Merkel madness may sink EU

Is this the ‘real’ beginning of the end of the EU? Germany rattling their own saber and threatening not to wait for EU or international approval before curbing speculation and making financial institutions cough up monies to cover the cost of the ‘crisis’. Merkel is proposing legislation that her government will expand ‘a partial ban on naked short-selling to all German stocks and certain EUR currency derivatives’. Other EU members believe that the Chancellors attempt to re-open the Lisbon and Maastricht treaties are ‘naïve and ill-advised’. Is China again the ‘white knight’ to sooth Merkel’s madness after declaring its allegiance to European investments? At the moment, the key to the EUR’s weakness is been driven by the ongoing asset allocation shift away from the Euro-zone, supported by the recent flow news (CFTC and FI reports). The currency remains contained, however, after last week’s breakout to the topside, the correction has managed to shake out the weaker short positions. The market seems steadfast on testing the EUR lows once again as positions dictate that.

The US$ is weaker in the O/N trading session. Currently it is lower against 12 of the 16 most actively traded currencies in another ‘whippy’ trading range.

US data yesterday was very strong and certainly supported ‘growth trading strategies’. New Home sales posted the largest increase in 2-years (+504k vs. +425k), supported once again by tax incentive programs and lower median prices. It was predominately the first-time program that expired at the end of last month that aided the record increase. Of course the question on analyst’s lips is what will happen to sales in both the new and resale market now that the tax credit has expired. With signs of growth in the US, the market will be relying on low borrowing costs and continued improvement in the labor market to support future gains, however the ‘magnitude of gains is expected to decline’. Digging deeper, the months’ supply fell to 5.0 (the lowest level in six-months). With the increase in demand for new homes over the last three-months coupled with this report should provide strong support for further home construction. Interestingly, both the median (-9.7%) and mean price (-4.8%) declined last month.

Not to be outdone, the US durable goods report was also strong (+2.9% vs. +1.1%) and keeps the ‘V’ shape recovery on track, at least for now. Digging deeper, inventories have been expanding at a rapid pace over the past 3-months, and should represent a solid inventory contribution to growth being repeated in the 2nd Q. Business investment (ex-non-defense capital goods) happened to decline last month by -2.4%, while transportation advanced +16.1%, offsetting the decline in the previous month. Shipments also happened to rise for a second consecutive month. Both of the above reports are strong proof, despite the fiscal meltdown in Europe, that the US recovery is still gathering momentum. However, with Europe being a part of their equation, the US economy cannot rely on its exports to sustain its recovery. Domestic demand has to lead growth and that’s down to the consumer and their spending habits.

The USD$ is lower against the EUR +0.71%, GBP +0.56%, CHF +0.30% and higher against JPY -0.35%. The commodity currencies are much stronger this morning, CAD +1.14% and AUD +1.51%. The loonie has drifted away from its six-month lows printed earlier this week after equities plummeted on fear of further weakness appearing in the Spanish banking system. The currency retreated on the back of stronger US fundamentals convincing investors that a ‘V’ shape recovery was very much on the cards. Robust commodity and equity prices are allowing ‘risk on’ trading strategies to be implemented and that includes the CAD. It also helps this growth currency that China has come out in favor of Europe and willing not to change its foreign-exchange reserve diversification. Assuming markets remain somewhat stable or less ‘insane’, dealers will begin focusing their attention on the BOC’s rate decision next week. The recent flight to quality, equity losses and the fear of a multilateral currency intervention has convinced a segment of the market (50%) to price out any rate hike by Governor Carney just yet. If this uncertain environment continues then the market will want to unwind some of the interest premium already priced into the currency. Longer term investors are looking at the 1.08-1.10 level to begin buying the loonie again. If commodities remain true, then intraday traders will be happy buyers of the currency on ‘any’ upticks.

Finally, the AUD found support and managed to print a one week high, as advancing regional bourses is convincing investors that ‘down under’ can withstand the pressures from a European debt fallout. O/N headlines that indicated China would not change its foreign-exchange reserve diversification helped to support the EUR, risk and therefore growth currencies like the AUD. The currency also found favor amongst investors on rumors that the Australian government was contemplating altering the rate at which its proposed mining profit tax would take effect. Up until last night, the currency had been heading for its worst performing month in nearly two-years as investors shied away from growth currencies. Plummeting equity markets in the region and potential war rhetoric apparently from Kim Jong had pushed the currency lower against nearly all its major trading partners. So far this month the AUD has managed to slide -10.1% on declining equity and commodity prices. The fickle investor is now a better buyer on pull backs as longer term support levels remain intact (0.8375).

Crude is higher in the O/N session ($72.55 up +104c). Crude prices have soared since yesterday for a number of reasons. Firstly, the weekly EIA report happened, to aid a rallying equity market, to drag crude prices away from this week’s oversold lows on European fiscal issues. The commodity at one point during the day climbed as much as +4.1% after the US Energy Department reported that total fuel demand gained +0.6% to +19.7m barrels a day and with stronger US data delivered yesterday had the bulls breathing a sigh of relief. Secondly, with durable goods increasing, signals growing manufacturing in the largest energy-consuming country. The weekly EIA report showed a +2.5m barrel increase in oil inventories vs. an expected +100k gain. On the flip side, gas stocks fell -200k barrels vs. an expected no change. Distillate inventories (including heating oil and diesel), fell -300k vs. an expected increase of the same amount. Interestingly, stocks at Cushing fell -300k barrels, the first loss in two months. Refinery utilization was down -0.1% to 87.8% of capacity, matching forecasts. Finally, fundamentals are starting to provide a difference to commodity prices and not just the dollar pricing.

Last week the story line was the EUR appreciating, equity losses mounting and inflationary fears ‘none’ existent had speculators heading for the exits. Now that the EUR has lost some of that firm footing has again revived the demand for the commodity as a ‘safer heaven’ asset class. The commodity has managed to rise to a one week high as the asset alternative of choice amid Europe’s sovereign- debt crisis. Longer term investors have been using the commodity as a ‘currency of last resort’ in addition to their EUR denominated assets. The technical bulls believe that $1,400 is a possible one-year target. For now, the market is a better buyer on deeper pull backs ($1,213). Soon we will have to be using an excuse of inflation if the equity market can remain firm!

The Nikkei closed at 9,639 up +117. The DAX index in Europe was at 5,841 up +83; the FTSE (UK) currently is 5,097 up +60. The early call for the open of key US indices is higher. The US 10-year backed up 3bp yesterday (3.26%) and is little changed in the O/N session. After treasury yields managed to print yearly lows on the back of plummeting global bourses earlier in the week, new found belief in US growth has investors willing to add some risk to their portfolio when treasuries were technically in over-bought territory. Yesterday, Treasury’s five year auction came in at a yield of +2.13%. The bid-to-cover was 2.71, on par with the past four auctions. Overall demand was healthy but trailed market expectations. On a macro level, prices should remain bid as demand for the ‘safer assets’ remains. Today we have the final tranche of this week’s US issues, $31b 7-year notes. Dealers continue to see better buying of product on pull backs.

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