Irresponsible Politicking aids EURO

Now that the pre-weekend optimism over the euro-zone debt solution has faded, the market is fully focused on Washington’s soap opera political circus, where irresponsible politicking is an art form.

Capital markets continue to react negatively to the ongoing US debt woes by selling the dollar, with Euro currencies leading the rally against the currency. Gains in the yen have been limited on speculation that the BoJ will intervene. Governor Shirakawa is ready to take appropriate action as needed if the currency’s strength begins to hurt their economy. It’s believed that other Asian central banks, like the MAS and BoK, are again smoothing ‘their’ currency appreciation.

Speeches by Obama and Boehner (House speaker) have been giving us little new information, but for the fact that they remain at odds over the plans to raise the debt ceiling. Any debt-limit increase must pass both the Republican-controlled House and the Democratic-run Senate and be signed by Obama.

Democrats have resisted cuts to entitlement programs and called for higher taxes, while Republicans have insisted a debt ceiling be accompanied by corresponding spending cuts and no tax increases. Irresponsibly it will come down to the wire. A deal will be done, but it may not be enough to stave off a ratings downgrade!

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 ‘volatile’ session.

Apart from US confidence and new home sales data, the Richmond Fed releases its index today, hot on the heels from yesterdays Dallas Fed in which new-orders rose to their highest level in over a year. The data so far suggest that manufacturing conditions have improved from the lows recorded two-months ago, but that progress remains very slow. The market expects a mild improvement in this morning’s release to 5 from 3.

The dollar is lower against the EUR +0.80%, GBP +0.73%, CHF +0.44% and JPY +0.28%. The commodity currencies are stronger this morning, CAD +0.47% and AUD +0.75%.

The loonie is wearing the ‘safer heaven’ hat as investors push the currency towards its four-year high. It’s a currency on steroids, performing well on the crosses especially CAD/JPY and EUR/CAD. The currency is still riding Carney’s hawkish coat tail comment last week that has futures traders pricing in at least one more hike by year-end despite a subdued CPI print. Month-to-date, it’s the fourth best trading currency among its 16 most-traded counterparts. It seems that the markets are now realizing that a reduction in the US credit status is going to have to be priced in overtime.

The Canadian dollar is guilt free from association to its largest trading partner on many fundamental fronts. Investors are looking forward to this Friday’s GDP print for further currency bullish confirmation. Currently, the market is in dollar sell uptick mode (0.9434).

The AUD gained O/N, like the loonie, investors seek alternatives to the greenback with US lawmakers remaining at odds on how to raise the debt ceiling and avoid a default. The currency has rallied to a two-month high ahead of this evening second quarter CPI report, advancing against 11 of its 16 major counterparts. Analysts expect consumer prices to advance +3.4% y/y in the second quarter.

RBA Governor Stevens did not comment on the future of interest rates in his prepared remarks earlier this morning. The Governor remains positive on the consumer outlook, arguing that the recent divergence between rising incomes and weak spending is unlikely to be sustained. He said ‘consumption will ultimately realign with income, pushing consumption growth up’, even if this is not to pre-crisis debt fueled rates. Reading between the lines, his speech argues against a-38bp cut in rates that futures markets seems to have already priced in for next year. Commenting directly on the currency, he noted it’s strength, but seems to have no direct issues with levels.

Fundamentally, Governor Stevens will wait for actual evidence that the consumer is back in play before he considers hiking rates.Weaker confidence and slower consumer spending add to the pressure on Governor Stevens to keep his key interest rate unchanged (+4.75%) until December.

Currently, the market is pricing a no hike in August unless both inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite (1.0923).

Crude is higher in the O/N session ($99.67 +$0.47c). Oil prices fell for the first time in five-days yesterday as the US Congress failed to agree on raising the debt ceiling, boosting concern that the government will default and damage the world’s largest economy. After all the recent Euro consideration, the market should return its attention to weekly US fundamentals.

Until the market can expect some sort of US debt resolution, the oil market can look forward to remaining volatile with market emphasis focusing on the weaker left hand side. On the flip side, crude bulls are focusing on the possibility that a US default remains a remote possibility and is “unlikely to translate into a real economic crisis”. Big picture, failing to raise the debt ceiling would mean the US could either default or have to cut spending on a variety of social services, which would have a negative affect on domestic oil demand, translating into lower prices.

Fear has gold prices printing new record highs often this month. There was another record print yesterday after US lawmakers failed to agree on hiking the federal debt limit over the weekend, raising fears over a possible default and boosting the appeal of bullion versus alternative asset classes.

Year-to-date, the yellow metal has advanced +14%, heading for its eleventh consecutive annual gain. Despite many believing that a deal will be done, “Rational” fear ahead of “the” decision continues to pressurize the dollar, hurting bonds and benefiting commodities. The metal is on course for its biggest monthly advance in three-months on concerns over euro-zone debt levels as well as the US negotiations. Monetizing US debt rather than fiscal consolidation has investors demanding the metal as a protection of wealth. In real terms you are not making any money by just holding cash, so there is demand for gold as a store of wealth. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on pullbacks until proven wrong ($1,614-$0.20c).

The Nikkei closed at 10,097 up+48. The DAX index in Europe was at 7,347 up+3; the FTSE (UK) currently is 5,934 up+9. 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.

The long end of the US yield curve remains under pressure as the lack of unity over the US debt ceiling saga has led to fresh fears of a ratings downgrade and default. Investors are clinging to hope that both political US parties would reach a compromise to increase the $14.3t borrowing ceiling before the government runs out of borrowing options in little over a week’s time. Comments from El-Erian at PIMCO that the US may still lose its AAA debt rating have bonds straddling their two-week high yields.

Also providing pressure is the Treasury’s plan to sell $99b at this week’s three auctions, starting with today’s $35b of two-year notes, tomorrow’s same amount of five-year’s and Thursday’s $29b of seven-year debt. The political impasse has boosted the chance that a rating agency will cut the US credit rating from AAA within three-months to 50%. On the bright side for the US debt bulls, derivatives show it’s riskier to hold Bunds than Treasuries even as the US faces a possible default!

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