Weekly Fundamental Analysis – Feb. 21st, 2011

The Euro remains under pressure:

The Euro moved higher, during the week as US yields began to ease and become a safe haven.  Geo-political unrest has created a drop in US 10 year yields from the recent highs above 3.70%.  The currency was able to hold up despite fourth quarter 2010 GDP figures were slightly disappointing coming in at 0.3% rather than 0.4% consensus, but the adverse impact of the weather and the stronger PMI readings this year encouraged the market to look past these figures.  Peripheral spreads are modestly wider on the day, with Portugal 10-year yield above 7% for the 10th straight day. News that demand for overnight loans from the ECB jumped to the highest in 20 months, indicate that stresses remain in the banking sector.

Inflation Ticks Up in the US

The markets needed to absorb news of higher than expected inflation during the week.  The Producer Price Index (PPI), rose a seasonally adjusted 0.8% in January from December, according to the Labor Department. The majority of the rise was in energy prices.  Core PPI, which excludes food and energy, increased 0.5% last month.  Economists expecting a 0.9% increase in overall producer prices and a 0.2% increase in the core index.  Earlier in the week greater than expected increase in import prices gave dollar bulls some amunition.  Higher inflation leads to higher yields in the long end of the interest rate curve, which has pushed the US Japanese 10 year yield spread to 100 basis points.  On Thursday, The Consumer-price index last month increased by 0.4% from December, and underlying inflation, which excludes volatile energy and food prices, rose by 0.2%.

Manufacturing in the US was mixed.  The Federal Reserve released industrial production as well as the last minutes from their latest meeting.  Minutes of the Fed's policy-setting meeting showed central bank officials expect U.S. gross domestic product to increase between 3.4% and 3.9% this year. That compares with a November 2010 prediction the economy would expand between 3.0% and 3.6% in 2011.  Industrial production declined by .1% compared to the .7% increase expected by economists.  In contrast, The Philly Fed index of general business activity hit its highest level since January 2004, outstripping expectations as it jumped to 35.9 in February from 19.3 the month prior.

Crude Oil Shows Some Life

WTI moved higher as a combination of continued unrest in the middle east, along with better than expected demand for heating fuels have pushed WTI prices higher. Brent prices have continue to lead the oil complex higher, and has remain above $100 dollar per barrel.

The political unrest which has spread from Egypt to Iran, Yemen and Algeria is keeping the oil markets on edge, as a potential disruption in supply is now closer to larger oil producers such as Iran.  The Department of Energy released inventory numbers on Wednesday, which showed a better than expected weekly picture.  U.S. stocks of oil rose by 900,000 barrels last week, compared to the  1.7-million-barrel increase that was expected by analysts. Gasoline stocks rose by 200,000 barrels after a survey showed analysts expected stocks to jump by 1.2 million barrels, but the increase pushed total gasoline stockpiles up to the highest level since 1990.  Stocks of distillates, which include heating oil and diesel, fell by 3.1 million barrels despite the move of 1 million barrels of heating oil from a government reserve to commercial stockpiles. Inventories were seen falling by 800,000 barrels.  Additionally, Total products supplied (demand) over the last four-week period has averaged 19.3 million barrels per day, up by 1.5 percent compared to the similar period last year.  The spread between WTI and Brent has now reached an all time high of $16 dollars a barrel.

Next week the markets will be watching:

• Monday German Ifo Survey (700 GMT) US Presidents Day Holiday
• Tuesday – Canada Retail Sales (1330 GMT), US Case Shiller (1400 GMT)
• Wednesday – US Existing Home Sales (1330 GMT), Japan CPI (2330 GMT)
• Thursday – EMU Economic Confidence (1000 GMT), US Durable Goods (1330 GMT)
• Friday – US GDP (1330 GMT)