the loonie is certainly holding its own after the stronger domestic data and BOC hiking rates last week (+25bps). Yesterday, for a period we witnessed risk appetite being more constructive on the back of Bernanke’s comments. Year-to-date, the currency has been the worlds second best performer (+10.6%) vs. its southern neighbor after the JPY. With the upcoming G8 and G20 meeting in Toronto or otherwise know as the ‘Austerity gig’, Canadian policy makers are beginning to become more vocal on how the impact of Europe’s debt crisis on Canada may escalate. Carney and Finance Minister Flaherty in Korea last weekend called on economies to boost domestic demand and signaled out China’s need to revalue its currency as part of any effort to rebalance global growth. The market is seen using the CAD as a safer way to play an economic recovery in the US with linkage to commodities and less banking or fiscal noise to be concerned about. Until the loonie breaks out of the 3c range (1.0350-1.0650), orderly CAD buying is preferred on dollar upticks.

It was not surprising to see the Kiwi’s hike rates 25bp to 2.75% last night for the first time in three years. The RBNZ Governor Bollard said that ‘underlying inflationary pressures are expected to increase’, signaling that faster inflation is a bigger threat to growth than further gains in the NZD. Elsewhere, Australian employment data surprised to the upside, adding +26.9k new jobs vs. an expected +20k and pushing the unemployment rate down from +5.4% to +5.2%. It is the third consecutive month of job gains, emphasizing the RBA’s call that that economic growth will accelerate this year. The AUD again found a strong bid as investors increased their bets that Governor Stevens will resume the country’s most aggressive round of monetary tightening. Currently Australia’s jobless rate is almost half that of both the EU zone and the US’s. Up until this point, questionable global growth has thus far naturally dampened demand for ‘commodity currencies’. Not containing Europe’s debt issues could lead to a global double dip and an aggressive sell off in the growth currencies. So far, it seems that the crisis in Europe has not had a material impact on the Australian economy. Depending on equities and commodities, some investors are looking to buy AUD on dips (0.8423).

Crude is lower in the O/N session ($74.06 down -32c). Crude prices traded higher for a second consecutive day yesterday as the weekly EIA report revealed that oil inventories fell for a second straight week, easing worries about excessive domestic supply. Crude stocks fell -1.8m barrels, more than double the streets estimate of a -700k decline. It’s worth noting that the decline in inventory was not accompanied by a clear decline in demand. The US demand was at +19.376m bpd, down -3.2%, or 645k barrels w/w. Last week demand had topped +20m. On the flipside, gas inventories were expected to fall -400k bpd were little changed, down by just -8k barrels, to +218.9m. Interestingly, over the last four weeks the EIA said gas demand lagged year-ago levels by -1% at the start of the summer driving season. This has led to analysts believing that the high gas inventories may continue to ‘weigh on futures traders, who have been reluctant to place bets that oil will continue to rise until demand figures strengthen to pull down excess supplies’. Distillates stocks (including diesel and heating oil) increased by +1.8m barrels, about six times the expected increase. Refineries lifted operations relative to capacity to 89.1% from 87.5% last week (the highest rate in two years). It’s all about demand and the technicals continue to point to a market being overbought in the short term. Sellers do remain on upticks.

One day after recording a record print, the ‘yellow metal’ temporally fell to a new reality as the EUR and global equities rebounded, eroding the precious metal’s safe haven appeal. We are now playing the technical game. How low can the commodity go after not been able to remain above the $1,250 price level? Generally, it has become the benefactor when all other currencies fail. The contagion debt effect not being contained has provided a reversal of fortunes for the commodity this year. Prior to yesterday’s move, the metal has appreciated year-to-date +14%. The threat to global growth from Europe’s debt crisis and weaker global bourses tends to increase the demand for the commodity as a ‘safer haven’ on pull backs. The questionable EUR has pushed investors to owning the yellow metal. Europeans are content in using the commodity as some sort of hedge against their European holdings, believing that the EUR has not bottomed out just yet. On the flip side, historically, ‘the physical market is unlikely to provide much support for gold over the summer months which are typically the seasonally weakest for jewelry demand’. Analysts believe that a print of $1,200 is doable this week ($1,226 -310c).

The Nikkei closed at 9,542 up +103. The DAX index in Europe was at 5,970 down -14; the FTSE (UK) currently is 5,058 down -27. The early call for the open of key US indices is higher. The US 10-year backed up 3bp yesterday (3.20%) and is little changed in the O/N session. Treasuries felt the weight of global bourses in the black after Bernankes comments and dealers making room to take down the 10-year auction. Again for today, expect dealers to push yields back up a tad in the long end to accommodate the 30-years-$13b supply. Yesterday’s 10-year reopening was healthy, yielding 3.242% vs. 3.24% WI’s. The bid-to-cover was 3.24 vs. the last four auction average of 3.20. Indirect bidders took 40%, a bit less than the last auction of 43.3% but above the four auction average of 35.5%. Direct bidders took 13% vs. an average of 15%. The short term bigger picture has treasury yields remaining under pressure on EU efforts to contain Europe’s debt crisis. At the moment, the market seems happy entertaining risk-on trading strategies.

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