Weak EURO Shorts Being Squeezed

Stronger than expected Chinese growth data has given a slight boost to risk appetite. Growth in Chinese industrial output (+13.3%) and fixed asset investment (+25.8%) remains robust and above market expectations, while retail sales (+16.9%) was modestly below expectations in O/N releases.

Despite the slowing of Chinese new loan data over the weekend pointing to future softer data, the market seems to be happy that their economy is not slowing sharply. Proof that Chinese demand and internal driven growth is still somewhat strong.

Market focus will now turn to US retail sales this morning where its expected to have stalled in May, the first time in eleven-months. Investors continue to feed off periphery headlines for vindication of their short EUR positions.

The US$ is weaker in the O/N trading session. Currently, it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ session.

The market is beginning to become blasé about credit rating actions surrounding Greece. S&P’s added to Greece’s woes yesterday by cutting its long term sovereign rating three notches to CCC, citing, a ‘significantly higher likelihood of one or more defaults’.

The dollar is lower against the EUR +0.31%, GBP +0.12% and JPY +0.02% and higher against CHF -0.24%. The commodity currencies are stronger this morning, CAD +0.24% and AUD +0.58%.

The loonie remains hemmed in a tight range on the back of softer commodity prices and lack of economic data giving guidance. The market so far this week has been on standby, unwilling to participate despite US bourses seeing black. So far this month the loonie has been at the mercy of its largest trading partner, on speculation that a slow recovery down south is curtailing demand.

On the crosses the currency has performed relatively well, boosted by last week’s employment numbers. The Canadian economy was able to add +22.3k new jobs and push the unemployment rate down to its lowest level in two-years (+7.4%).

For most of last week, growth and risk sensitive currencies have been trading under pressure as global growth becomes more of a concern. The loonie is being subjected to the pull of either risk or risk aversion trading strategies. Investors remain better buyers of Canadian dollars on US rallies (0.9740).

The AUD has found its ‘mojo’, at least for now, after data showed China’s industrial production grew by more than economists had estimated, boosting prospects for growth in exports from the region. China is the country’s largest trading partner.

In the O/N session the currency has gained against all its trading partners after gains in China’s CPI index were in line with markets expectations. With inflation data less than expected there is less need to tighten policy aggressively. However, reports that June inflation numbers could lead to further tightening by the PBoC in July has been able to pare some of the O/N rally. Many expect that a slowdown in China is a possibility in the second half of the year, which would be a negative for risk appetite.

Last week, the markets reacted negatively to the much lower-than-expected Australian employment report (+7.8k) by pushing the Aussie dollar to a ten-day low. Rate dealers have cut their pricing for RBA rate hikes over the next year by 10bp. The report has severely reduced the chance of a July RBA rate hike and allows the currency to trade in a modest range until investors can get more clarity about Governor Stevens’s interest rate outlook.

Aussie yields are still the highest in the G10 and always look attractive. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on these much deeper pullbacks for the time being (1.0652).

Crude is higher in the O/N session ($97.57 +0.29c). Oil prices eased again yesterday ahead of expected soft US data that should curb fuel demand in the world’s largest fuel consumer. Demand is obviously the unknown variable. Last week, OPEC failed to make a deal to raise supplies in Vienna. With no extra supply, it provides for a tight market. However, it is believed that the Saudis will increase production and offer more oil to Asian.

The weekly EIA report showed that oil inventories decreased by -4.8m barrels. At +369m barrels, crude oil inventories are above the upper limit of the average range for this time of year. On the flip side and negating the bullish headline, gas inventories increased by +2.2m barrels and are in the upper limit of the average range. Distillate fuel inventories increased by +0.8m barrels last week and are in the upper limit of the average range for this time of year. Refineries operated at +87.2% of their operable capacity.

While US crude futures slipped, Brent crude futures rallied more than $1 and the Brent/WTI spread widened to a record $21 a barrel yesterday. The market believes that the US has ample crude stocks, allowing WTI prices to remain in check, while the Brent market continues to price in lost production of preferred sweet crude from Libya.

Gold has managed to print a new weekly low as investors sold the yellow metal to cover losses in other assert classes. With equities on a six-week losing streak, the fear that margin calls will increase in the short term has the weak longs exiting their positions. Last week, the metal dropped -0.9%, the first decline in five-weeks. Year-to-date, the commodity had climbed +7.6% this year.

The market expects gold to rally this week on the back of the dollar losing some of its bid momentum. Dollar weakness tends to lift gold prices, as it makes dollar-priced assets cheaper for other currency holders and boosts the precious metal’s appeal as an alternative investment.

Big picture, the yellow metal remains in demand on speculation that borrowing costs in the US will remain low after economic data signaled that the recovery may be faltering and on the back of Bernanke’s comments that further stimulus is required. However, the market may have to experience a good purge before climbing higher again.

Strong buying recommendations from Goldman and Morgan Stanley have also been good enough reason to drag the commodity higher this month. The yellow metal is being used as a store-of-value and trades like a currency.

The metals bull-run is far from over with speculators continuing to look to buy gold on deeper pullbacks ($1,520 +$4.90c).

The Nikkei closed at 9,547 up+100. The DAX index in Europe was at 7,196 up+110; the FTSE (UK) currently is 5,801 up+28. The early call for the open of key US indices is higher. The US 10-year backed up 3bp yesterday (3.00%) and is little changed in the O/N session.

Is the treasury market losing momentum? After last week’s aggressive advance and with global bourses in the black, has allowed investors to pare some of their risk aversion trading strategies and lock in some profit. With M&A activity pushing equities higher seems to be overshadowing some of the concerns that the US the economy is slowing. Last week completed the longest winning stretch in the FI market in three-years.

According to a piece in the FT over the weekend, US banks are preparing to reduce their use of treasuries ‘as a safety measure against volatility that could occur should Democrats and Republicans fail to increase the country’s debt ceiling soon’. This action would probably require them to have more ‘cash’ on hand.

Bernanke’s comments earlier this month continues to provide fodder for the bulls to push longer dated yields lower. The reality, record monetary stimulus is still needed to support US economic recovery. It seems that market consensus has us believing that there’s going to be another dip in economic growth and that will require a QE3 package.

With the Fed expected to remain on hold for a considerable time is creating a new paradigm of longer term lower interest rates.

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