FOREX TRADING

RBA holds rate policy steady

The Reserve Bank of Australia (RBA) elected to keep rate policy steady at 4.5%. A steady RBA rate decision was widely expected. In its policy statement accompanying the rate decision the RBA said that policy was appropriate for the near-term. The RBA policy statement indicated that RBA officials were focused on the EU debt crisis. The RBA policy statement noted concern about sovereign credit worthiness in several European countries and that because of this concern equity prices and long-term bond yields have been declining and the AUD posted a sharp decline. The RBA noted the effort by European policymakers to address the EU debt crisis agreeing to a large aid package and renewed commitment to bring down the deficits. The RBA expects global growth to be close to trend in 2010 and said that the recovery is becoming more established in North America and growth in Asia remains quite strong. The RBA also stated that output growth in Australia will likely be above trend and that inflation could be near the upper half of the central bank’s target zone. The RBA gave no clues whether interest-rate policy will be changed anytime soon. In its policy statement the RBA noted that there is a little more uncertainty because of the debt crisis in Europe. The RBA appeared to signal that rates may remain on hold for some time to come. The AUD was trading lower ahead of the RBA policy announcement pressured by weaker equity markets and report of weak PMI data from China. AUD downside was partly limited by the fact that the RBA policy statement was seen as neutral. There had been speculation that the RBA policy statement would have been more dovish. The RBA was the first central bank to begin hiking rates back in November. The recent RBA rate hikes mean that the RBA is ahead of other major banks in its rate hike cycle. The EU debt crisis may encourage a longer pause in the RBA’s tightening cycle.

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Market Outlook:

Tactical view:

• EUR crosses stay offered; counting on stocks for GBP relief
• USD, JPY outperform in risk averse world

The USD continues to attract solid buying interest as confidence in the EUR and GBP wanes. With risk reversals still heavily skewed towards USD calls, the outlook for the dollar index remains uniformly bullish even as the probability of a Fed rate hike this year fades. Economic data has been playing second fiddle in recent weeks and until the picture for risk assets clears up and EU debt fears subside, we think macro data are unlikely to be critical for price action near-term. The high correlation with equities continues to weigh on GBP but with the BoE now also reasserting its influence, we see no immediate escape for GBP from the clutches of the sterling bears. April retail sales and CPI data, and the MPC minutes will keep GBP on a knife-edge next week.

Recap

The positive knee-jerk reaction to a Cons/LD government quickly petered out and saw the market re-establish short GBP positions vs the principal G10 currencies except vs the EUR. GBP/USD dropped below 1.45, and following a dovish BoE QIR, the cross is now slowly gravitating towards the 1.40-1.44 area. Buying of EU peripheral debt by the ECB briefly underpinned the EUR, but selling resumed as the Ascension Day holiday pushed peripheral spreads wider again over bunds. EUR/USD slipped below 1.2500 and now threatens 1.2330, the Oct-08 low. The JPY and USD were the best performers in the G10 as a probe into US sub-prime mortgages and lower commodity prices caused equities to resume their decline, spurring a flight-to-quality. The CAD held up remarkably well considering the fall in crude oil below $75 to a 3-month low, but looks well placed to draw support from the outlook for higher interest rates.

Economic data continues to be a sideshow to the jitters in equity and sovereign debt space. The BoE kept Bank rate unchanged at 0.50% and the APF at £200bln, but in its quarterly Inflation Report it warned of downside risks to growth as public spending cuts in the EU and the UK threaten to hit demand. The BoE also sees CPI below 2% target in two years time based on the implied futures curve for interest rates. Manufacturing production rose a much stronger than forecast 2.3% m/m in March, fuelling speculation of an upward revision to Q1 GDP later this month. Jobless claims fell in March by 27,100, and the ILO unemployment rate held steady at 8%.

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The Reserve Bank of Australia (RBA) will hold a policy meeting on Tuesday, May 4th. The RBA hiked rates 25bps in April and in the policy statement left the door open for future rate hikes. According to the April RBA policy statement the global economy is growing, Australian growth is close to trend, global financial markets are functioning better, inflation has risen and interest rates remain somewhat below average. The RBA has raised rates by 125bps since October with current overnight rate at 4.25%. There are a number of factors that point to a 25bps point rate hike by the RBA Tuesday. Recent Australian economic data confirms improving domestic growth and rising inflationary pressures. Australia’s GDP grew at its fastest pace in two years rising 0.9% in Q1 as consumer spending has been strong. The Q1 inflation rate rose by 0.9% compared to 0.5% in the fourth quarter. Australian employers have created more than 200k jobs over the last five months and the unemployment rate is at an 11 month low of 5.3%. Australia’s industrial activity surged in Q1 rising at its fastest pace in two years. Australian swap rates rose to an eight-month high Monday and implied forwards predict a 70% chance of an RBA rate hike Tuesday up from 55% Friday. The rise in swap rates increases the odds that the RBA will raise rates.

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The biggest outperformer on the session has been CAD after the BoC rate decision revealed a first hike may be far more imminent than markets have priced in. Although rates were indeed kept on hold at 0.25% as expected, there was a notable absence in the statement of the conditional pledge to keep rates at that level until at least July – suggesting a tightening cycle may begin before that time. USDCAD has plunged below parity to 0.9971 lows, a move that represents approximately a 2% gain for CAD against the USD today.

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The Bank of Canada (BOC) will hold a policy meeting on Tuesday, April 20th. At the March policy meeting the BOC left interest rates unchanged at a record low 0.25% and said that inflation and economic growth had been higher than expected. The BOC reaffirmed its commitment to maintaining yields at the record low level through June 2010 conditional on inflation. The March policy statement said that Canada’s domestic economic activity had been slightly higher than projected in its January report and the recovery in exports continues. The recovery is supported by policy stimulus, increased confidence, improved financial conditions, global growth and higher terms of trade. Strength of the CAD and low demand from the US act as drag on the Canadian recovery. Recent Canadian economic data confirms faster growth and higher inflation. Canada’s economy expanded at its fastest pace in three years in January and the trade surplus grew for the fifth straight month with exports rising by 2.8% in February. Canada created 17,900 new jobs in March and inflationary pressures are building. Canada’s annual core inflation rate accelerated to 2.1% in February. The BOC’s Business Outlook survey released on April 12th states that 40% of Canadian executives surveyed expect inflation to rise by 2 to 3% over the next two years. This is up from 20% of executives in January. BOC inflation target is 2%.

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Sunrise Market Commentary

• More details on Greek support package put bonds under pressure
  Friday, the bund came under pressure on expectations a more detailed Greek rescue package would be made public soon. Over the weekend, authorities did publish a huge €40-46B package that will go some way to ease investors’ concerns about the country. Return of risk appetite should weigh on the bunds.
• Euro rebounds on new Greek rescue plan
  On Friday, a short covering move helped EUR/USD to recoup a big part of the week losses as markets anticipated a new EU initiative to support Greece. A new plan was announced over the weekend. This triggered additional euro gains this morning. However, it is highly doubtful that the current development will mark a major U-turn for the EUR/USD cross rate in a longer term perspective. (more…)

Ahead of the BoE and ECB rate decision today, we see that the UK industrial and manufacturing productions beat estimates therefore supporting the fact that the expansion in the manufacturing sector is due to the higher production output.

Starting off with the industrial production in February, we saw that it rose to 1.0% from the revised prior reading of -0.5% from -0.4% which is better than the projected reading of 0.5%, while on the year it improved to -0.1% from the revised previous reading of -1.6% from -1.5%, while the markets were expecting a decline of 0.5 percent.

As the production from the manufacturing sector is recovering, this hints that production output is somewhat enhancing as industries are trying their hardest to shake off the worst global recession witnessed since post World War era. The higher production output indicates that demand levels are slightly inclining and this helping industries produce more.

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The minutes released this afternoon from the March 16 FOMC meeting provided some background discussion that lay behind the statement that was released at the conclusion of that meeting. The statement contained very little in terms of surprises although it seemed to hint at a slightly more upbeat assessment of the economic recovery. Today’s minutes reinforced this impression of commenting that “participants agreed that economic activity continued to strengthen and that the labour market appeared to be stabilizing.” This was qualified by the observation that incoming data confirmed that the “economic recovery was likely to proceed at a moderate pace;” however, the revised outlook for growth was not significant enough to alter Fed’s view that inflation is “likely to be subdued for some time.” In fact, today’s minutes revealed that FOMC members “saw recent inflation readings as suggesting a slightly greater deceleration in consumer prices than had been anticipated.”

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News and Events:

Newswires were buzzing overnight regarding an article, which suggests that Greece wants to cut out the IMF participation portion from the recently agreed upon financial aid plan. In addition, Greece has been rumored to be trying to fix or get details regarding some of the hazy specifics. Given the number of will EU member participants which signed the agreement, we doubt a carve-out or clarification will be very simple. However, from broader perspective this recent episode highlights the complications of actually executing the plan and introduces further uncertainty into FX markets. We doubt that the EU has the political will to ever fully execute a Greek bailout and the EUR should continue to suffer near-term. In the UK, PM Gordon Brown is widely expected to call a general election for May 6th (politics has been broadly negative for the GBP). Given the uncertainty surrounding the political events in the UK, the sterling will be highly reactive to news stories and politically biased conjecture. In Australia, the RBA hiked its policy rate by 25bp to 4.25% as was widely expected, the fifth increase in seven months. (more…)

The RBA will hold the policy meeting on Tuesday, April 6th. At the March policy meeting the RBA hiked interest rates 25bps to 4%. This followed 25bps rate hikes in October, November, and December of 2009. According to the March RBA policy statement the global economy is growing and GDP is expected to be close to trend in 2010/2011.The RBA said that financial markets are functioning better than they were a year ago but credit conditions remained difficult in some major countries. The RBA noted the potential negative impact from sovereign debt risks, most likely a reference to Europe. The RBA also said that Australian economic conditions were stronger than expected in 2009 and dwelling prices have risen significantly over the past year. In the March policy statement the RBA concluded the risk of serious economic contraction in Australia has passed and there is less of a need for monetary stimulus.

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• USD: Higher, pending home sales surge, non- manufacturing ISM beats expectations, Dow approaches 11k
• JPY: Higher, diminished threat of BOJ ease, Yuan revaluation speculation
• EUR: Lower, pressured by rising US bond yields/strong US employment, housing and services data
• GBP: Higher, election polls point to a Conservative majority diminishing the risk of a hung parliament
• CHF: Mixed, EUR/CHF rebounds from record low on SNB intervention
• CAD and AUD: AUD lower & CAD higher, rumors that the RBA will hold monetary policy steady Tuesday

Overview

USD traded mixed to firmer Monday extending Friday’s gains versus the EUR and weakening versus the JPY and commodity currencies. USD traded higher Friday supported by report that the US economy added the most jobs in three years and in reaction to the rise in 10 year bond yields to a 10 month high. The main focus of Monday’s trade was UK election polls, Yuan revaluation speculation and strong US data. UK election polls show that the Tories have a 10 point lead over Labor. A Tory victory would reduce the risk of a hung parliament and may diminish concern about an imminent downgrade of the UK’s sovereign debt rating. The U.S. Treasury will delay the April 15th currency report on China in hopes that the delay will encourage China to strengthen the Yuan. JPY edged higher supported by Yuan revaluation speculation and diminished ease speculation. Recent weakness of the JPY will diminish the odds of the BOJ rate cut at this week’s policy meeting. AUD traded lower pressured by rumors that the RBA will hold rate policy steady at Tuesday’s policy meeting. Today’s US economic data was positive with pending home sales posting an unexpected rise and non manufacturing ISM beat expectations. The pending home sales rise may reflect the fact that the home buyers tax credit will expire at the end of April. The employment component and the business outlook of the non-manufacturing ISM posted strong gains. CFTC commitment of traders for last week showed that speculators increased USD long positions the highest level since February 23rd. Bullish USD sentiment is rising with US bond yields. US ten-year yields are approaching 4% as the US economy improves.

This week’s main focus will be central bank policy meetings in Australia Tuesday, Japan Wednesday and Europe Thursday. The RBA is expected to hike rates 25 basis points to 4.25% but the RBA policy decision is a close call. The BOJ is expected to leave monetary policy unchanged in reaction to recent weakness of the JPY. The ECB and BOE are expected to remain on hold.

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U.S. Review

Economic Recovery Continues, but is it Enough?

• Economic indicators this week suggested continued economic growth. Factory orders, the Institute for Supply Management manufacturing index and employment all suggest continued progress.
• Yet the pace of the recovery still presents several fundamental challenges. First, construction spending is disappointing and for a society that has put so much emphasis on housing, there is a disconnect between aspirations and reality. Second, the pace of growth will not likely solve the budget shortfalls in many states or at the national level.

Economic Recovery Continues, but is it Enough?

Three important economic indicators this week suggested continued economic growth. Factory orders, the Institute for Supply Management Index and employment all suggested continued progress on the economic front. Factory orders increased 0.6 percent in February and the gain reported for January was revised higher. Factory orders have gained in 10 of the past 11 months and are now more than a third of the way back to where they were at their peak in July 2008. Specifically, new orders for non-defense capital goods ex-aircraft are up nine percent (annualized) over the last three months, consistent with our expectations for 8 percent or more gains in real equipment & software spending for this year.

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Bullish Dollar Index Challenges Inverse Equity Correlations

The major forex pairs are going into a period of trade that has price action losing its direction, and offering mixed trend and momentum reads on the 4 Hour charts. Traders are seeing bouts of Usd buying and selling as each of the regional traded markets open and close that although sporadic, still have a long-Usd bias.

Currency valuations are back to the areas that March started trade at, with the Usd now able to challenge the 12-month 90% inverse correlation to S/P trade. In March, the S/P market has gained 7%, while at the same time the dollar index has found buyers, indicating that the global market is starting to price in the Federal Reserve rate increases at a rate that will probably outstrip other regions, whenever it is the Fed starts to monthly increases to overnight interest rates.

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Weekly Economic and Financial Commentary

U.S. Review

Public Policy Grabs Center Stage

• Public policy dominated this week, with the passage of healthcare reform and confirmation the social security system would run into deficit this year contributing to disappointing Treasury auctions and higher bond yields.
• Advance orders for durable goods rose in line with expectations, but a large downward revision to January’s nondefense capital goods orders raises a red flag as to how strong capital spending will be in the first quarter.
• Sales of new and existing homes both declined in February, raising fears the incipient recovery in housing has faltered.

Strange Days in the Credit Markets

The bond market is the ultimate truth detector and its verdict on healthcare reform is the new law will be more costly than the Congressional Budget Office (CBO) estimated and budget deficits will be larger. The bond market was already on edge from the ongoing Greek debt saga and reports that Berkshire Hathaway and a handful of other businesses can now borrow more cheaply than the U.S. Treasury. The CBO confirmed the Social Security system would pay out more in benefits this year than it receives in taxes, something that was not supposed to occur until 2016. The Social Security shortfall means the Treasury will need to redeem the “special issue notes” issued to the Social Security trust fund, which will require the Treasury to sell real bonds, which has become more challenging in recent weeks.

The last few years have seen Treasury yields rise during the spring, triggering a whole new set of challenges. History looks like it will repeat itself this year, with the end of the Fed’s mortgage-backed securities purchases next week adding to the upward drift in yields. The supply of bonds coming to market will remain a challenge, with additional money needed to pay Social Security benefits and recapitalize Fannie Mae and Freddie Mac. Sovereign credit risk and worries about growing supply also extend to municipalities, which saw yields climb sharply recently.

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Discount Rate Discussions Keeping Floor Under Bonds

Once again bond markets are having a hard time maintaining a rally after the Fed’s earlier stand on its policy of maintaining low interest rates. Dealers continue to mull the potential for a second nudge higher in the Fed’s discount rate, which is overhanging market sentiment. As much as investors want to see a continuation of near-zero interest rates the threat of increases at the Fed’s symbolic rate serves to remind fixed income investors that benchmark interest rates may not be going up today, but that’s the general direction at some unspecified point. The relief rally in the Eurozone that’s helped push yields towards record lows also appears to be running tired of the story that Greek woes will splinter the Eurozone.

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