Is it EURO Risk On or Off?

Are we about to witness another gathering of conflicted regional interests that will not result in an actual plan? This belief has certainly forced more risk out of this market in the last 24-hours. The divergence in recent EU policy statements suggests that there is considerable risk that today’s battle might produce a ‘general agreement on principles and measures’, but with limited information on implementation details. On the flip side, market expectations appear to be set so relatively low that this month’s risk rally may be easily extended if discussions appear to be making progress.

Most individuals like time tables, Europeans love timetables. Today will progress along the following timeline with Merkel addressing the Bundestag at 12:00pm local time (6:00am EDT). German precision has her speaking for about 20 minutes, before the lower house debates (90-minutes) and then votes on broadening the EFSF. The official Summit will begin at 6:00pm local time, with a working session, followed by a working dinner at 7:15 (1:15pm EDT). At the conclusion of the dinner there will a press conference by the president of the European Council (Herman van Rompuy) and the president of the European Commission (Jose Manuel Barroso). Will they get to enjoy their dessert?

Investors had quite a bit thrown at them yesterday, horrible data, and unnerving Euro policy maker’s decisions. With so many trying to remain on the sidelines, price vacuums and volatility shot way off the charts. The twist and turns at one point had a dollar in demand and then there was the fear of Q3 had individuals dumping these positions. Market expectations for the Euro-zone seem to have been a tad optimistic this month. It triggered a more drastic fall for emerging market currencies when European leaders disappoint. Proof was in the pudding when the Econfin ministers’ meeting was cancelled allowing emerging market currencies to take the biggest hit.

The mood amongst US consumers remains very black this month. Confidence headline prints have reverted to recessionary levels (39.8 vs. 46.4) as individuals turn more pessimistic about the US labor market. The underlying details were also horrible. Consumer expectation for economic activity over the next six months dropped to 48.7 from a revised 55.1. The present situation index, a gauge of consumer’s assessment of current economic conditions fell for the sixth consecutive month to 26.3 from 33.3 in September. These numbers piggyback recessionary levels of three years ago and was more evident in the higher-income families. The usual factors are contributing to this dower print. The Limited job availability, deteriorating home values and the threat of a European debt default has the makings of a rough holiday season ahead.

Other data showed that US house prices rose modestly in August on seasonal effects. This represents the fifth consecutive monthly increase for the S&P’s Case-Shiller home price index (+0.2%, m/m). Adjusting for seasonal factors, the 20-city index was flat. Despite modest glimmer of hope, the US market has remained depressed despite lower prices and low historical interest rates. The labor market squarely takes the blame. Last week, the NAR reported that existing home sales dropped-3% in September.

The dollar is lower against the EUR +0.21%, GBP +0.00%, CHF +0.31% and JPY +0.23%. The commodity currencies are mixed this morning, CAD +0.23% and the AUD -0.62%.

The loonies decided to go ‘walkabout’ yesterday. It did not need the dovish one page monetary report from the BoC to send it on its merry way. Canceling the Econfin meeting today had a strong negative affect on risk currencies who seemed to have too much Euro optimism priced in.

Governor Carney kept Canadian O/N rates on hold yesterday (+1%), citing greater risks to the global economy only supported the renewed negative CAD sentiment. The BoC stated that the ‘outlook for the Canadian economy had weakened since July, with significant less favorable external environment affecting Canada through financial, confidence and trade channels’. Economic momentum has slowed and is to remain ‘modest through out the middle of next year’. The BoC cut its economic growth outlook and has removed a reference to withdrawing stimulus from its statement as the global economy slows. Today’s Monetary Policy Report will provide more detail.

The BoC is looking for slower growth ahead. The market on the other hand had been anticipating a bit more positive sentiment on the economic front, without it, the Canadian bulls were trapped yesterday and now provide dollar support on these pullbacks. The loonie remains vulnerable to following the broader trends, especially to that which is transpiring in Europe. There’s tremendous sensitivity because of the unprecedented Euro event risk. The market remains a good buyer of dollars on dips (1.0144)

Until last night, the AUD had been one of the best performers this month, rallying +3.7% outright as currencies followed an improvement in risk appetite. However, domestic data last night showed that Australia’s underlying inflation slowed last quarter to its weakest pace in 14-years (+0.3% vs. +0.6%), sending the nation’s currency lower as traders bet that the RBA is now able to ease rates next week. Inflationary measures are comfortably back within the RBA’s +2%-3% target band. Despite futures traders pricing in a -25bp cut, the AUD remains at the mercy of global developments and progress in the Euro-zone debt debacle. The currency depreciated almost-10% last quarter on the back of weaker employment growth and global risks increasing. Again, this risk and interest rate sensitive currency remains in the mercy of the Euro-rhetoric ticker today.

The AUD, earlier in the week, was supported by China and anything positive in China tends to rub off on the AUD. Chinese manufacturing data released last weekend signaled that their manufacturing may expand (51.1 vs. 49.9) for the first time in four-months, boosting demand for higher yielding assets. However, the currencies gains have been limited on the back of domestic data and the EU debt crisis. Perhaps, when it comes to cutting rates the EU holds the key? Before this morning’s inflation report, the market had not considered the RBA to be pro-active ahead of the G20 meeting in Caen at which Europe is due to reveal its “comprehensive policy package”. The inflation surprise data now has the RBA moving next week. The market is a better seller of the currency on rallies (1.0370).

Crude is higher in the O/N session ($92.29 up+0.12c). Oil rallied to a three-month high on supply concerns yesterday. According to a satellite survey, supplies at Cushing, Oklahoma (WTI delivery point) fell last week, pushing futures to cross over into ‘bull market’ pricing. It seems that the market has ‘just’ realized that there is a supply issue at distribution. Analysts note that with Brent Crude trading above $110, West Texas still has some catching up to do (futures have rallied +24% since October 4 and a +20% gain is the common definition of a bull market).

Even with negative economic headlines WTI continues to rise, which suggests that it’s disconnected from the fundamentals. The CFTC commitment of traders saw the biggest gain of oil contracts (bullish indication) since the beginning of September reported last week. However, the “current geopolitical context creates significant tail risks in a world with such limited spare capacity”.

Later this morning we will also get this week’s inventory report. Last weeks EIA crude stocks fell by -4.70m barrels to +332.90m, and remain in the upper limit of the average range for this time of year. Stockpiles were forecast to climb +2m barrels. Gas was not going to be left behind, its inventory print also moved down by -3.30m barrels, a week after decreasing -4.10m. This too remains in the upper limit of the average range. Inventories of distillate fuel (heating oil and diesel), decreased -4.27m barrels to +149.7m, the biggest drop since November. Oil refinery inputs averaged +14.4m barrels per day during the week, which were +134k barrels below the previous week’s average as refineries operated at +83.10% of their operable capacity.

Brent December contracts should begin turning their attention back to supply issue questions out of Libya as the country’s supply comes back online. Until then, expect investors to run into technical selling on some of these steeper rallies as they wait for a clearer idea of where we are going on the economic front.

The market felt like it was coming and yesterday’s disappointing US consumer confidence print provided the impetus for gold to rally aggressively as the data showed consumers were at their gloomiest in 2-1/2 years. This undermined the dollar and fed safe-haven demand for bullion. The risks of the whole EU debt crisis remains skewed to the upside, and assuming there is some kind of result of some of the problems, markets should move higher dragging gold along for the ride.

Everyone wants to know the details from Europe. Lack of details is pushing gold up as a safe-haven bet. The commodity has also found support (store-of-value) on concern that US monetary policy aimed at shoring up growth will eventually spur inflation. Over the past two-weeks, commodities have followed the moves in riskier assets, with the precious metal’s safe-haven appeal diminishing a tad after the price purge swings in the past quarter. Stronger Chinese growth is also providing a source for support. On the weekend, China’s strong PMI print suggests that the slowdown in the country may have peaked. Last week, the yellow metal rallied the most in a week, as a drop in the dollar boosted investor demand.

Right now, we are back to the inverse dollar-gold correlation play. It seems that the demand for ‘physical’ gold from India will provide the strongest tangible support on these pullbacks. Fundamentally, the commodity is trying to find a balance ‘between the two opposing forces’, a risk investment or a safe haven play ($1,715 up+$15.40).

The Nikkei closed at 8,748 down-14. The DAX index in Europe was at 6,032 down-14; the FTSE (UK) currently is 5,524 down-2. The early call for the open of key US indices is higher. The US 10-year eased-10bp yesterday (+2.14%) and is little changed in the O/N session.

Treasury prices have rallied to weekly highs ahead of today’s EU summit. Yesterday’s cancellation of today’s Econfin meeting has spurred concern that EU policy makers may struggle to resolve their debt crisis, boosting US debt appeal. Also supporting debt market gains was a recessionary consumer confidence print yesterday.

Investors overwhelming concern about Euro debt direction should provide further support for treasuries and lower yields going forward. The 2/10‘s spread narrowed for the first time in four-days, aided by the Fed’s ongoing “Operation Twist”. Bond price gains have been limited ahead of the Treasury selling $35b 2’s, 5’s and $29b seven-year securities this week.

Yesterday’s $35b 2-year market was unchanged in its offering size for the ninth consecutive month and stopped slightly through the screws at +0.28%. The bid-to-cover was 3.64, above the average of 3.36 for the last four auctions. Indirect buyers bought +39.2% of the offering, compared to the +29.5% average. Direct bidders took down +8.2%. The Treasury market for the near term remains “policy-dependent, not data-dependent”.

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