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Geopolitical concerns have financial markets behaving in a cautious manner to start the new trading week, as flare-ups in Iraq and Ukraine are causing investors to rotate into perceived safe-haven asset classes.    Combat between the Iraqi military and the Sunni insurgents continues in Northern Iraq, though their progress has been stalled with counter-strikes from the Shiite government.   It  has also been reported that Iran is preparing to send troops to Iraq to help with the insurgency, and that under  certain circumstances the White House could open direct talks with Iran on how to coordinate support for the Iraqi government.   At  this point oil production has not been greatly affected by the conflict as it has taken place mainly in the north, though if oil supplies do see a large disruption, a spike in Brent north of $120/barrel would not be out of the  question; currently the global benchmark is  sitting roughly unchanged at $112/barrel.

Also adding  to the nervousness in global markets, the talks between Ukraine and Gazprom have broken down, with the  Russian  energy giant  saying it will only provide enough  gas to Ukraine’s pipeline network to  cover demand from other European countries.   This was after an agreement could not be reached  for ongoing prices of natural gas supplies to Ukraine, along with the payments in arrears currently owed to Russia.    The Russians had agreed to drop the price to $385 per 1000 cubic meters, yet Kiev decided to play hardball and not budge above its interim offer of $326 per 100 cubic meters.   With less usage in the summer and  its current stockpiles, Kiev said it expects to be able to meet demand until the fall, so it’s likely the negotiations will continue  until it is absolutely necessary for Ukraine to get  the gas flowing again.
The combination of the two geopolitical events has safe-havens like the Japanese Yen and fixed income garnering trade flows this morning,  while global equities having  trouble  coming out of the starting blocks as  S&P futures are pointing to a lower open to kick of the new week.    USDJPY has  lost the 102 handle to the downside, with the yield on the 10-year US  treasury dipping below 2.6% as bonds outperform.   The Loonie is weaker against the  USD this morning, hurt  on the flight-to-safety trade that dominates market action.   USDCAD has picked up from the bottom end of  it’s recent range and is heading into the high-1.08s,  despite an encouraging sign in April that foreigners  added  $10.1bn of exposure to Canadian securities during the month.   The inflow into corporate debt and  equity markets is a positive sign for the Canadian economy, and should continue throughout the year  as the  energy industry in the West records record levels of revenue which will spur  cap-ex, and should  help keep the Loonie from experiencing another drastic drop even if the export sector fails to pick-up over the coming months.      

The Week Ahead…

Although the macro-economic data points to be released throughout the upcoming week will likely  be insufficient to greatly alter the global economic landscape, there are  a number of key reports and central bank action for participants to decipher.
After Mark Carney’s comments from last week  highlighted the  divergence in monetary policy stances between  the Bank of England  and the European  Central Bank, the UK will see  CPI for the month of May drop  early  on  Tuesday, followed up by the monetary policy minutes from the last BoE rate decision a few weeks  ago.    The pace of consumer price increases  within the UK economy has consolidated after peaking  in June of last  year, and has  given Carney more leeway to keep rates low while the economy chews through some of the excess slack.   Now with  prices with forecast to stabilize around the 1.7% level on a y/o/y basis, a  bottoming  for the CPI index could have Carney beginning to think about the optimal time to begin the gradual normalization of rates.   While Carney’s hawkish comments that a  rate hike might unfold sooner than the market anticipates has sent  the Pound within spitting distance of the 1.70  handle against the USD,  a dissent showing up on the voting card of the  MPC  would  spark further speculation the  rate hike could come as soon as the end of 2014, keeping  the Sterling rally alive and well.   It’s no far stretch to  think GBPUSD could be trading comfortably in the  low 1.70s later this week should a strong CPI report and hawkish  MPC minutes materialize, though  another failure to overtake the 1.70 handle  would be a negative technical development for long-GBP  participants.
Another central bank that is getting close to tightening policy will also  be in the spotlight this week, as the Federal Reserve holds their two-day policy meeting that will concludeon Wednesday.   While growth has experienced a welcome pickup from the sharp contraction in Q1, the resulting rebound has been less than stellar, as consumer demand was shown to have moderated in the first few months of the second quarter.   That being said, the labour market  has  remained resilient year-to-date, with the  ancillary data like average workweek hours and  earnings  picking up, showing some of the notable slack in the labour market may be tightening.   While the  autopilot of a $10bn/month taper program is unlikely to be in jeopardy of seeing a change, the risk heading into the report is one of a hawkish nature, and that of further upside for the USD.   Even with the Fed acknowledging the contraction in Q1 was greater than originally anticipated, the  likely downward revision to the end of year unemployment  forecast and potential for an upward revision to PCE forecasts may flow through  to the  FOMC’s dot plot of interest rate projections, and thus  warn a tightening could be expected  earlier than the mid-to-late 2015  market mindset.   In addition, this will be the first meeting of the new Vice Chairman Stanley Fischer, the former Bank of Israel  head,  and could skew the spectrum of the board to one that is slightly hawkish than  before his appointment.
While the early part of the week will be quiet from  a domestic economic standpoint, CPI figures for the month of May  to be released  on Friday  should liven things up for the Loonie. Expectations are for the  temporary effects of higher energy prices to continue, with the headline print breaking above the 2.0% handle on a y/o/y basis, while the core print remains  slightly more  subdued at  1.5%.    We would caution  the CAD bears that the larger, fat-tail risk for the CPI numbers  on Friday  is one that surprises to the upside, and has market participants questioning Poloz’s  dovish stance on inflation; though, subdued retail sales, an uncertain labour market, and  less than stellar  external demand should  keep inflation from getting out of hand, so the greater likelihood  is to see prices  remain close  to the 2.0%  level.
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