Panic in Capital Markets as Flu cannot be contained!

Europe seems to have too many wannabe ‘Chiefs’, who believe that they are a positive influence. Consensus has always been the ECB’s biggest problem. Already we have witnessed conflicting statements that sent the EUR plummeting yesterday. Trichet explained why lowering interest rates is not always the best path, especially given the complexity of the Euro-land. While Nowotny yesterday elaborated on the use of ‘unconventional’ steps which caused the EUR to violently gap lower. Next week we will get to see how opaque the organization has become! News that the Fed pushes Citi and BoA to increase capital are conflicting with earlier Geithner comments that all banks passed the stress test. This stress teat was a white wash exercise and not a paint job!

The US$ is stronger in the O/N trading session. Currently it is higher against 14 of the 16 most actively traded currencies, in a ‘whippy’ trading range.

Rumors and innuendos are rife and with little fundamental to go on. Newspaper reports comment on how the Fed pushing Citi and BOA to increase their capital base, this of course is opposite to Geithner’s public comments that all banks passed the stress test. Publically we won’t get to see until next week. However rumor (that’s all we have at this stage) has many of the banks being technically insolvent. Geithner suggestion of converting preferred stock to common would not require TARP drawdown, but dilute shareholders value and partially nationalize the institution as the Treasury holds the equity! To complicate matters the swine flu hysteria has reached new levels with the WHO increasing the pandemic alert level by one notch to 4. The market continues to wait for the US banks stress test results as well as the ECB meeting and the US employment data. But, it will be the potential death count from influenza that will captivate and heighten our fears!

The USD$ currently is stronger against the EUR -0.05%, GBP -0.66%, CHF -0.09% and weaker against JPY +0.97%. The commodity currencies are weaker this morning, CAD -0.22% and AUD -1.25%. The loonie was initially little changed in the morning session yesterday despite a stronger greenback impeding commodity prices and as GM increased the number of dealer shutdowns and job cuts (another +23k) in North America. Last week surprise by the BOC Carney’s no immediate quantitative easing or credit comments caught the market short CAD. Obviously the hangover was still being felt early morning. The market was caught flatfooted and still in their off-side positions. However, ECB comments about introducing potential quantitative methods immediately pressurized the EUR as investors sough the greenback thus putting the loonie under pressure. With commodities being sold you would expect better buying of USD on pull backs. Prior to yesterday, CAD had appreciated very quickly over the past week. Do not be surprised to see some profit taking occurring if fears that the swine flu may take a firmer grip on this global recession.

It comes as no surprise that the Mexican swine flu fears has once again pressurized the AUD for the 2nd-time in 4-trading sessions. The fear that the global economic recession will deepen has investors paring most of their recent riskier acquisitions and seeking some risk aversion trading strategies to benefit their portfolios. Lawrence Summers comments that US economy will shrink ‘for some time to come’, combined with the Japanese government lowering their output forecasts does not help the currency’s plight at the moment (0.7018). Investors continue to sell on upticks.

Crude is lower in the O/N session ($48.68 down -146c). Yesterday as feared, crude prices fell the most in over a week on the back of investor concerns that the US economy will keep shrinking and the swine-flu outbreak will ‘curtail’ air travel (airline stocks have since plummeted) and hence global demand. Lawrence Summers recent comments that the US economy will shrink ‘for some time to come’, combined with Algerian Oil Minister Khelil stating that non-OPEC members have left the market oversupplied by about +720k barrels a day should continue to pressurize black-stuff prices. The resurgence of the greenback as a safer heaven will continue to undermine commodities, especially now the market believes that ECB will ease again next month. Last weeks EIA inventory report was an ugly bearish headline for the black-stuff. The report showed that stocks rose +3.86m barrels to +370.6m (the highest level in 19-years) vs. an expected increase of +2.5m. It was a bearish report that revealed that supplies were up in every category. The 4-week total average fuel demand slipped -6.5%, y/y to +18.5m barrels. Gas stockpiles rose +802k to +217.3m vs. an expected decline of -700k barrels. Finally, the supply of distillate fuel (heating oil and diesel), climbed +2.68m barrels to +142.3m, the biggest increase since the 1st week of this year. Over the weekend, Secretary General for OPEC (they supply 40% of the world’s oil) el-Badri said that they will reduce oil production again if necessary to support prices. OPEC next meets on May 28th. So far the organization has had 83% compliance to its production cut quotas by its members. Not to be left out in the cold, Gold fell from its 3-week high as concerns about the flu epidemic helped push the greenback higher and by default commodities lower, thus paring demand for the ‘yellow metal’ as an alternative investment ($897).

The Nikkei closed 8,493 down -232. The DAX index in Europe was at 4,574 down -119; the FTSE (UK) currently is 4,089 down -77. The early call for the open of key US indices is lower. The 10-year Treasury’s eased4bp yesterday (2.91%) and is little changed in the O/N session. It’s all about ample supply vs. buy back’s that have dictated FI prices of late. Yesterday, the $7b+ of the Fed’s buy-back, off the run 2013-16 issues, had traders pricing the curve initially more expensive. But, this week the US treasury will sell another $101b of 2’s 5’s and 7’s. One can expect the market to cheapen the curve back towards last week high-yields. It’s like stealing candy from a baby to make money at the US governments expense! However the flight to quality remains strong.

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