USD$-Where to now?

Capital markets recovered some of their luster last week as investors found positives from both the housing and financial debacles. The greenback has remained stable as stern realistic rhetoric by both US Treasury Sec. Paulson and Fed Chair Bernanke has given the street something to hold on to.

The USD$ is weaker in the O/N trading session. Currently it is lower against 11 of the 16 most actively traded currencies in a ‘subdued’ trading range.

On Friday, with no US economic data to feed on, investors chewed on Citibank’s financials. The institution reported fewer losses than analysts had estimated and gave the street confidence to shed some of their risk aversion trades of late. Traders were happy to end last week with a light volume trading day after recent volatility. Expect durable goods and housing numbers this week to provide further evidence that the ongoing problems and credit issues remain well entrenched in recession levels. Stress in the financial markets and restriction in lending are going to make it more difficult for the US economy to grow. With Bernanke touting ‘stagflation’ and trying to balance interest rates (2%) the global economy is a long way from seeing light at the end of the tunnel. The big picture has not changed for the US economy, the greenback and rates. The question is how deep and how long will a recession last for? Will rapid inflation persist? When will a hiking cycle begin at the Fed? Hawkish sentiment prevails and the Fed cannot be perceived to be caught behind the curve again, or consumer confidence will have further adverse effects on capital markets.

There is positive evidence starting to build in favor for the USD$. After the more than $50b Anheuser-Busch purchase from European based InBev there is now an offer from Swiss based Roche to buy the rest of Genentech for $44b. Last weeks several hawkish Fed speakers have been joined this morning by the Fed’s Gary Stern, who indicated that the Fed should ‘not’ be waiting for housing and financial markets to stabilize before it begins raising interest rates and finally oil technically has reversed its uptrend, lower prices equates to a stronger buck. Only time will tell if these jigsaw pieces make a picture.

The US $ currently is weaker against the EUR +0.31%, CHF +0.28%, JPY +0.34% and stronger against GBP -0.22%. The commodity currencies are higher this morning, CAD +0.16% and AUD +0.32%. On Friday, Canadian whole sale trade came in much stronger than anticipated (+1.6% vs. +0.5%) and lifted the loonie against most of its major trading partners. The headline pop mostly reflected price effects, but even a +0.7% emphasizes that volume strength was impressive (ex-autos-the gain would have been +2.2% m/m). Last week’s fundamental data was supportive for the currency, month to date, it has appreciated +1.5% vs. it southern neighbor. Governor Carney gave an upbeat assessment of the economy and held rates steady at 3% last Tuesday. The economy has been holding its own despite its ‘proximity and association’ with the US. The only concern will be the decline of commodity prices. Being largely a resourced based exporting country, the decline will eventually put pressure on the loonie. Futures traders are beginning to price in a hike by year end; this may be too early, as uneasiness of financial institutions ongoing problems continue to be reported. For now, investors are looking for better levels to sell the currency.

The AUD$ rose to a new 10-month high (0.9762) vs. JPY, as investors speculated that the RBA will retain its interest-rate advantage (7.25%) over the US and Japan. With interest differentials to remain on hold for now, expect better buying on pull backs if risk aversion trades subside. Any commodity price increase can only add to the AUD$ advantage as it strides towards parity vs. the greenback.

Crude is higher O/N ($130.77 up +130c). Crude oil continued its weak bias after inventory data last week revealed that natural gas stock piles grew by 6% (+104bcf vs. +88bcf) and on signs slower global economic growth is curbing fuel consumption. The EIA report also showed that crude inventories jumped +2.95m barrels to 296.9m. The Bush administration lent a hand to the speed of the decline by agreeing to send some senior officials to hold nuclear talks with Iran. This has reduced the possibility of a Middle East conflict curbing oil production and distribution, hence the eroding of the insurance premium. Despite immediate positive feedback on Iran’s determined position, we still have two weeks for the ‘last official’ response from the country. With Bernanke saying that risks to US expansion and inflation have risen can only help crudes prices to soften even further. The market is starting to factor a ‘deeper recession’ taking a firm grip and by default unsettling future demand. Currently, traders are also eyeing a storm approaching the Gulf of Mexico. This will also provide some strength in the short term. Gold eased ($958) as global equities rallied on Friday discouraging investors to purchase the yellow metal as an alternative investment. Investors continue to look for better selling opportunities as the greenback stables.

The Nikkei closed at 12,803 down -84. The DAX index in Europe was at 6,364 down -18; the FTSE (UK) currently is 5,363 down -13. The early call for the open of key US indices is lower. Yields of the US 10-year bond backed up 5bp on Friday (4.07%) and are little changed O/N. Treasury prices eased again as financial equities rose on better than forecasted earnings from Citigroup. With traders and investors believing that the worst of the credit crisis fallout may be behind us (may be too soon), has speculators shying away from the appeal of risk aversion government debt products.

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