Foreign Exchange Market Recap "OPEC's Optical Illusion" October 4, 2016

OPEC's Optical Illusion

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Given the market's prosaic task of price discovery – a task usurped in large measure by central banks, more below – generally there is little in the way of sudden, dramatic events that will distract investors. War, plague, pestilence – these can be spotted usually well in advance. Last week, however, saw a surprising number of major developments that kept Mr. Market on high alert. Let's take a look at what happened, starting with OPEC and their attempt, once again, to control crude prices.

Briefly, OPEC members have agreed to hold production levels in a range of 32.5 – 33.0 million bbl/day. This hasn't yet been finalised – November is the likely date – and quotas haven't been assigned either, but the appearance of OPEC solidarity has galvanised the crude market. However, this production cap is right at the record level of oil shipments seen in 2008, so it's questionable just how effective this will be in terms of firming up oil prices. Moreover, if crude rallies very strongly, Canadian oil sands and American frackers stand ready to start pumping aggressively, which will act to depress prices. Much higher prices will also entice members to cheat on their quotas, long a problem at the cartel. The bottom line is that OPEC simply doesn't have the leverage it once had in the 70s and 80s.

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Not surprisingly, being an oil exporter, CAD was a major gainer on the week. It didn't hurt that commodity currencies as a whole were up but, coupled with a strong July GDP print (+0.5% m/m vs call +0.3% m/m. +1.3% yr/yr) CAD gained nearly two full cents from its low trade of the week. Both AUD and NZD continued firm on relatively high domestic interest rates as outlined in last week's newsletter.

In America, a large number of Fed officials spoke during the week but largely stuck to the party line. Numerous economic statistics were released as well, the most notable being revised Q2 GDP (+1.4% vs call +1.3%), Conference Board September Consumer Confidence (104.1 vs call 99.0) and August Durable Goods (Flat vs call -1.5%). The real wild card for traders was last Monday's first presidential debate between Donald Trump and Hillary Clinton. This encounter was both highly anticipated and widely watched – reportedly 94 million-plus viewers. It isn't clear which candidate is really preferred by Mr. Market, although Ms Clinton appears favoured.

Overseas in Japan, following the monetary policy review released in mid-September by the Bank of Japan, events were relatively subdued. JPY did fall somewhat on higher oil prices, the reasoning being that costlier crude would be inflationary and thus reduce the need for further QE or stimulus spending.

In the UK a lack of any breaking news saw GBP trade marginally stronger on the week.

The really interesting news last week emerged from the Eurozone, part of the ongoing banking crisis. Not surprisingly, three of the zone's major banks were in the spotlight, one Dutch and two German, no less. ING Bank of the Netherlands will be announcing this week major layoffs, while Commerzbank last week fired almost 20,000 employees and announced a major restructuring. Threatening to eclipse all these developments – Eurozone politics, OPEC, US election race etc. – is the suddenly obvious fragility of Deutsche Bank, Germany's leading bank.

As mentioned in last week's newsletter, DB had recently been assessed a 14 bln USD fine for mortgage irregularities and, as we noted, the bank is beset on many fronts. Its creditworthiness as a trading counterparty is now in question, as well as its ability to raise fresh capital. Chancellor Angela Merkel has ruled out any state aid for the bank and, given that the German government has harshly lectured Italy and Greece about bank bailouts in these member countries, Frau Merkel may find herself trapped by her own rhetoric. It is rather difficult to foresee this ending well, and events may move quickly.

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Lastly, a number of hedge fund managers recently interviewed expressed frustration with the fact that, as central banks globally have moved rates down to near-zero and beyond and, in the case of the European Central Bank, are buying virtually any credit offered for sale, the need for hedging is diminishing. There simply isn't the risk in the marketplace against which to hedge. In other words, assessing risk and managing it is an essential part of price discovery and was long the basic function of markets. Central banks, by bidding on everything to fulfil their QE quotas and maintaining ultra-low rates, have essentially arrogated this function to themselves. At some point markets will have to reclaim this function, but it isn't clear when.

Key Data Releases This Week

Forecast

Previous

MONDAY, OCTOBER 3

All Day

EUR

German Bank Holiday

04:30

GBP

Manufacturing PMI

52.1

53.4

10:00

USD

ISM Manufacturing PMI

50.4

49.4

All Day

CNY

Bank Holiday

20:30

AUD

Building Approvals m/m

-5.8%

11.3%

21:30

NZD

RBNZ Gov Wheeler Speaks

23:30

AUD

Cash Rate & Monetary Policy Statement

1.5%

1.5%

TUESDAY, OCTOBER 4

04:30

gbp

Construction PMI

49.1

49.2

Tentative

NZD

GDT Price Index

1.7%

All Day

CNY

Bank Holiday

20:30

AUD

Retail Sales m/m

0.2%

0.0%

WEDNESDAY, OCTOBER 5

All Day

CNY

Bank Holiday

04:30

GBP

Services PMI

52.1

52.9

08:15

USD

ADP Non-Farm Employment Change

166K

177K

08:30

CAD

Trade Balance

-2.5B

10:00

USD

ISM Non-Manufacturing PMI

53.1

51.4

10:30

USD

Crude Oil Inventories

-1.9M

20:30

AUD

Trade Balance

-2.32B

-2.41B

THURSDAY, OCTOBER 6

All Day

CNY

Bank Holiday

08:30

USD

Unemployment Claims

255K

254K

FRIDAY, OCTOBER 7

04:30

GBP

Manufacturing Production m/m

0.4%

-0.9%

08:30

CAD

Employment Change

26.2K

08:30

CAD

Unemployment Rate

7.0%

08:30

USD

Average Hourly Earnings m/m

0.2%

0.1%

08:30

USD

Non-Farm Employment Change

171K

151K

08:30

USD

Unemployment Rate

4.9%

4.9%

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