King’s stalling has GBP stuttering

The BOE has sent a strong message this morning that it will not be hiking rates as rapidly as the market expects. King went as far as to say ‘that some people are getting ahead of themselves’. This has certainly caused some damage to the long sterling punters positions. In this morning inflation report, the BOE has raised its forecast for inflation for 2011 but said growth would also be slower, as ‘high commodity price squeezes, household incomes and governments budget cut’s start to bite’. They expect inflation to fall below target from late 2012. Technically, if rates stay unchanged, they suggest that inflation will be slightly above target two-years out. In translation, they will raise rates, not as quickly or as high as the market expects. Perhaps the BOE focus on longer term inflation target may reveal market worries of a double-dip?

The US$ is weaker the O/N trading session. Currently, it is lower against 11 of the 16 most actively traded currencies in a ‘subdued’ O/N session.

Yesterday’s US data was a market surprise as investors had been expecting better. Headline (+0.3% vs. +0.5%) and core-US retail sales (+0.3% +0.5%) continue to rise but disappointed the aggressive upbeat expectations. Analysts are questioning the price versus volume effects in calculating the market disappointment. There is talk about a downward revision to 4th Q GDP. The backward revisions certainly took some of the steam out of the January report. Both the headline and core were revised lower in December and it was just the core print adjusted for the November release. Digging deeper, of the 13 subcategories, 8 posted gains and 5 improved results over the prior month. The strongest performance was seen in gas stations (+1.4%-price effect), food (+1.3%) and non-store retailers. It’s worth noting that analysts are suspicious of the commodity sensitive categories, they are concerned that the retail sales in volume terms were weaker than the headline readings. The offset effect came from building materials (-2.9%), sporting goods (-1.3%) and food services (-0.7%). Unusually severe weather in many parts of the country is likely to have weighed on consumer spending and better results are expected in the quarter, helped by recent reduction in payroll taxes. The US consumer is the key to unlocking a full economic recovery. The consumer is still shopping despite high unemployment, questionable income growth and tight credit. That being said, the cost pressures from commodities will pose a challenge in the months ahead.

US import prices accelerated higher last month, doubling to +1.5%, higher than market expectations. This is the fourth consecutive month of price increases (4-month annualized rate more than +15%). These numbers will have the Fed being challenged on its price stability policy. Digging deeper, both fuel (+3.9%) and non-fuel imports (+0.8%) provided the largest increases. Not to be outdone, Export prices were up for the sixth consecutive month, rising by +1.2% and supported mostly by agriculture (+3.2%) and non-agriculture (+0.9%). Year-over-year, import prices are up +5.3%, while export prices are +6.8% higher. Obviously, export prices got a boost from the Fed’s QE2 stance.

Finally, manufacturing in the NY region grew at its fastest pace in eight-months yesterday (+11.92 to +15.43). Analysts note that with capacity utilization at historical lows, there remains plenty of room for manufacturing to aid consumer consumption in the economic recovery. Digging deeper, the main highlights saw the new-order index soften from +12.39 to +11.80, while current shipments plummeted from +25.39 to +11.31. The employment index was mixed, with current employment easing from +8.42 to +3.61 and the workweek index rising from +2.11 to +6.02. It’s worth noting that the Empire index has been relatively consistent over the past year. Analysts are optimistic that business will begin open their coffers and spend more of their cash hoards on capital goods.

The USD$ is lower against the EUR +0.37%, GBP +0.03, CHF +0.45% and JPY +0.16%. The commodity currencies are stronger this morning, CAD +0.33% and AUD +0.32%. With the lack of Canadian data yesterday, the loonie took its cue from the softer US retail sales data and eased a tad vs. its largest trading partner outright, but performed admirably on the crosses, managing to print a six-month high against JPY. The weaker sales print suggests that it will not be a straight arrow to economic growth. The loonie remains contained in a tight range outright, requiring some guidance from domestic data that starts with today’s leading indicator and manufacturing release and finishing this week with Canada’s inflation snapshot. Stronger fundamentals of late (trade surplus and employment) has helped to push the loonie higher against most of its major trading partners on speculation that Governor Carney will hike borrowing costs quicker than other Cbank. Swaps traders are pricing that the BOC will raise its target lending rate by +0.83% over the next 12-months, up from +0.60% a week ago. Parity, the new paradigm, is becoming well adjusted too by investors, consumers and manufactures. We can continue to expect CAD to outperform on the non-U.S. dollar crosses and outright, better sellers have appeared on dollar rallies (0.9863).

The AUD has strengthened from a two-week low in the O/N session vs. the greenback as Asian bourses gained, increasing demand for higher-yielding assets. The currency temporarily strengthened to a nine-month high vs. the JPY after Chinese inflation data saw CPI rising less than expected (4.9% vs. 5.3%) earlier this week. This has boosted the demand for higher-yielding assets. Also aiding the currency was the RBA minutes from this month’s meeting stating that a ‘slightly restrictive’ policy stance was appropriate as a resources boom boosts incomes. The minutes offered no new real news, but stated clearly that the medium-term outlook for the Australian economy remains robust. Analysts believe that Governor Stevens is waiting for the consumer to start consuming before looking to hike rates again. For the time being, policy is ‘appropriate’ in ‘restrictive’ territory, and is dependent on the consumer when rates will rise again. Last week, the market pricing for rate hikes over the next 12-months fell-4bp to +34bp. Analysts note that with futures dealers interpretation, combined with such a clear message from Stevens, still leaves the rates market vulnerable to the weaker data on lending and consumption over the next few months. With risk appetite on the up and Chinese CPI less than expected has investors wanting to acquire the carry trade again (1.0000).

Crude is little changed in the O/N session ($84.76 +0.44c). Oil prices fell yesterday, giving back some early Tuesday gains as the dollar briefly turned higher and equities slipped on mixed US economic data. Deeper pullbacks continue to be supported by the geopolitical variable. Concerns about the Middle East and production problems in the North Sea are boosting Brent relative to WTI. Lower-than-feared Chinese inflation tentatively supported oil prices earlier this week. Even the value of the Yuan lent a helping hand, especially after reaching a 17-year high vs. the dollar making it much cheaper for them to acquire ‘their’ coveted commodities. Last weeks EIA report revealed no surprises. Both crude and gas stocks happened to edge higher. Fundamentally there is far more oil in storage, more fuel capacity and more idle oil wells to limit a much stronger market rally. It is the fear of a sudden reduction in supply from the Middle-East that will support commodities longer term.

Gold futures have climbed to the highest level in a month as rising consumer prices is boosting the demand for the precious metal as a hedge against inflation. Despite the market not witnessing the same level of speculative fund and ETF participation that occurred throughout December, the commodity is receiving support from Chinese’s inflation, which accelerated the most in at least six years, and on UK consumer prices rising the most in more than two years. The commodity that every investor hated last month continues to find support on deeper pullbacks. This is because the Middle-East remains the unknown variable. The commodity is being used as a store of value. Has the commodity peaked or is it simply a short-term correction? The commodity is attracting technical buyers after rallying above its 20-day moving average. On deeper pullbacks, the metal should 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 ($1,376 +$2.60c)

The Nikkei closed at 10,808 up+61. The DAX index in Europe was at 7,419 up+19; the FTSE (UK) currently is 6,072 up+35. The early call for the open of key US indices is higher. The US 10-year eased 3bp yesterday (3.60%) and is little changed in the O/N session. The Fed completed the second of four-rounds of US securities purchases yesterday, again supporting the longer end of the yield curve. Treasuries seem to be trading in a vacuum as the market debates the merits of yesterday’s US economic releases. Investors are questioning the true strength of the softer US retail sales release and the Empire manufacturing pick up. The 2’s/10’s spread tightened (+273) as concerns eased that inflation in accelerating. Despite the data being somewhat bullish for the FI market, overall bearish sentiment is capping the price rally and keeping the market within a tight range.

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