The Dollar Gains by Default

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 |  Includes: FXA, FXB, FXC, FXE, FXF, FXY, GLD, JYN, OIL, SZE, UDN, UUP
by: Dean Popplewell

By Dean Popplewell

Until now it was easy, the market was trading FX on monetary policy. Nothing is that simple when you are dealing with a group of individual countries that created the EUR. In this holiday shortened week, Greece is resurfacing as a default risk.

Complicating matters, the True Finn’s Party’s elections gains is creating the possibility that Portugal’s EFSF program may need to find a way to exclude participation by Finland.

All of this has occurred on the back of a surprise Chinese hike in its reserve requirements over the weekend. Cutting risk seems to be a prerequisite before Easter, but, to be long the dollar just because the Euro-region is in trouble, do not think so.

The US$ is stronger in the O/N trading session. Currently, it is higher against 12 of the 16 most actively traded currencies in an ‘volatile’ session.

Forex heatmap

In the run-up to the Easter holidays, markets will focus on US earnings and key leading indicators in Euro-zone and the Spanish bond-auction midweek.

The USD is higher against the EUR -0.68%, GBP -0.41%, CHF -0.31% and lower against JPY +0.47%. The commodity currencies are weaker this morning, CAD -0.18% and AUD -0.20%.

The loonie remains contained in a tight directionless range as traders look for reasons to buy-and-sell. The currency has underperformed on fears that Europe’s most indebted nations may be forced to reorganize debt payments to bondholders, damping demand for currencies linked to growth. Commodities have helped the CAD to pare some of these losses as oil prices get a boost.

Last week, Governor Carney kept rates on hold at +1%. The BoC’s MPR showed that policy makers expect to gradually hike interest rates through 2013, while warning that the strong CAD could hurt exports and act as a drag on growth, as well as put added downward pressure on inflation through cheaper imports. Their new forecast for the loonie is 0.9700.

Overall, the BoC is less concerned about global and US risk as it focuses on the strong dollar. Governor Carney has been trying to talk the CAD down. The BoC statement was less hawkish than it could have been, and suggests the strong potential for policy neutrality for an extended ‘period-of-time’. It’s worth noting that with only 10% of Canadian exports going to emerging markets, Canada is not likely to benefit from the current commodity boom (0.9635).

Despite leading the G10 rally this month, the AUD fell for a third day against the yen on renewed concern Greece’s fiscal crisis will worsen and on speculation that the PBoC will raise rates again to combat inflation after reports showed inflation (+5.4% March) accelerated to the fastest pace in more than two years.

The market weakness in commodities and emerging market equities certainly is not supporting growth sensitive currencies. Depending on how risk appetite pans out, these pull backs may end up being a good buying opportunity. Big picture, with Japan’s loose monetary policy, the yen is expected to weaken with Japan lagging any significant recovery.

Australian yields are still the highest in the G10 and continue to attract regional investor’s en masse. The expected mix of trade surpluses and rising capital inflows should provide support for the currency on these pullbacks (1.0537).

Crude is lower in the O/N session ($108.72 -90c). Oil prices rallied on Friday after better than expected confidence and industrial headline prints lifted consumer optimism. There is growing expectation among investors that the Fed will lag other Cbanks in tightening monetary policy is creating a supportive backdrop for commodities.

Over the weekend, Saudi Arabia’s Oil Minister al-Naimi said that the global ‘market is oversupplied’ with crude, and this after they personally cut output in March by more than +800k barrels a day.

The EIA report showed crude stocks climbed +1.60m barrels to +359.3m, remaining above the upper limit of the average range for this time of year. On the flip side, gas supplies plummeted-7m barrels and are near the lower limit of the average range. Oil refinery inputs averaged +14.0m barrels per day during the week, which were-354k barrels per day below the previous week’s average as refineries operated at +81.4% of capacity.

Earlier in the week the IEA said it maintains its 2011 global oil demand growth forecast but noted that the high oil prices are beginning to dent demand growth based on its preliminary data for January and February. Both the IEA and IMF have said that prices above the $100 watermark are beginning to hurt the global economy. Even Goldman is recommending to investors to take profit on the one directional commodity trades.

Gold raced to another record on Friday, on speculation that the sovereign-debt crisis in Europe will worsen, boosting the appeal of the yellow metal as an alternative to currencies. Prices are well supported on speculation that record-low interest rates will encourage demand for an inflation hedge amid expectations that the Fed will maintain its accommodative monetary policy in the medium term. Gold, as a non-yielding asset, has a higher opportunity cost when interest rates rise.

The precious metal has become the currency of choice despite Goldman recommending last week that if one owned commodities, the risks outweigh any further potential gain. Regardless of event and geopolitical risk, the general dollar malaise against its major G7 trading partners is supporting commodities. The dollar tends to trade inversely with the price of the commodity. The metal has jumped +29% in the past year.

The metals bull-run is far from over with investors continuing to look to buy the commodity on dips. Any price pullbacks are viewed as favorable opportunities for investors to continue to diversify into safe-haven assets, especially metal being used as a store of value ($1,485 -90c).

The Nikkei closed at 9,556 down-35. The DAX index in Europe was at 7,126 down-52; the FTSE (UK) currently is 5,965 down-31. The early call for the open of key US indices is lower. The US 10-year eased 6bp on Friday (3.41%) and another 3bp (3.38%) in the O/N session.

Treasuries have rallied, pushing the benchmark 10-year yields down the most in 11-months, after data revealed that US inflation has cooled and as speculation rises that Europe’s debt crisis is worsening. Together, this is forcing a loss of risk appetite.

Last week, FI rose for the first week in a month as Obama pledged to cut the deficit and Ireland’s debt rating was lowered by Moody’s, boosting demand for relative safety. The US Government sold successfully $66b in notes and bonds, and this week the Fed will buy as much as $11.5b of Treasuries to keep rates low and spur growth as part of their QE2 mandate.

The fear of having to restructure Greece’s debt burden will keep rates depressed as speculators become better buyers on pull backs. Investors are beginning to realizing that the global recovery is not necessarily a ‘one-way move up, but will remain inconsistent’.