Will the Euro Follow the Script?

Jun.30.11 | About: iPath EUR/USD (ERO)

By Dean Popplewell

Papandreou clinched enough votes to pass the first part of an austerity plan aimed at meeting EU aid requirements and staving off a default. The EUR did what most anticipated, rally up towards 1.45 as residual speculative shorts are closed. Now what? According to the script, upside momentum is expected to stall around these levels as markets turn their focus to Wednesday morning’s Greek vote on implementation of the various fiscal measures, weekend discussions on private sector participation in the 2012 bailout, and risks around key U.S. PMI data due out Thursday.

On the flip side, the EUR is certainly looking prettier than GBP and the USD this Wednesday morning, proving to be market resilient. Certainly strong proof how fundamentally flawed the markets treatment of the dollar and sterling is!

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

Forex heatmap

Finally, a pleasant surprise or is it? May’s U.S. pending home sales index rose +8.2%, well above the market expectation of +3.2%. Analysts note that we should be appreciating the rise in the context of the -11.3% decline that was registered in April. It’s this print that verifies the unimpressive trend in existing home sales. Last month’s spike looks like a correction from the April release. Housing data reported of late does not point to any correction. Tuesday’s pending numbers are consistent with existing sales data, while mortgage information from NAHB and MBA points to further market weakness. The +13.4%, y/y, pending home sales figure is caused by the May 2010 tax credit expiry, which pushed the numbers to move below the underlying trend from the ‘previously inflated levels’. The future trend remains flat at best.

The dollar is lower against the EUR +0.31%, CHF +0.03% and JPY +0.47% and higher against GBP -0.28%. The commodity currencies are stronger this morning, CAD +0.40% and AUD +0.47%.

The Canadian headline inflation number Tuesday can be seen as a total ‘head-fake’ (+0.7% vs. +0.3%). Analyst’s noted that the spike can be explained away by seasonal adjustments, gas clothing and footwear. The surprise print does not speak to a ‘fanning out of inflationary pressures’. While headline (+3.7%, y/y) and core-CPI came in higher than expected in unadjusted terms, when adjusting for seasonality, inflation still remains well contained with both headline and core-CPI up +0.2% m/m, one-tenth below that registered in the prior month. That's a scenario that Bank of Canada Governor Mark Carney has already alluded to. On an unadjusted basis, both food and gas prices continued to move up in May. However, next month's report will likely show ‘modest’ headline gains as gas and energy prices decline.

Investors liked the data, pricing in a BoC hike for October and pushed the currency to a monthly high outright, aided by rising oil prices. Any fear about rate hikes after Tuesday’s print may be tempered by this morning’s GDP data. It’s expected to be weak and underscore the headwinds facing the economy, again backing up Governor Carney’s recent rhetoric.

Will the second leg of Greek voting today have investors looking to pare some of their recent risk appetite? With the Fed cutting its growth objective for the remainder of the year should have higher yielding growth sensitive currencies trading under pressure. Expect the Canadian dollar to be subjected to the pull of either risk or risk aversion trading strategies. CAD is vulnerable now with U.S. data likely to continue to print weak into mid-July (0.9662).

The AUD has ignored the slew of mixed domestic data and traded higher in the O/N session. Job vacancies in the three-months to May fell -4.5% from the previous period. Rismark House prices continued to decline last month and fell -0.3%. Private sector credit growth remained a subdued +0.3% in May and personal and business credit growth softened, while housing credit increased +0.5%, following an increase of +0.4%in April.

The currency advanced for a third consecutive day against the dollar as traders pared bets on a cut in interest rate by the RBA. Investors have been buying equities, pulling markets higher as a relief buying spilled into another session after Greece moved closer to receiving more aid to avoid a sovereign default.

Gains have been capped on fear that that a Greek austerity plan will not resolve Europe’s sovereign-debt crisis. Technically, the market is waiting for funding schedule clarity. Currently, the market is pricing a no hike in August unless inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite. Global data needs to improve before we can embrace any rate hike policy thinking. Investors remain better sellers on rallies (1.0724).

Oil

Crude is lower in the O/N session ($94.50 -0.27c). Crude extended this week’s gains after the weekly EIA report showed a larger-than-expected decline in inventories and as more Americans signed contracts last month to buy previously owned homes, a sign that the real estate market may be rebounding from its lows. Also aiding prices was a market concern that the Saudis would cut production in response to the IEA dumping move last week. Tropical Storm Arlene seems to be causing a stir in the Gulf of Mexico.

The market is concerned that the ‘tightness’ in the oil market will continue to undermine the fragile global economic recovery and the reason why the IEA and its members agreed to release crude from their SPR’s to ease some of this market tension. According to analysts, this supply move is significant, as it ‘represents a reach by member countries for the remedy of last resort to high oil prices’.

Oil inventory fell much more than expected last week as imports declined and gas stocks recorded a surprise fall. Crude stockpiles dropped for the fourth-consecutive week by -4.38m barrels to +359.47m. The market had been expecting a drawdown of -1.4m barrels. Weekly crude imports fell-271k barrels per day to +8.84m. A surprise was gas stocks unexpectedly falling -1.43m barrels to +213.1m. Analysts had projected a build of +600k barrels. Distillates (heating oil and diesel), rose +258k to +142.2m. Refinery utilization came off its 10-month high, falling -1.1% to +88.1%.

This year’s energy spike is being cited as the reason for the global economic slowdown. Analyst’s note that from its peak, crude is off-20%. The technicals see strong support first appearing at around $87.

Gold rallied for a second consecutive day after dropping to a five-week low, encouraging some investors to buy the precious metal as a protection of wealth and alternative to currencies. Last week, the commodity fell -4.4% and is up +6% this year.

After a positive Greek vote, the market had been wishing to see more of a pullback as people reduced their safe heaven position taking. This has not occurred because too many speculators have had the same thought.

Gold

Gold is viewed by some investors as a hedge against inflation, and the surprise release of crude oil stockpiles last week from developed nations’ reserves has dampened sentiment amongst investors for rising prices. However, commodities dependency on the buck and the outlook for U.S. rates is likely to remain intact for now. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on these deep pullbacks ($1,509 -0.90c). Technical analysts see $1,485 as the first level of real support.

The Nikkei closed at 9,816 up+19. The DAX index in Europe was at 7,302 up+9; the FTSE (NASDAQ:UK) currently is 5,895 up+39. The early call for the open of key U.S. indices was lower. The U.S. 10-year backed up 5bp yesterday (3.09%) and were little changed in the O/N session.

The U.S. yield curve rose from almost a record low ahead of this week’s three-treasury auctions ($99b-2’s, 5’s and 7’s), on bets that the Greek Socialist Party will get parliamentary approval for its austerity measures needed to secure a troika bailout. So far, they are two-thirds of the way there.

The U.S. 10-year benchmark was able to back up for a third consecutive day as Greece’s lawmakers passed the first part of an austerity plan needed to assure further bailout funds, damping demand for a refuge in U.S. government paper. Thursday, they get to vote for implementation of austerity. Ten-year yields have gained +21 basis points over the past three days. Is this a volatile market or what?

This week’s five-year auction was not well received and drew the lowest demand in a year as the sharp drop in yields has turned off investors. Dealers were able to create a small concession for Tuesday’s 7-year auction. However, the concession was not deep enough, as it too was a horrible auction, with dealers having to take down over half of the issue (+56.1% vs. +45%).

After the auction, bond prices hit new session lows. The issue tailed a whopping +3.25bp at a record low yield of +2.43%. The tranche had a 2.62 bid-to-cover ratio (smallest since July 2010) compared to an average cover of 2.87 in the six-prior auctions. Indirect bidders took +32.2% of the issue (the smallest take down in two-years) versus an average of +50.5%.

The jump in yield spreads between 2-year U.S. and Japanese bonds (17 basis points to 30) had been partially responsible for pushing USD/JPY up into the large resting offers of 81, temporarily at least.

Disclosure: None