Moody’s plays the Grinch, Dollar rally limited

We might downgrade, we might not downgrade. Moody’s stating that they are considering downgrading Spanish Government debt further is just another example of irresponsible credit management reporting. When Capital Market liquidity is at a premium, the swings tend to be over exaggerated. For most of this month investors have focused on US yields for dollar guidance. Not surprisingly, the dollar has extended its gains this morning after the contagion rating announcement despite slightly lower US yields. Be forewarned, a soft US inflation print again will be supportive for continued QE and help US debt to find their feet after the recent selloff, limiting the dollar gains. Similarly, expect the ongoing Fed purchases to push US yields lower over the holidays, leaving the USD vulnerable as long as Euro periphery news remains subdued.

The US$ is stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘whippy’ O/N session.

Yesterday’s US data was a welcome surprise. US core-retail sales aggressively beat expectations (+1.2% vs. +0.6%),. It was twice the expected pace and its strongest growth in nine months. The headline print also edged higher, managing to record its seventh consecutive monthly gain (+0.8% vs. +0.6%). On the face of it, the uptick in retail sales was most likely volume related and not price. Even the revisions made a strong market affect. The previous months results were revised substantially higher, with the headline print posting a gain of +1.7% (up from the original +1.2%) and core-receipts were up +0.8%, double the original estimate. Digging deeper, the underlying data was equally encouraging. Analyst’s note that retail sales ex-autos, building materials and gas (a component that that feeds directly into GDP) was up +0.92%, the most in nearly a year. Gains were widespread across most of the subcategories, with 8 posting gains and 9 better results. The top performing categories included clothing (+2.3%), sporting (+2.3%) and restaurants (+2.1%). While declines in autos (-0.8%), electronics (-0.6%) and furniture (-0.5%) provided the offset. It seems that consumers are stepping up to the plate and loosening their purse strings and buying discretionary items. It’s worth noting that the discretionary spending subcategory has been increasing over the past five months, also suggesting that the consumer psyche is turning the corner.   

US PPI came in higher than expected, again beating market expectations (+0.8% vs. +0.6%), while core-PPI (ex-food and energy) recorded a +0.3% gain. Year-over-year, both the core and headline advanced +3.5% and +1.2%, respectively. Most of the headline gain was contributed by higher prices of energy goods (+2.1%, index weight of 20%) and consumer foods (+1.0%). Since its lows last December (-0.6%), core-PPI has advanced just under +2%. The usual constraints of household balance sheets, an uneven labor market outlook and excess economic slack, continue to limit pricing power and the knock on to the consumer basket.

The Fed provided us with a ‘modest’ upgrade to the economic outlook yesterday and left policy settings unchanged, as widely expected. In the first paragraph of the communiqué, the committee said the ‘economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.’ The description of household spending was also upgraded from ‘increasing gradually’ to ‘increasing at a moderate pace’. What happened to retail sales then? Policy makers again have widened their take on the depressed character of housing activity, broadening their scope from ‘starts’ to ‘housing sector’. Finally, despite the somewhat brighter growth situation, ‘measures of underlying inflation continued to trend downward’, a comment that analysts believe is slightly stronger than ‘have trended lower in recent quarters’. It was another boring FOMC meeting ‘to maintain a super-accommodative posture in US monetary policy’.

The USD$ is higher against the EUR -0.56%, GBP -0.45%, JPY -0.42% and CHF -0.17%. The commodity currencies are weaker this morning, CAD -0.25% and AUD -0.83%. Yesterday Canadian labor productivity happened to unexpectedly edge higher (+0.1%) after falling a revised -0.6% in the 2nd Q. The 3rd Q gain reflects modest growth in the Canadian economy (+0.1%) and notably with no changes in the hours worked. To date, in the 4th Q, data is shaping up to repeat a negative decline. This month the loonie has gained +1.8% outright vs. its largest trading partner. Gains in commodities and stocks have been making economic growth currencies more attractive. The CAD has only witnessed modest strength as Governor Carney highlighting the dangers of a persistently strong domestic currency. The loonie continues to struggle within striking distance of parity because of the strong corporate interest to own dollars there. The market expects support for the loonie from the Russian Cbank on dollar rallies on the back of their desire to convert approximately 1-2% of their reserves into loonies. Some of the currencies shine has been taken away with Governor Carney’s comments after the BOC kept rates on hold last week. Carney acknowledged economic growth in the second half of this year is weaker than previously anticipated and expressed concern about the expected recovery in net exports (that’s a strong loonie problem). The market has taken this as a dovish sign for rates. Corporate dollar interest near parity should provide resistance for the loonie until the New-Year.

The AUD fell for the first time this week outright in the O/N session as US Treasury yields climbed, narrowing the yield advantage of assets down-under. The currency has fallen against all its major trading partners on fear that China will act in answer to slow inflation, thus reducing the demand for growth sensitive and higher-yielding assets. Earlier this week, the Aussie had rallied on the back of stronger commodity and equity prices as investors tried to embrace risk. The currency briefly was able to penetrate the parity level, which remains a strong resistance point. The AUD has climbed +9.8% this year (second biggest winner after JPY), on prospects for commodity-driven economic growth and the yield advantage of the nation’s debt compared with other developed markets. Domestic data remains strong, this months employment data blew all analysts expectations out of the water and supports the currency on pullbacks. Not aiding the currency is the concerns for long dated interest rates in the US. Analysts are beginning to agree that the tight labor market will bring the RBA back into the picture, but believe that Governor Stevens is not behind the curve just yet and will not be required to hike rates in February. With consumers boosting their savings significantly in an environment of rising job and wage growth, suggests that the RBA is still ahead of that curve. Governor Stevens has also mentioned that rates are ‘appropriate’ for the economic outlook. Investors remain better buyers on dips, planning an assault on parity again (0.9897).

Crude is lower in the O/N session ($87.54 -74c). Crude prices have fluctuated after the FOMC statement and ahead of today’s weekly inventory report that is expected to reveal another drawdown on stocks. The black-stuff had garnered support from reports over last weekend revealing that China’s refiners increased their processing rate last month. The world’s biggest energy consumer boosted their net imports of the black stuff by +26%, m/m, and increased their processing rates to ease a diesel shortage. Coupled with OPEC announcement to maintain their production quotas and the PBOC refraining from tightening monetary policy is supporting the market, probably to the year end at least. OPEC believes that supply and demand are ‘in balance,’ and expect demand growth will slow as the global economy struggles to recover, amid ample supplies. Recent prices have already been elevated on the back of last week’s large fundamental drawdown of inventories and not on the strength of the dollar. The EIA inventory crude headline fell -3.82m barrels to +355.9m. Supplies were forecasted to drop by -1.4m barrels. Technically, the rise in these categories confirms there is nothing wrong with supply, but the demand picture in the US is not that robust. This is certainly in contrast to the stronger fundamentals that are occurring in Asia. Technically, expect the market to meet resistance again at the $90 high printed earlier this month.

Gold prices have found support from China refraining to hike interest rates over the weekend. The muted response to the PBOC decision to raise banks reserve requirements to +18.5% gave investors the green light to strap on some risk. Market fears that China would tighten monetary policy had eroded the demand for precious metals for most of this month. Bottom feeders have managed to stem the slide, believing that the $60 fall from its highs last week was a good opportunity to own a store of value as an alternative investment. It was only natural to see some profit taking after gold surged to a new record ($1,432.50). The commodity remains supported by the persistent concern over Euro debt levels. To date, debt contagion has driven investors into the third ‘reservable’ currency as they seek a store of value. Despite the fear that China will tighten their monetary policy, most likely in the New-year, a move to curb speculation and dampen inflation, global demand remains robust. Even though the one direction trade feels overdone, investors continue to hold gold as a hedge against currency debasement and long-term inflation. The Euro-zone backdrop is trying to put a floor on metal prices on demand for a haven. Year-to-date, the metal is up + 27.5% and is poised to record its 10th consecutive annual gain ($1,393 -$11.10c). Technical analysts believe that gold will outshine other precious metal in 2011 and peak somewhere above $1,600 in 2012.

The Nikkei closed at 10,309 down-7. The DAX index in Europe was at 6,985 down-42; the FTSE (UK) currently is 5,874 down-17. The early call for the open of key US indices is lower. The US 10-year backed up 18bp yesterday (3.47%) and eased 6bp in the O/N session (3.41%). Treasury prices plunged, pushing yields up to June levels on the back of a retail sales print aggressively beating all market expectations, partly on unconfirmed rumors that China was selling treasuries and with the Fed staying the course and maintaining a $600b program of debt purchases. Fundamentally, the market is benefiting from a drop in risk aversion and an improvement in the economic outlook. With no Government supply coming down the pipe for a couple of weeks, one would expect some support for yields at these levels. Fear of a Spanish downgrade is providing the early support for bonds this morning.

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