Smelling PIIGs erase post QE2 gains

With QE and NFP event risk out of the way, the dollar has continued its follow-on profit taking and position reduction driven by rising Euro-zone peripheral sovereign yields this morning. Capital Markets have shifted their focus towards the ailing periphery PIIGs after three months of myopic trading pending QE2 announcement. Described as the ‘week from hell’, consensus has us believing that the change in US policy last week, ‘undermines the spirit of multilateral cooperation that G20 leaders have fought so hard to maintain during the current crisis’. Bernanke continues to defend his actions and is determined to focus on ‘at home objectives rather than overseas economies’. Expect currency and trade imbalances to dominate the G20 meeting in Korea this week. Bernanke has been doing the ‘dog and pony show’, trying to justify pending large-scale asset purchases and how they will boost economic growth through lower borrowing costs and higher stock prices. According to the Fed, inflation concerns are ‘overstated’. The rest of the world is worried about the impact of a covert devaluation of the dollar. Is this the beginning of currency protectionist rhetoric?

The US$ is stronger in the O/N trading session. Currently it is higher against 15 of the 16 most actively traded currencies in a ‘volatile’ trading range.

US Employment numbers blew all market expectations out of the water on Friday, the headline was stronger than expected and managed to recored the first positive monthly print in five months (+151k), even the monthly revisions were strong, however, the unemployment rate continues to hover near that psychological +10% rate. Aiding the dollar somewhat, was the European retail sales numbers softening and proof that Spain’s economy stagnated, additional proof that PIIGS are struggling to plug their budget gaps. What did we learn last week? First, the US economy is perhaps stronger than we have been giving it credit. Second, the Fed validated market expectations and that Friday’s surprisingly strong number may eventually reveal that the market improvement in the outlook has not been proportionately matched by positioning. The market still has room to acquire more risk taking, maybe. The Fed requires the equity market rally to continue, with free money and few asset classes to invest in, a higher equity market increases an individual’s wealth effect and hopefully promote spending, investing and boost confidence, leading to economic growth. Has the Fed’s actions persuaded investors to look again at equities as an asset class?

The USD$ is higher against the EUR -0.73%, GBP -0.35%, CHF -0.48% and lower against JPY +0.15%. The commodity currencies are weaker this morning, CAD -0.38% and AUD -0.47%. Canadian employment headline print on Friday disappointed analysts (+3k), even the unemployment rate falling a notch was not for the most positive of reasons (+7.9%). The Canadian economy has now fully recovered the number of jobs lost in the recession, however, employment growth has started to slow. With the domestic economic recovery losing momentum future growth will also be affected. The Canadian job market has averaged +6k per month over the last four months, as opposed to the first six-months, when job growth averaged +51k. The uneven profile for employment is occurring as economic growth has downshifted to something closer to trend or slightly below. The 4th Q hours worked recorded a modest gain (+0.2%, m/m, +1.3%, q/q annualized) and less than in 3rd Q (+1.6%, q/q annualized), signaling a slower profile for 4th Q GDP growth. The unemployment rate has fallen for the wrong reason, the decline can be attributed to the drop in the labor force (-4k). Despite this, the loonie happened to trade through parity on Friday and continues to underperformed against all of its major trading partners even as commodity prices register new medium term highs. Weaker Canadian Ivey PMI data last week (56.7 vs. 65.8) mixed with a bit of concern of Ben’s rhetoric of weakness of the US economy and Canada’s natural close ties will should have the loonie continuing to underperform its other G8 partners, short term.

The AUD has snapped its one week win streak on speculation that European nations’ efforts to cut spending will crimp economic growth and sap demand for higher-yielding assets, like the Aussie. The AUD has been this quarter’s best-performing major currency vs. its US counterpart. Interest rate differentials have been a big plus for the currency. Governor Stevens is expected to increase interest rates further even as the US and Japan leave borrowing costs near zero. Policy makers at the RBA said that economic growth will accelerate next year and ‘the Aussie’s advance will help slow inflation’. With the Australian economy continuing to grow ‘at or above trend and inflation remaining in the upper part of the band’ provides support for further monetary-policy tightening from the RBA. The currency trades at a strong premium to its US counterpart after Bernanke’s QE2 announcement. The interest rate differential and the issue of dollar liquidation favor commodity growth sensitive currencies. Australasian bourses and commodity prices in the black will favor the AUD over the longer term. The currency remains in demand on pull backs as the carry look attractive to investors (1.0110).

Crude is lower in the O/N session ($86.27 -58c). Oil on Friday surged to its highest level in two years as last months NFP convincingly beat market expectations, proof that the US economy is recovering, while the dollar recorded another weekly decline vs. its G20 allies. A positive employment report tends to be good news for the market situation. More jobs leads to increased gas demand and refinery boosting runs. The black-stuff also received support after last week’s EIA report showed that fuel supplies plummeted when refineries reduced operating rates to the lowest level in seven-months. Crude stocks rose +1.95m barrels to +368.2m vs. an expected +1.5m barrel climb. Offsetting all of these gains was the gas inventories headline print. It fell -2.69m barrels to +212.3m, the lowest level in twelvemonths. Providing a leg up was the refineries operating at +81.8% capacity last week, the weakest print in seven-months causing the crack spread (crude into oil) falling -46% in that period. Technically, the decline in stocks is primarily due to the low production numbers been witnessed. Gas stockpiles were expected to be little changed from the previous report. Distillate supplies (heating oil and diesel) decreased -3.57m to +164.9m, providing the biggest drop in over two-years. Currently. OPEC is happy with prices between $70 and $85, although an increase to $90 would not impede economic growth. Technical analysts believe on an RSI basis that the commodities price is trading close to easing. The market remains wary that the underlying fundamentals have not changed. The ‘big’ dollars value continues to push the price about.

Gold rallied to a new record on Friday, after posting the largest one-day move in twenty-months on the back of the Fed buying more debt announcement last week. Covertly, policy makers are trying to drive the greenback lower, which by default would boost the demand for precious metals as alternative investment. After Friday’s surprising NFP report, the dollar caught a break on the ‘bashing front’, despite this, commodities remained better bid, temporarily side stepping the strong inverse relationship between the two. The commodity has posted seventeen record highs in little more than five weeks in Sept and Oct. Last week, it managed to rise more than +2.9% on the week. The metal should remain in demand on speculation that steps to support growth through QE and low interest rates will boost demand for the commodity as an alternative to some currencies, the store of value theme. Any pullbacks will continued to be bought. For most of this year speculators have sought an alternative investment strategy to the historical reserve currency and have been using the commodity as a proxy for a ‘third reservable currency’, hence the reason for the record highs. The debasing fears of the dollar should have investors seeking protection in an asset with a ‘store of value’ ($1,391 -$6.40).

The Nikkei closed at 9,732 up +107. The DAX index in Europe was at 6,745 down -8; the FTSE (UK) currently is 5,865 -10. The early call for the open of key US indices is lower. The US 10-years backed up 4bp on Friday (2.53%) and are little changed in the O/N session. The FI asset class has been in a spin after the FOMC actions last week. The front end of the yield curve recorded record low yields after the Fed said it would buy an additional $600b of US debt to keep borrowing costs low and sustain the economic recovery. The tail backed up after Bernanke said they would buy fewer longer-term securities than many had anticipated. Not helping the longer maturities is the pending $72b note and bond auctions this week. From here on in the market will be talking about specific areas of the curve now that the Fed has extended its bond buying program. It will be interesting to see how much dealers are willing to charge.

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