Trichet ‘Stand and Deliver’

The market prepares for a sharp hawkish turn from the ECB. Trichet better ‘stand and deliver‘ or mayhem will occur. The hawks are expecting to embrace a communique that will provide bullish implications for the EUR. Recent rhetoric from Wellink, Mersch, Bini Smaghi, and Costancio have surprised markets with hawkish commentary. Why stop now? Their deliver was a coordinated communication policy to prepare us for this mornings shift in language. The bears are hoping not. A shift in inflation risk could push forward the ECB’s first rate hike to June? The key to defining Trichet and Co.’s policy stance will be whether the 2012 inflation forecast is revised. Despite the market pricing rates above +1% near term, peripheral financing remains the Euro-regions ‘black-hole’. Any tightening bias will only add stress to EFSF talks later this month.

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

Investors know not to draw too many conclusions from yesterdays ADP data regarding tomorrows NFP report. However, it does provide us with clues. Private payrolls rose +217k last month, up from a revised +189k. In truth, the report has been rather volatile relative to payrolls over the past few months and is unlikely to alter greatly analyst’s forecasts for tomorrows print. It’s worth noting that ADP overestimated the initial private payrolls by +184k in December and +137k in January, strong proof that the report is not particularly useful in forecasting NFP. Digging deeper, manufacturing payrolls were seen rising at about trend (+20k), while service payroll rose aggressively (+202k), while the construction sector provided the negative (-9k).

The Fed’s Beige Book suggests that overall ‘economic activity continued to expand at a modest to moderate pace in January and early February’ and that price pressures are increasing. Nearly all the districts recorded ‘solid’ growth in manufacturing and retail sales increased in all districts. For prices and labour, the Fed districts reported that manufactures and retailers are starting to pass on rising input costs and planned to continue to do so in the future.

The USD$ is higher against the EUR -0.04%, GBP -0.30% and CHF -0.24% and lower against JPY +0.05%. The commodity currencies are weaker this morning, CAD -0.05% and AUD -0.11%. As expected, the BoC held rates steady earlier this week at +1%. The danger was that Governor Carney would try to talk down the currency’s rise. In their communiqué, the BoC expressed its concern about the strength of the loonie ‘the export sector continues to face considerable challenges from the effects of the persistent strength in the Canadian dollar and Canada’s poor relative productivity performance’. The new reality is a Canadian dollar at or close to parity as the economy adjusts to this paradigm. Without commodity prices aggressively rising again yesterday the CAD would have probably underperformed. The market has preferred been long this currency for both risk averse and commodity supporting reasons. However, Governor Carney is in no rush to raise interest rates, stressing as before that ‘any further reduction in monetary policy stimulus would need to be considered carefully’. If the Bank really was contemplating an early rate hike, would we not expect the forward looking guidance to be altered? (0.9732)

The AUD fell from a two-month high outright after reports last night showed home-building approvals slumping in January (-15.9%) and exports declining (-4%). The announcement also narrowed US/Aussie spreads. However, Australian fundamentals continue to support a higher policy rate environment, and a currency appreciating medium term. Analysts note that the Australian economy finished last year with ‘strong’ momentum and despite severe flooding affecting first quarter 2011 GDP growth, futures dealers anticipate a solid uplift in growth for the first half of the year. The RBA, this week, has noted that mildly restrictive rates are appropriate. The futures market is pricing in further modest tightening starting in third quarter as the data strengthens and the threat to inflation rises along with commodity prices and higher wage growth. Commodity prices continue to provide support on pull backs. Next question, is this growth sustainable in a higher oil price environment? Expect the RBNZ actions to weigh on Governor Stevens monetary policy thinking.

Crude is lower in the O/N session ($101.92 -31c). Crude prices remain elevated on Middle-East geopolitical concerns and this despite the Saudis offering to make up for supplies lost. Contagion fears continue to price in a substantial risk premium. Oil has surpassed its 30-month high of last week on concerns of further supply disruptions. ‘While there’s a risk of contagion, of this spreading to Iran or Saudi Arabia, the market is going to see prices elevated from these levels’. The IEA’s chief economist said that ‘higher oil prices pose a danger for a global economic recovery’. Last week’s EIA report again has provided some support for the US crude market on pull backs. The report showed a smaller-than-expected increase in supplies. Crude inventories fell by-364k barrels to +346.4m vs. an expected increase of +750k. Even worse was the gas inventory headline declining, stocks plummeted -3.59m barrels to +234.7m, greatly exceeding market expectations for a-400k draw. Inventories at Cushing rose by +1.13m barrels to a record +38.57m. This rise is partly responsible for the wide discount of WTI to Brent crude in recent weeks. Distillate stocks (heating oil and gas) fell-751k barrels to +159.1m, less than analyst expectations for a decline of -1.2m barrels. Refinery utilization rose +1.5% to 80.9% of capacity. The Oil market is beginning to show signs of ‘demand destruction’ as high prices erode consumption. With supply the number one concern, the commodity will remain bid because of the contagion concerns.

Like most commodities, gold is heading for its longest rally in six-months, as mounting tensions in North Africa and the Middle East boost demand for a ‘safe haven’. Last week the commodity was up +1% and is on course to replicate that appreciation. The yellow metal continues to be supported by geopolitical factors and inflation threats. Prices have risen nearly +7% this month, as protests in favor of democratic reform in North Africa turned bloody. Investors have grown increasingly uneasy that the crisis could spread. Even hawkish global rhetoric has managed to give the yellow metal a leg up in February. Consumer prices are also boosting the demand for the precious metal as a hedge against global inflation. Last week, the market witnessed Chinese’s inflation accelerating the most in six years, and UK consumer prices the most in two years. Even US data is showing that their inflation numbers are edging higher. This week’s European PPI accelerated more than forecasted in January. China is supporting the commodity’s outright, purchases in the country climbed to 200 metric-tons in the first two months of this year. With the commodity being used as a store of value the asset class is expected to remain better bid on any pullbacks ($1,432 -$5.60c).

The Nikkei closed at 10,586 up+94. The DAX index in Europe was at 7,214 up+34; the FTSE (UK) currently is 5,950 up+36. The early call for the open of key US indices is higher. The US 10-year backed up 2bp yesterday (3.46%) and is little changed in the O/N session. Geopolitical pressures continue to support treasuries despite the uptick in global inflation numbers and better than expected US private payroll numbers yesterday. Treasuries prices were little changed, paring some their initial losses as crude prices rose amid turmoil in the Middle-East. Higher prices continues to fuel concerns about curtailing global economic growth. US yields are in danger of being too low to sustain demand for US debt as the Fed approaches the end of its second round of QE. Yesterday, Bernanke did not rule out expanding their asset buying aimed at stimulating the economy, saying he ‘does not want to see the economy relapse into recession’. Event risk remains the order of the day despite more encouraging global economic data.

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