Reasons for the upsurge in Risk Appetite

Risk appetite has been quick to rebound, hot on the heels of rising global equities, buoyed by stronger earnings and Euro data. A number of reasons have emerged in the O/N session that is fueling this appetite.

First, the charge is being led by the antipodeans, mostly on the back of an article that suggests that the Aussie government is considering tax breaks on foreign sovereign investments in Australia, mind you the highest G10 yields also look appealing.

Second, Finnish Prime Minister said that an EFSF package for Portugal is necessary and that Finland should not ‘create problems but help solve them’, however, the program may require some changes to secure approval. In translation, Finland will not be responsible for the failure of the EU providing assistance to Portugal.

Finally, a strong Iberian bond sale, despite higher rates, should help reinforce the perception that Spain is decoupling from the weaker peripheral economies, and lower Euro-zone systemic risk.

Optically, all the reason are just, fundamentally, global economies have a ways to go to sustain this somewhat euphoric nature.

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 ‘whippy’ session.

US data yesterday continues to highlight the housing woes that the construction industry faces. March’s headline housing starts (+7.2% or 0.55m) bounced back from February’s very low levels (-18.5%), but the details suggests the US housing sector remains very weak. Building permits, a gauge of future construction, climbed +11.2%, m/m, to an annual rate of +594k. However, year-over-year, overall new home construction was down -13.4%. The housing market has continued to struggle even as other categories of the US economy begin to improve.

Construction has slowed due to weak demand and potential buyers having trouble getting credit. With falling house prices, investors prefer to choose foreclosed properties and other previously owned homes rather than the more expensive new homes.

The USD is lower against the EUR +1.06%, GBP +0.22%, CHF +0.75% and higher against JPY -0.20%. The commodity currencies are stronger this morning, CAD +0.40% and AUD +1.19%.

Canadian inflation data yesterday beat all analysts expectations, even the BoC’s target set out just last week in its monetary policy report, marking the biggest monthly headline gain in 20-years (+1.1% vs. +0.3%) and the largest annual advance in nearly three-years (+3.3%). This after one week when the BoC Governor dampened expectations of a rate hike with a dovish slant on the currency’s value (+4% outright gain this year) creating ‘headwinds’. The core also advanced to +0.7% vs. +0.2%, m/m, and up +1.7%, y/y.

How much of a dampener is the loonie really having on prices? Governor Carney gets to see one more CPI ahead of the May meeting and its then we will get to see if yesterday’s release was a ‘one-off’ print. It may be too soon for policy makers to shift monetary policy by that meeting. The Governor will point to ‘extenuating outside risks’ and we should expect him to remain ‘extraordinarily cautious’.

Other data released showed that Canadian leading index rose faster than expected last month (+0.8% vs. +0.5%), it’s sixth consecutive gain, led by increases in the stock market (+2.2%) and housing index (+2.2%).

After the reports the loonie has advanced to its 2007 year highs outright, and has technically run into resistance profit taking ahead of 0.9500 option protected level. Investors are expected to covet the loonie as an alternative to the EUR and the dollar on pull backs (0.9522).

The AUD rose to a record in the O/N session after stronger European data is adding to signs that the global recovery is gathering momentum. On the domestic data front, antipodeans witnessed a stronger terms of trade, where export prices rose +5.2%, q/q, in the first quarter, while import prices rose +1.4%, q/q. Analysts note that these gains largely reversed falls in fourth quarter and pushed up Australia’s terms of trade to close to their 2008 and 2010 highs. This will give the RBA food for thought and another reason to raise interest rates (+4.75%).

The RBA seem comfortable with interest rates at the moment, as highlighted in the released minutes this week. The Governor viewed his policy setting as appropriate, saying they will ‘look through’ higher inflation and slower growth stemming from natural disasters. ‘Headline inflation was likely to be quite high in the March quarter, while GDP would be held down, to a greater extent than earlier assumed’. It’s expected that the RBA will want to see more data that’s not so distorted by weather, which may take some time to come through, before moving on rates again.

Australian yields are still the highest in the G10 and do look attractive. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on any pullbacks (1.0655).

Crude is higher in the O/N session ($109.75 +$1.47c). Oil prices remain supported despite concerns that price close to three-year highs is pressuring the global economy and may cause fuel demand to falter. Saudi Arabia stated that because of weak demand had forced it to reduce its crude output. Saudi’s Oil Minister al-Naimi said that the global ‘market is oversupplied’ with crude, forcing them to cut output last month by more than +800k barrels a day. OPEC said the group is unlikely to alter output targets when it meets in June as there is ‘no shortage of oil anywhere in the world’ even after supply curtailments in Libya.

Last week the IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth based on its preliminary data for January and February. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy. Even Goldman is recommending to investors to take profit on the one directional commodity trades. Market remains a better seller on rallies.

Gold has raced to another record, breaking the psychological $1,500 mark, on speculation that the sovereign-debt crisis in Europe will worsen and after S&P revised its US credit outlook to negative. Investors are looking to gold as the ultimate currency. Fundamentally, prices are supported on speculation that record-low interest rates will encourage demand for an inflation hedge amid expectations that the Fed will maintain its accommodative monetary policy in the medium term. Gold, as a non-yielding asset, has a higher opportunity cost when interest rates rise.

The precious metal has become the currency of choice despite Goldman recommending last week that if one owned commodities, the risks outweigh any further potential gain. The metal has jumped +29% in the past year.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store-of-value ($1,504 +$9.40c).

The Nikkei closed at 9,606 up +165. The DAX index in Europe was at 7,178 up+139; the FTSE (UK) currently is 6,004 up+107. The early call for the open of key US indices is higher. The US 10-year eased 2bp yesterday (3.38%) and is little changed in the O/N session.

The benchmark ten-year note yield was little changed yesterday, hovering close to their three-week lows, as European periphery debt issues trumped a cut in the US credit rating outlook by S&P earlier this week.

There are a few other factors tentatively supporting the FI market, first, the gain in US housing starts (+7.2%) failing to make up for ground lost the previous month (-18.2) had investors buying on dips, second, the Japanese finance minister, despite the ratings cut, continues to see value in US securities and finally, the Fed’s is buying a total of $11.5b’s worth of US product this week, which will also weigh on yields.

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