Trichet’s Yada Yada to hurt the EURO

Most of the EUR’s gain this week has come on the back of investors believing that the recent hawkish comments from Trichet warrant a Euro-zone rate hike sooner rather than later. The ECB is expected to keep rates on hold this morning. It’s the tone of their communiqué that the market is focusing on, specifically after the firm January CPI. With only three weeks having passed since their last decision, it seems unlikely that ECB President Trichet will send a substantially new message. Expect to hear that inflation risks are balanced and could shift to the upside which would require careful monitoring. An unchanged message will help curb Euro’s upside momentum especially after another weak Euro-zone sales number. However, risk may get a boost from US weekly claims and non-manufacturing PMI.

The US$ is mixed the O/N trading session. Currently, it is higher against 11 of the 16 most actively traded currencies in a ‘subdued’ O/N session.

Yesterday we got the first of this week’s US job indicators. Even though recent ADP prints have done a lousy job in predicting NFP, yesterday’s headline beat all analyst’s estimates again (+187k vs. +148k). However, there are strings attached, the previous month was negatively revised down by-50k to +247k. The reports lack of consistency is unlikely to alter many forecasts for tomorrow print (+140k). Last month’s NFP was grossly overestimated, close to +200k. The blame was attributed to an end-of-year quirk in the ADP’s methodology. Digging deeper, manufacturing happened to contribute +19k of the gain, the goods-producing sector +21k, while the bulk of the increase came from the service industry (+166k). The only negative print and not a surprise due to the US housing sector woes came from the construction sector, shedding-1k. This morning’s weekly claims and the employment index in non-manufacturing PMI may sway NFP estimates.

The USD$ is higher against the EUR -0.22% and CHF -0.33% and lower against GBP +0.40% and JPY +0.40%. The commodity currencies are stronger this morning, CAD +0.09% and AUD +0.34%. The loonie managed to print a two week high yesterday, outperforming other commodity-exporting countries, after oil traded near its two-year high. Once the commodity rally was able to take its foot off the gas, the CAD pared some of its gains. Anything that indicates that US growth is strong, like the surprising ADP numbers, tends to positive for the Canadian growth outlook and that’s because of the country’s proximity and close trading ties with its largest neighbor. Earlier this week Finance Minister Flaherty indicated that Canada will have a ‘challenge’ with jobless numbers. Canadian employment numbers are out tomorrow. The market expects the Canadian economy to add another +15k jobs after December’s stellar +34k release. Concerns about the over valued Canadian dollar, according to Governor Carney, waning government capital spending, a cooling housing market, and moderating retail sales will eventually combine to limit overall GDP growth this year. These are all stellar reasons for BOC to be concerned, as a ‘persistent strength in the currency is a threat to economic expansion’. With strong risk appetite in vogue, the loonie has cautious buyers on dollar rallies as we head towards the IVY and jobs report (0.9871).

Down-under, building approvals surged +8.7% in December, above the consensus expectation of +1.3% and reversed the + 3.9% drop in November. The market now believes that the earlier tightening by the RBA might be causing less pain in the housing market. Futures traders are betting that the RBA will begin tightening later this year, driven by earlier moves in the US and less severe effects of cyclone ‘Yasi’ than had been feared. The cyclone will probably further dent March quarter GDP following the floods in January. Some geopolitical reduced risk sentiment has pared the AUD advance, after trading near its one month high against the greenback as stocks and commodity prices rose amid signs the global economy is picking up, increasing demand for higher-yielding assets. Through parity is a surprise with a backdrop of a flood disaster, Chinese rate hikes and a toppy equity market. However, there is a risk-on mood spreading across the markets on the back of the improving global economy. This week’s RBA rhetoric was both dovish and hawkish, something with a twist, depending on what way you want to look at it. Governor Stevens left the overnight cash rate target at 4.75% and said that policy makers will ‘look through’ the near-term affect growth and prices of flooding across the nation’s east coast will have. Stevens stated that ‘flood reconstruction doesn’t pose much inflation risk and called the global economic outlook strong for this year. He went on to say that ‘net additional demand from rebuilding is unlikely to have a major affect on the medium-term outlook for inflation’. The RBA ‘expects that inflation over the year ahead will continue to be consistent with its 2% to 3% target range’. It’s difficult to sell AUD on the back of the statement as it removes any chance whatsoever of a rate cut. The market looks for better levels to own the currency as investors look towards the ‘carry trade’ (1.0136).

Crude is higher in the O/N session ($91.49 +63c). The crude rally temporally spiked to a 27-month high yesterday, as Middle-East event risk dominates trading desks. The market worries about the surety of supplies from the region. Middle-East supplies so far have not been disrupted by protests in Egypt. The market should realize that the Suez, even it were blocked for a some time, would only disrupt transportation routes and have little impact on overall supply. However, geopolitical risk premium continues to be priced in. Last weeks EIA report revealed another build up in inventory. Crude stocks grew by +2.6m barrels to +343.2m barrels, which are +4.3% above year-ago levels. The market had expected oil stocks to grow by +3m barrels. Gas was the big surprise, growing by +6.2m barrels, or +2.7%, to +236.2m barrels. That was +3.6% above year-ago levels. The four-week gas demand was +0.6% higher than last year, averaging nearly +8.7m barrels a day. Refineries ran at +84.5% of total capacity, a rise of +2.7%. Finally, distillate inventories (diesel and heating oil) fell by -1.6m barrels to +164.1m. Despite OPEC believing that supply and demand is ‘in balance’, the unknown factor, Egypt will continue to provide support on pullbacks. The country is a significant oil producer and a rapidly growing natural-gas producer with approximately +6% of global daily oil production running through the region. However, fundamentally there is far more oil in storage, more fuel capacity and more idle oil wells to limit a much stronger market rally. It’s fear that generally exaggerates the price.

If it is not supported by geopolitical risk premium, then gold, with the way it has been underperforming of late, has little support fundamentally and technically. For most of this month gold has suffered, down -6.7%, on lackluster physical buying as the commodities appeal deteriorates and on hedge fund liquidation triggering vulnerable support levels. Before tensions in the Middle East, investors had been shying away from the commodity and sought ‘price appreciation’ in equities. Fundamentally, the bulls are trapped in this month’s price action with the trend turning rather badly against them. Expect the weak longs to sell on up ticks. Natural physical buying has been less than modest with the commodity off to its worst start in 14-years. Has the gold peaked or is simply a short-term correction? Gold prices have depreciated just over $100 from its December highs. With the Euro-zone being able to sell their bonds, there’s less of a flight to quality, which could cause this asset class to be staring at a sub $1,300 a once soon. The market remains a seller on rallies despite what’s happening in the Middle-East ($1,329 -$2.30).

The Nikkei closed at 10,431 down-26. The DAX index in Europe was at 7,190 up+7; the FTSE (UK) currently is 5,979 down-21. The early call for the open of key US indices is higher. The US 10-year backed up 6bp yesterday (3.48%) and is little changed in the O/N session. A stronger US ADP report had the FI market pare some of its early morning gains to eventually give some of that back on a Murbarak backlash as he attempted to regain control of Cairo’s streets. There is an appetite to own FI on pullbacks as unrest in Egypt ‘is the sort of event risk that is difficult to hedge, so many will prefer to be better safe than sorry’. What will the curve look like if we happen to get payroll growth this Friday? The Fed stance on ultra low rates is expected to provide strong resistance for the 10’s at 3.50%. Investors continue to demand compensation for the prospect of accelerating inflation and on speculation the US may struggle to fund its deficit. The Fed’s pledge to its asset buyback program will support speculation that any additional rise in yields will be gradual.

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