Is this the week that Capital Markets die?

Is this the beginning of the perfect storm? Aside from today’s inactivity due in part to the Japanese Golden week and UK bank holiday, it seems that Capital markets are setting themselves up for something ‘BIG’. Aside from the euphoric rise in the equity markets and the scrambling to get risk on board, one should expect to see fireworks starting this Thursday. Japan will return from its hiatus and it is the day that Trichet stands up to be counted, anything less that what we already believe or any indication of non-consensus, the EUR will die in the water! Not to be out done, we all get to feast, supposedly, on the stress test results after equities close. If all this excitement is not enough, we will finish the main course off with the mighty NFP on Friday. By then we will be chanting TGIF!

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.

On Friday, the US manufacturing sector improved by the largest amount in nearly 2-decades. Analysts are starting to believe that the manufacturing sector ‘may’ have seen the worst of this recession as the ISM manufacturing index clambers towards the psychological break-even level of 50. Last month we witnessed a print of +40.1 vs. +36.3. One can expect that with the fresh ‘auto’ announcements last week combined with the ‘temporary for now’ assembly plant closures in the 3rd Q, could put the index readings under renewed pressure. Digging deeper, the sub-component of New orders continues to push higher, rising to +47.2 (the highest level in 7-months), which some ‘pundits’ believing that the pace of deterioration has slowed dramatically with the potential for growth only months away. Both domestic and foreign demand accounted for the gain with new export orders up almost +13% (the largest increase on record). Production also rose to +40.4, however like most other reports inventories need to contract further, otherwise new production cannot be ramped up! Employment improved to +34.4, but similar to other employment indicators, the pace of contraction remains intense. It’s not surprising to see that prices remain muted, not deflationary, but muted especially after experiencing the fast pace of growth we witnessed when oil was a $100 dollars higher.

Other data showed that US factory orders fell more than expected in Mar.(-0.9%) and the previous months headline was aggressively revised down from +1.8% to + 0.7%. This large revision gives you some sort of indication on how volatile this report can be! Looking at specific sub-components, the Non-defense capital goods (ex-aircraft orders), analysts like to use this as ‘a proxy for business spending, advanced in Mar. despite a -0.9%, m/m, decline in ex-transportation orders. Shipments declined -1.2%, m/m, while inventories declined only -0.8%, which pushed the inventory-to-shipments ratio higher. While durable goods orders were revised down in Feb. from +2.1% to +1.6%, m/m, non-durable goods dropped from a gain of +1.5%, m/m, to a decline of -0.2%!

The USD$ currently is weaker against the EUR +0.37%, GBP +0.24%, CHF +0.20% and stronger against JPY -0.28%. The commodity currencies are stronger this morning, CAD +0.41% and AUD +0.75%. The loonie managed to print a new 3-month high on Friday and has maintained its longest winning streak of 5-weeks since Nov. 2007, as global optimism believe that we may have seen the worst of this recession, which has helped to promote the ‘carry’ and riskier trades. If the equity market can keep the faith then by default commodity currencies will surely get another leg up in the short term. With Chrysler filing for Chapter 11 protection, a surgical bankruptcy should not hinder the currency in the long run. Not unexpected, but, the loonie has remained vulnerable on occasion, like many other currencies, as investors gravitated towards some sort of risk aversion trading strategies as fears that the ‘unstoppable’ virus would curtail a recovery in the global economy. If the WHO declares a pandemic, it does not necessarily mean that the insurance premium returns with a vengeance. So far, strains outside the original source local have been mild. Technically there should be some good market support for the USD at the 1.1800 level. The market seems to have bought into this euphoric move and traders want to sell USD on upticks for the time being.

Higher yielding currencies are benefiting from that glimmer of hope that we have witnessed the bottom of this recession. This renewed optimism is dragged the AUD to its 10th consecutive gain. The AUD rose to its highest level since Oct. in the O/N session as an expansion in Chinese manufacturing added to optimism the global slump is easing. With S&P’s rallying nearly 10% last week has only looked favorably on other commodity currencies. The trend remains your friend, look to buy AUD on pull backs (0.7333).

Crude is higher in the O/N session ($53.38 up +18c). On Friday, the black-stuff rallied to a new 5-week high on the back of a few good reasons. Consumer confidence improved (+65.1 vs. +61.7), and as highlighted above the manufacturing sector declined at the slowest pace in over 6-months, which may indicate that the potential for the recession to end sooner rather than later. Renewed optimism pushed oil up nearly 5%, imagine ‘hope’ is doing this and we still have no issues with record inventory levels! In reality, one should not expect these moves to be sustainable as the fundamentals of the market are poor. There remains the ‘great debate’ between forward looking data (stronger than expected manufacturing numbers and the threat of OPEC to cut production even further) and the backward looking reports (historical inventory levels and demand destruction). Optimism heavily favors forward thinking data, hence, the strong rally of late. As noted last week, we are technically range bound, all because of the bigger picture, record inventories, H1N1 potentially curtailing travel demand and renewed optimism that the worst may be over. Last weeks EIA report was definitely bearish for the neutral observer. Supplies rose +4.05m barrels to +374.7m barrels vs. an expected increase of +1.8m barrels. This headline print prompted Libya’s top oil official to state that OPEC will ‘keep all its options open, including a production cut before the end of the months meeting’. Like all fellow members, they remain concerned with the overhang of prices with these elevated stock prints. Since Sept. OPEC members agreed to slash +4.2m barrels from its daily production and to date 83% of members have been compliant. Similar to Bonds, Gold ended last month on a decline and managed to print the largest weekly loss in over a month as rising global equities have reduced the demand for the yellow metal at the moment ($893). One should expect speculators to continue to sell on upticks for now.

The Nikkei closed 8,977 up +149 (holiday). The DAX index in Europe was at 4,840 up +71; the FTSE (UK) currently is 4,243 down -1. The early call for the open of key US indices is higher. The 10-year Treasury’s backed up 4bp on Friday (3.16%) and is little changed in the O/N session. The FI asset class managed to solidify a monthly loss and a 6th week decline (the longest loosing streak in 2-years) as the Fed abstained from increasing purchases of government debt coupled with the US economy showing some signs of stabilizing. Last week, PIMCO believed that the Fed at these levels would step up their buy-back program to keep longer rates low, however that does not seem to be the case at the moment. With ‘risk’ being back, the market does not have the appetite for FI. A record $71b in long-term debt is to be sold this week and expect dealers to cheapen the curve, with 10’s having a chance of trading towards 3.25%!

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