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FX MARKET BEGINS 2010 BUYING COMMODITY CURRENCIES USD under pressure as commodity currencies gain on Chinese manufacturing PMI.
-Bernanke would not rule out using higher rates to preemptively deflate asset bubbles.
-Pimco decreases UK and US debt holdings due to monetary policy and fiscal deficits.
-Oil jumps back up above $80/barrel, giving commodity currencies a lift.

FX Market Update

The FX market is showing a good push toward the buying of commodity currencies today, buoyed by strong December manufacturing data out of China (indicated by both the government and HSBC manufacturing PMIs) and strong commodity prices as oil, gold and copper all put in gains. The USD is generally under pressure as all major currencies are up against the greenback. CHF, JPY and GBP are lagging while the aforementioned commodity currency outperformance is being led by CAD, with AUD NZD further behind and SEK trailing only CAD.
• Though still elevated, the USD index is trading below its multi-month high near 78.45 achieved on December 22nd, however the index has not yet shown a break to the downside as its current trading level (at 77.57) remains above a key two week low of 77.32. It is interesting to note that as the USD began to surge higher in very early December, SEK, AUD and EUR were the worst performing majors (in that order). This has somewhat reversed since the 22nd as AUD and SEK have rebounded (along with NZD). However, EUR has underperformed by gaining only marginally against the USD since then. CAD and NZD were actually best able to hold their value while it appears that EUR and JPY are carrying the most damage going into 2010 as a result of December’s USD strength. We look for this USD strength to be temporary and for most major currencies to gain ground from current levels and set higher highs against the greenback in 2010.
• The US government bond trend seen at the end of last year is still in effect as the 10-year has reached near 3.90% intraday, the highest level since June of 2009, though the 2-year yield is down somewhat but still holding at elevated levels near 1.10%. We’ll be watching the shorter end of the curve for indications of rate support for the USD, particularly as it relates to the short end of the curve for other major currencies, as the end of year move higher in the dollar has sharply correlated with a similar move in short US yields. In fact, the rolling one month correlation between the 2-year Treasury and the US dollar index has been positive and significant (near 0.62 today, see chart) for an unusually long period of time considering the precedent of the past couple of years.
• The market also continues to maintain a higher implied yield pricing of August Fed funds futures contracts, now at 0.56%, while the December contract is showing increasingly aggressive rate pricing and has reached 1.10%, more than 25 basis points higher than just two weeks ago. In a speech before the American Economic Association on Sunday, Governor Bernanke didn’t give any hints to the potential for short term policy moves, though he did give the impression that while he placed the blame for the housing bubble on regulation, he would not be adverse to using the Fed policy rate to avoid future bubbles. S.T.

Americas

USDCAD (1.0385) • USDCAD has traded through the 1.04 level, as CAD is up 1.4% on the day to lead the majors against the USD. USDCAD looks weighty after sharply losing ground through the latter parts of December, and recently failing to beak back above its 50-day moving average (on the 30th). This could hold a key topside level (the 50-day is currently at 1.0579) for the pair while the low near 1.0367 from last Tuesday remains an important downside target as it constituted the bottom end of the recent downside run in USDCAD that temporarily appeared to have the pair ready to break out and test 2009 lows just above 1.02. Though we get industrial and raw materials prices along with Ivey PMI this week, the main focus will be on Friday’s Canadian employment data which the market currently expects to show a CAD positive result. S.T.

Europe

EURUSD (1.4395) • EUR is beginning the year where we expect it to finish as a mid-performer, with modest gains against the USD, but underperforming the commodity currencies. Fundamental data from the Eurozone was mixed today, with sentix investor confidence climbing to the highest level since June 2008, manufacturing PMI came in at consensus of 51.6, but German PMI disappointed coming in at just 52.7. Giving the EUR a lift today is a generally weaker USD, risk seeking investor behaviour and 2-year bond yield spreads, which are generally moving in favour of EUR today. • Technically, the 200-day moving average (1.4232) has provided solid support over the last several weeks. A break above the December 29th high of 1.4458 would open up a test back above 1.45. C.S.
GBPUSD (1.6205) • Sterling is underperforming, having gained just 0.2% against the USD as we move into the North American open. Fundamental data from the UK was relatively strong today, with the manufacturing PMI jumping up to 54.1, mortgage approvals increasing to 60.5k and net lending on dwellings stronger than expected. However, Pimco’s decision to cut back holdings of UK and US debt as they expect these markets to be “negatively affected as borrowing rises and central bank buying declines” is weighing on GBP. We expect GBP to underperform in 2010 as it is weighed down by large fiscal deficits, a dovish central bank and negative sentiment. C.S.
EURCHF (1.4875) • EURCHF has dropped well below 1.50 (the SNB’s rumoured line in the sand), with little fanfare. Markets are watching closely for SNB intervention, but so far there has been little evidence that they are in the market. Thursday, Switzerland will release inflation data, which could sway the SNB to step further back or become more aggressive. As of January 1st, Philipp Hildebrand has replaced Jean-Pierre Roth as Chairman of the SNB. C.S.

Asia / Oceania

USDJPY (92.80) • The yen is essentially flat as we move into the North American session, with USDJPY trading near the top of its recent range. The 200-day moving average is at 93.60, USDJPY has not traded above this moving average since August 2009. There was no fundamental data released but there is some focus on a government proposal to exempt overseas investors from paying the 15% tax on interest income from corporate bonds. C.S.
USDCNY (6.8273) • The yuan is flat today and 1 year forwards are pricing in just 2.6% appreciation. We expect China to begin to slowly allow some appreciation in the yuan later this year. • Providing a lift to commodity currencies, PBoC’s Sheng Songchen has commented that China should invest FX reserves into oil and other strategic resources. • On a positive note for the global recovery China’s HSBC manufacturing PMI jumped up to 56.1. C.S.

Commodities

Oil (81.00) • Crude has broken over $80 a barrel, pushed higher by news that Russia has stopped supplying Belarus and a PBoC official that has commented that China should diversify its FX reserves into oil and other strategic assets. The 2009 high in oil was $82.00/barrel, which is now well within sight. Scotia Economics expects oil to average $90/barrel in 2010. The 30-day correlation between CAD and oil has moved up to 0.64 (see bottom chart on page 1). C.S.
Gold (1117.00) • Gold has jumped back up to $1117/oz and is testing a break above its 50-day moving average of $1,121.09. C.S.

Suggested Reading

Fed Chief Edges Closer to Using Rates to Pop Bubbles, Jon Hilsenrath and Luca DiLeo, WSJ (January 4, 2010) PMICO’s Cyclical 2010 Outlook, Paul McCulley, PIMCO (December 2009) Euro-Denominated Bonds Win Fans, Ed Moisson, FT (January 4, 2010) Deficit, Budget Woes Need Solutions as US Nears the Precipice, Mark Whitehouse, WSJ (January 4, 2010) China Still Has Appetite for M&A, Peter Stein, WSJ (January 4, 2010) UK Deficit Warning from City Economists, C. Giles, D. Pimlott & J. Eaglesham, FT (January 4, 2010) Grading the World’s Central Bankers, Brian Milner, G&M (January 4, 2010) After the decade of debt: A course to chart, Michael MacKenzie et al., FT (January 3, 2010)
Camilla Sutton, CFA, CMT Sacha Tihanyi
Currency Strategist Currency Strategist
Scotia Capital Scotia Capital
416-866-5470 416-862-3154
Camilla_sutton@scotiacapital.com Sacha_tihanyi@scotiacapital.com



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