The ‘Buck’ get’s a get out of jail card!

Moody’s ‘might’ increase Brazil’s credit rating managed to force Capital markets to do an about-turn yesterday. Equities pared losses and the ‘buck’ gave up ground, all temporarily of course. Leaving the G8 reserve currency debate aside, there are strong reasons why the market will see a stronger USD over the coming weeks. First, European bond maturities, and lots of them, EUR 31.5b’s worth should cap the currency in the medium term. Secondly, the IMM contract positions say so. There has been a net rise in USD short positions. Apparently the largest in over a year and you know futures traders they expect to be squeezed out! Thirdly, commodities look sick, no fundamental support for them and by default a higher USD. Market mentality has been to sell the EUR and we will see you down there!

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’ O/N session.

Yesterday we witnessed the June ISM-non manufacturing index inch even closer to its break-even point (47 vs. 44). The service sector continues to shrink but at a slower pace as foreign demand is starting to expand. The index is now at its highest level since Sept. 2008. Digging deeper, foreign orders is pushing into expansion territory which was behind most of the service strength. Business activity rose to 49.8, with new orders, employment, new export orders and imports all improving, but, they do continue to contract. Interestingly, the prices paid component moved above 50 and most analysts expect that inflation will remain benign for the remainder of the year.

The USD$ currently is higher against the EUR -0.38%, GBP -0.57%, CHF -0.45% and lower against JPY +0.15%. The commodity currencies are weaker this morning, CAD -0.22% and AUD -0.18%. The loonie has faltered, in line with most of the other trading partners of the US. The commodity based currency continues to feel pressurized as commodity prices tumble, especially oil, which has lost close to -15% since last week. Expect investor’s to continue to trim bets on riskier assets and carry trades on signs that a global economic recovery may take much longer than originally anticipated. This is a data laden week for the currency ending with the employment report on Friday. Technically, after printing a 7-week low it has opened up for it to test back towards the 1.1800 handle. Expect the currency to be sold on a USD pull back in the short term as global sentiment seeks that a ‘safer heaven’ currency.

The AUD lost ground again in the O/N session for various reasons. Firstly, with global equities retreating, it has dampened the demand for higher yielding assets as investors become risk averse in their trading. Secondly, the RBA as expected kept it O/N lending rate on hold at 3%, but indicated that the inflation outlook allowed room for an interest-rate cut (0.7957).

Crude is lower in the O/N session ($63.79 down -23c). Crude fell to a new 5-week low yesterday on the back of plummeting global equities and on concerns that that the global economic recovery will falter, providing support for further ‘demand destruction’. It was the 5th-consecutive day of declines as the greenback remained firm vs. the EUR (longest losing streak in 9-months) and limiting investor’s appetite for commodities as a hedge against inflation. The commodity has retreated more than 14% from its recent highs just before the release of the US unemployment data last week. Prices had got ahead of fundamentals in a big way over the past few months, and recent movements seem to be filling in that gap. With ‘demand destruction’ come higher inventories and it’s speculated that this week’s inventory reports will further pressurize prices. Despite last week’s API showing the biggest decline in crude inventories in 9-months in the US, demand remains weak. The commodity had gained approximately +39% last quarter, the largest advance in 20-years as a rebounding world equity markets and a weaker dollar convinced investors to buy the ‘black stuff’ as an alternative investment. The second half of the year certainly has not started on the right foot, fundamental cracks remain persistent. The IEA lowered its 5-year forecasts for global crude demand because of the economic slump. They are cutting daily consumption levels by -3m bpd until 2013. Demand destruction remains commodities greatest nemesis and not volatile currency levels. Similar to other commodities, the ‘yellow metal’ faltered yesterday as the greenback rallied reducing demand for the commodity as a way to preserve ‘store of value’ ($922).

The Nikkei closed 9,647 down -33. The DAX index in Europe was at 4,652 up +1; the FTSE (UK) currently is 4,201 up +7. The early call for the open of key US indices is lower. The 10-year Treasury’s backed up 3bp yesterday (3.53%) and is little changed in the O/N session. The US yield curve managed to steepen yesterday (2’s -10’s spread-260) as the front end was coveted because of weakening equity market and US government buy-backs. The back end was sold to make way for more ‘product’ coming down the pipeline later this week. Expect supply to dominate the rest of the week. Will foreign Cbanks want more US product?

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