QE and free money the final solution

Everything is to be bought because of free money. The disclaimer of course is the ‘global reserve currency’ the once mighty dollar. With free money in Japan, free money in the US, every asset class is to be loved. The object of Governments is to turn the consumer psyche, get them spending again, promote growth. A double-dip scenario is probably further off, but stagnant growth and higher unemployment is here. Free money and low yields gives us higher equity prices to instill some market confidence. The object is to get cash laden companies to open their coffers, invest, hire get the growth ball rolling. QE is the final solution. BOJ is ahead of the curve on their QE announcement. The Fed, probably no commitment until after the mid-term election. Until then, lets embrace the pending currency war debates that are appearing on the horizon.

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 somewhat ‘subdued’ trading range.

The pace of expansion of the US service sector accelerated yesterday (53.2 vs. 51.5), and encouragingly reversed the weak readings posted in Aug. The ISM non-manufacturing print confirms that the services sector will remain a positive contributor to US GDP growth. Digging deeper, 50% of the sub-components posted gains. This week, emphasis is on the job market. The service sector jobs have been growing steadily thus far this year, unlike the ISM service jobs category, which until now remained in the red. Last month’s subindex reading climbed to break even at 50.2. The new-service sector orders climbed into expansion territory, a month after softening. It’s worth noting that all gains in orders seem to be coming from the export side and from a side that’s not seasonally adjusted. The prices paid component continues to rise at a steady clip over the last two months. The previous months softening can be attributed to commodity prices. Inventories happened to record the biggest correction (47 vs. 53.5), followed by a further deceleration in the pace of business activity and the backlog of orders. Finally, the composite ISM gauge (adding the manufacturing and service readings into one) registered 53.3 last month vs. 52.1. This is the 10th-consecutive month of growth Sate side. What will this do to the double-dip talk of late?

The USD$ is lower against the EUR +0.13%, GBP +0.13%, CHF +0.05% and JPY +0.19%. The commodity currencies are stronger, CAD +0.32% and AUD +0.56%. A combination of increased risk appetite, a weak dollar, stronger global bourses and rising commodity prices has managed to guide the loonie to new two-month highs vs. its southern partner. Year-to-date, the currency is up +3.3% vs. the dollar as demand for Canadian raw materials recovers. With the markets in ‘risk-seeking mode’, oil straddling $83 and gold registering new record highs daily has put upward pressure on the loonie again. The economic highlight for the remainder of this week will be the jobs report on Friday. Analysts believe the risk is towards a stronger report, which would provide further support for the market to own the CAD on USD rallies. For most of last month the market had begun questioning the ‘true’ strength of the Canadian Economy after the last few data releases came in much softer than expected. As of this week analysts are predicting slower inflation and a ‘more gradual pace of BOC lending rate increases than they did a month ago’. That been said, interest rate differentials is not the primary reason for wanting to own the currency. The ongoing threat of QE2 continues to gives all major currencies a leg up on the ‘historical reserve currency’.

The RBA’s dovish approach to policy by leaving its interest rate unchanged for the fifth consecutive month earlier this week only temporarily affected the value of the currency. The AUD has reclaimed all of its losses and then some since the surprise announcement from Governor Stevens. It was widely anticipated that they would hike. The AUD is trading near its two-year high vs. the dollar as gains in stocks and commodities boosted demand for growth-sensitive currencies. The currency has gained ground against all of its major trading partners as the ‘vix index’ of volatility softened, boosting investor appetite for assets tied to growth. ‘Clearly what happens in the Australian economy is now more dependent upon what happens in China’. Investors are better buyers on deeper pullbacks as the interest rate differential continues to be of appeal for alternative investments (0.9773).

Crude is a tad higher in the O/N session ($83.02 +20c). Oil printed a two-month high yesterday on speculation that steps by Cbanks to promote economic growth will boost the demand for the black-stuff. The market is also anticipating that this morning’s weekly inventory report will reveal that ‘fuel supplies are shrinking’. Even the demise of the dollar is aiding commodity prices and technically is expected to do so further in the short term. Recent data is convincing investors that the world’s largest consumer of crude may just be turning that economic corner. Last week’s surprise inventory report temporarily convinced the market that perhaps US demand for the commodity may be faltering. Crude supplies rose +970k barrels to +358.3m. The market had been expecting a shortfall of -1.75m barrels. Stocks of gas and distillates (heating oil and diesel) also increased unexpectedly. Gas inventories rose by +1.6m barrels, while distillates rose by +300k barrels. Until the report, higher inventory supplies had been the biggest inhibitor for a market advance over the past quarter as stockpiles of oil have recorded the highest levels in 27-years. The market remains wary that the underlying fundamentals have not changed, but the dollar value continues to support the commodity.

Despite everything, Gold is a commodity in demand even at record highs. Wealthy private investors are even buying it by the ton. There is no confidence in currency prices and with free money it’s making the commodity very attractive. For the twelfth consecutive session the yellow metal has managed to print a record high. Aiding the crowded, one directional trade, has been the collapse of the dollar vs. its major trading partners. Any time that governments are in the business of printing money then the commodity is bound to do well. Gold has outperformed global equities and treasuries, prompting record investment in gold-backed exchange-traded products. Over the past two months the yellow metal has managed to climb +11.3%. A concern about the strength of the dollar coupled with the sustainable growth issues of the US economy has investors seeking protection in an asset with a ‘store of value’. With the Fed on the verge of implementing further QE programs ‘tend to be supportive of asset prices and is fueling concerns about the potential longer-term inflationary affect of such measures’. The opportunity costs of holding gold are low due to falling interest rates, by default, the market should expect better buying of the metal on pull backs ($1,347 +$7.30c).

The Nikkei closed at 9,691 up +172. The DAX index in Europe was at 6,283 up +68; the FTSE (UK) currently is 5,690 +55. The early call for the open of key US indices is higher. The US 10-year eased 5bp yesterday (2.46%) and is little changed in the O/N session. Longer-term debt is the winner on the US curve, leading advances, as traders speculate that the Fed will increase their purchases of debt. Bernanke said earlier this week that the ‘first so-called quantitative-easing round has improved the economy and more purchases would ease financial conditions’. QE2 fundamentally will keep yields low. Yesterday’s ISM data is not strong enough to dissuade investors from thinking that QE2 is not coming. The US yield curve stands at +205bp and remains better bid on pull backs.

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