Bernanke to disappoint EURO positions?

Despite Euro-zone sovereign bonds continuing to be sold off, European Banks funding under stress with CDS at record highs, Greenspan believing that the common currency will break down, a plunge in the German ZEW investor confidence reading, an ifo Business Climate survey printing new yearly lows investors continue to grasp for any good news or news more positive than expected to keep the EUR buoyant. It also seems to prove that the market is no mood to go heavily short ahead of Bernanke’s highly anticipated speech tomorrow.

Reports continue to do the rounds stating that Bernanke is to do nothing at Jackson Hole. The market should expect policy makers to again reassure investors that the Fed stands ready to deploy ‘other’ tools if necessary. It’s important that the Fed gets to retain some degree of flexibility against a backdrop of ‘lower-for-longer’ official interest rates.

Tomorrow, Bernanke and company should say one of three things. First, repeat this summers message, second, lay the groundwork for another extraordinary easing or third, open the door wider to more easing. Last year at this time he said the Fed would ‘do all that it can’ to ensure a continuation of the economic recovery and that buying more debt might be warranted if growth slowed. Two months later, the Fed announced a $600b QE2 plan. The market has gotten ahead of itself and is probably putting too much emphasis on Ben’s speech. Ahead of the meet, the bias will be to own some dollars as many do not see Bernanke coming out swinging and delivering anything too dramatic.

The US$ is mixed in the O/N trading session. Currently, it is lower against 10 of the 16 most actively traded currencies in a ‘tight’ trading session.

US durable orders climbed more than expected last month (+4%) as a surge in demand for aircraft (+43%) and autos trumped a decrease in business equipment, including computers and machinery. The auto sector has rebounded from the slump caused by the Japanese earthquake and on the back of a few manufacturers benefiting from growing sales in emerging markets. What is of concern in the report is that the improvement seems to be narrowly based. Digging deeper, orders for non-defense capital goods ex-aircraft, a proxy for future business investment, dropped -1.5%, the most in six months, after a revised +0.6% gain in June.

Despite the optimistic headline order print, regional factory surveys this month have shown that demand has plunged as concern over the European debt crisis worsens. Empire manufacturing data has slowed for a third consecutive month and the Philly Fed results have contracted the most in two years. Even the Richmond results show that its business activity has dropped to its weakest point in 18-months. Much of the growth in the second quarter has come from corporate investment and trade, while consumer spending continues to stagnate, this would suggest that US GDP growth is set to remain subdued. Now we wait for Ben!

The dollar is lower against the EUR +0.04% and CHF +0.29% and higher against GBP -0.08% and JPY -0.17%. The commodity currencies are weaker this morning, CAD -0.16% and AUD -0.33%.

There is no denying it, the commodity growth sensitive currency, the loonie, remains range bound. It’s movements are been dictated to by the risk loving and risk aversion trading strategies that are positioning most portfolios ahead of Ben’s highly ‘over’ anticipated speech in Jackson Hole tomorrow. The CAD managed to trade to intraday highs as US durable goods orders for July beat expectations yesterday. The currency tends to have a strong correlation to the price of oil, and to macro data from south of the border, who consume nearly +70% of Canada’s total exports.

Outlook for the Canadian economy has come under serious scrutiny over the past few weeks. Governor Carney says second-quarter growth is likely to be flat or down slightly. It was only a month ago they had forecasted growth of +1.5% on an annualized basis in the quarter. With weaker US demand growth prospects the currency should come under renewed pressure in the medium term. Parity looms again for the loonie on fears about the stability of the European banking system and on the back of weaker data from its largest trading partner. Technically, the currency needs to fill in that gap. The loonie has dropped –4.1% so far this month, as global equities remain on the back foot. Investors are better buyers of dollars on dips (0.9869).

The AUD for a third consecutive day fell outright in the o/n session as a private report showed deteriorating consumer sentiment in Germany damping demand for higher-yielding assets. US data is potentially reducing the chance of Bernanke announcing any quantitative measures to be implemented soon. The Aussie is on course for a fifth weekly drop against the JPY as traders increase bets for an interest-rate cut from the RBA amid concern that global growth is slowing.

Reports earlier this week show that one of the leading Aussie economic index’s for June fell (-0.8%) and second-quarter construction work missed economists’ estimates (+0.7% vs. +1%). Concerns over developments in Europe and the US continue to overshadowed the RBA’s robust medium term domestic outlook. Many now expect Governor Stevens to remain on hold for the remainder of the year, as ‘risks for the RBA have become more evenly balanced and the outlook remains conditional on the strength of the global economy’. Currently, investors are better sellers of the currency on rallies (1.0456).

Crude is higher in the O/N session ($85.47 up+0.31c). Crude prices have again found support after yesterdays weekly EIA report showed inventories had unexpectedly declined as refinery rates matched their highest level for this year.

Oil stockpiles fell -2.21m barrels to +351.7m last week. The market had been anticipating a build of inventories of +800k barrels. Crude imports fell-477k barrels per day to +8.77m. Also of note, data released by the IEA shows that the US SPR supply fell -4.8m barrels last week. On the flip-side, gas inventories rallied +1.36m barrels to +211.4m. Analysts had been expecting a-1m barrel decline. Average gas demand in the last four-weeks fell -2.4% from a year ago. Finally, distillates (heating oil and diesel), rose +1.73m barrels to +155.7m, more than the forecasted rise of +700k barrels. Refinery utilization rose +1.2% to +90.3% of capacity.

The report is bullish for crude and bearish for the products. For the moment, Crude prices continue to hold just above strong support levels, support by Libya, exclude them from the equation and the commodity remains vulnerable. The Fed’s monetary policy will be bearish for the dollar and so should be bullish for crude in the longer term. The market now waits for Ben to re-enforce the Fed’s intentions.

It’s a brave soul who wants to trade in the commodity markets this week. Yesterday, the yellow metal completed its largest one-day clean out in eighteen months and today is no different. The ‘perfect storm’ had many weak long investors tapping the market and taking some profit off the table on speculation that financial markets may be stabilizing, eroding the appeal of the precious metal as a safer haven. The commodity has lost over 5% in the past two days, that’s equal all of the last two week gains. Technically it’s a crowded trade that investors wish to pare on expectations Bernanke will do something to boost equity prices tomorrow.

Before this week’s carnage, the commodity trade was up +31%, y/d, as the global debt crises and volatile stock markets boosted the appeal of the metal as an alternative asset. A hike in margin requirements for gold forwards in Shanghai is also helping to curb the precious metal’s meteoric rise. This is a similar move to the COMEX margin hike of +22% earlier in the month.

Big picture, with the Fed’s efforts to drive interest rates lower to support lending should curtail the dollar’s appeal as a safe haven and by default, support commodities eventually. The commodity is heading for its eleventh consecutive annual gain ($1,718-$39).

The Nikkei closed at 8,772 up+132. The DAX index in Europe was at 5,729 up+49; the FTSE (UK) currently is 5,206 up+1. The early call for the open of key US indices is lower. The US 10-year backed up 14bp yesterday (2.27%) and is little changed in the O/N session.

Yields on shorter term Treasuries remain rooted to their record lows amid speculation that the Fed will signal tomorrow that policy makers are willing to take further measures to prevent the US from falling back into a recession.

The current 2/10’s spread is below last year’s low, which coincidentally occurred in August as Ben was preparing his QE2 pre-announcement speech for Jackson Hole. A section of the market is expecting a repeat performance tomorrow. Disappointment should push the US yield curve to continue to trend lower as money is forced to seek yields that are further out the curve. With 2’s tied to o/n funds the only way for the curve to steepen is through higher inflation expectations.

The market has been focusing on the demand for US product as yields fall to new record lows. This week, the US treasury will issue $99b of new notes supply. Already we have seen that demand for 2’s remains strong. Even yesterday’s $35b 5’s was able to print record low yields. The issue was offered at +1.029%, down sharply from last months +1.58%. The bid-to-cover ratio was +2.71, compared with the average of +2.8. The indirect bid was +42.1% compared to the average of +40.3%. Today we get the final of this weeks sales, $29b 7’s.

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