Weekly Forex Currency Review 02-03-2012

The global central banks will continue to provide a very expansionary monetary policy in the short-term with a particular focus on the ECB following the second LTRO operation. The expansionary policies will help underpin global risk appetite, although there will still be fears surrounding the banking sector as pressure for de-leveraging will continue.  This is likely to curb demand for risk assets even if confidence remains firm initially.

Key events for the forthcoming week

Dollar:

There should be some degree of optimism surrounding the US economy in the short-term following a run of generally favourable releases, although this confidence could still prove to be very brittle given the underlying debt stresses. Federal Reserve policies will inevitably remain an important focus and diminished expectations of further quantitative easing will provide some degree of initial dollar support. The Fed will, however, still maintain a very loose policy and another round of bond purchases will certainly remain an option. The US currency will lose defensive support while there is optimism that aggressive liquidity supply will boost global risk assets.  

The dollar struggled to gain support during the week as defensive demand remained weaker, but it did move off its weakest levels and there was a recovery in the trade-weighted index as the Euro and yen weakened.
 
The US economic data was mixed with a slightly stronger than expected fourth-quarter GDP revision up to 3.0% from 2.8% previously.  The Chicago PMI index rose to 64.0 for February from 60.2 previously and the Fed’s Beige Book reported that growth was modest to moderate in most districts.

US jobless claims data recorded little change at 351,000 in the latest week while there was a small increase in personal spending. Somewhat surprisingly given the regional surveys, there was a decline in the PMI manufacturing index to 52.4 for February from 54.1 previously, although there were solid readings for orders and employment which helped lessen the impact.

Comments from Fed Chairman Bernanke were watched very closely, especially with quantitative easing an important international focus. The Fed Chief was slightly more optimistic surrounding the economic outlook with comments that unemployment was falling faster than expected. Bernanke maintained that an aggressive and expansionary monetary policy was justified, but he also stated that there was no immediate case for a further expansion of quantitative easing.

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There will be further expectations that the aggressive liquidity operation by the ECB will be important in boosting demand for peripheral bonds which will help keep yields low.  There will also be hopes that the an easier monetary policy will help offset fiscal contraction. There will be tensions surrounding ECB policies which will tend to undermine the Euro and the policy mix will not be Euro supportive. There will also be fears that the Greek crisis has still not been resolved and that there will eventually be a Euro exit.  In this environment, the Euro will still find it very difficult to gain sustained support.

The Euro rallied early in the week before weakening following the LTRO operation as the implications of effective quantitative easing undermined the currency.

The ECB announced that EUR530bn was allocated in the second LTRO operation which was marginally higher than expected and compared with a EUR489bn figure last time. There was a surprise in the number of banks which took part as more than 800 institutions took funds in the operation from 500 last time.

There were some fears that the substantial number of banks taking part suggested that more banks were facing funding stresses. The Euro was also undermined by the quasi quantitative easing and by further doubts surrounding the banks balance sheet and the exposure to bad debts. There was also a sharp rise in Portuguese bond yields.

The positive expectations were also offset by the announcement from Ireland that the government will hold a referendum on the EU proposed fiscal compact. This will inject fresh uncertainty over the medium-term outlook even though there was little market confidence in the concept of a fiscal compact in the first place.   

The Euro-zone unemployment rate rose to a fresh 15-year high of 10.7% for January from a revised 10.6% the previous month, reinforcing fears over underlying demand conditions and there was a further slide in the Greek PMI index.

The underlying Greek situation remained an important focus as the ISDA ruled that the Greek private-sector debt swap and ECB bond swap did not constitute a credit event which would trigger credit default payments.  The ISDA did warn that it was still monitoring developments and the triggering of Collective Action Clauses could still trigger action. The underlying stance increased doubts over peripheral bonds.

There were also further signs of tensions between the ECB and Bundesbank as a letter between Bundesbank Head Weidmann and ECB head Draghi revealed policy disagreements. There were also suggestions that part of the Greek loan would be withheld as required measures were still to be implemented.

Yen:

There will be further concerns surrounding the industrial outlook with important stresses within the high-tech sector.  The latest economic data will provide some relief, especially if stronger investment flows can be sustained. The Bank of Japan will maintain a highly expansionary monetary policy which will curb yen demand and there will be pressure for even more aggressive action if the currency regains ground.  The yen may gain some near-term support from capital repatriation, but the dollar should be able to maintain a robust tone.

The dollar was able to find support below the 80 area against the yen and, after an initial period of consolidation, the currency pushed sharply higher during the middle of the week.  The US currency drew initial support from the stronger than expected GDP data and momentum accelerated following Fed Chairman Bernanke’s comments which downplayed the potential for further quantitative easing and boosted US yields.

The Japanese household spending data was weaker than expected with a 2.3% annual decline while unemployment was unchanged while core consumer prices fell 0.1% over the year. The main focus was on Bank of Japan Governor Shirakawa’s comments as he stated that the central bank would continue to ease monetary policy. The dollar moved back to a 7-month peak in the 81.50 region following the comments.

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There has been some shift in sentiment over the past month with slightly greater confidence in the economy and reduced expectations of further quantitative easing by the Bank of England.  The improvement in confidence could be very fragile given the underlying debt fears even if lower inflation helps protect real incomes. Sterling will tend to gain support if global risk appetite improves, but this will be offset by reduced defensive demand if the improvement is triggered by an improvement in Euro-zone sentiment. Importers will tend to increase Sterling selling near current levels against the Euro.

Sterling was able to strengthen sharply against the Euro during the week as it pushed to the 0.8350 area and this help the UK currency maintain a robust tone against the dollar as it tested 3-month highs near 1.60.

The latest CBI retail sales survey was significantly stronger than expected with a reading of -2 for February from -22 previously and there was also a slightly more optimistic outlook. Mortgage approvals increased to a two-year high of 59,000 while consumer net lending was also significantly stronger than expected. There will also be some Bank of England relief that there was an expansion in money supply.

There were inevitably mixed comments in Bank of England parliamentary testimony on the inflation report.  Governor King remained very anxious surrounding bank capital levels, but also stated uncertainty surrounding further quantitative easing. Tucker and Bean expressed some concerns over the inflation outlook and Weale was more forthright instating that he did not see the case for further easing.

The latest PMI data was slightly weaker than expected with the manufacturing index edging down to 51.2 from 52.0 previously. There was, however, some relief that the index stayed above the pivotal 50 level for the month which maintained reduced expectations of recession. There was also a monthly increase in house prices according to the latest Nationwide survey.

There were also expectations that the ECB would be more aggressive than the Bank of England in boosting monetary policy which helped Sterling.  
 
Swiss franc:

Fears over the economic outlook are likely to ease slightly in the very short-term. National Bank policies will remain an extremely important focus in the short-term. The bank has remained determined to block franc gains, but there is still the risk of a fresh attack on the minimum Euro level, especially given persistent fears surrounding the Euro-zone outlook. The franc could also gain some defensive support as an alternative safe-haven if there is a sustained reduction in confidence surrounding the yen and other major currencies.

The dollar was able to find support below the 0.90 level against the Swiss franc during the week and the Euro also found support below the 1.2050 level.

The latest Swiss KOF index was little changed with an improvement to -0.12 from -0.15 previously as companies remained uneasy over the outlook. The Swiss PMI index rose 49 for February from 47.3 previously and coincidentally was the same figure as the Euro-zone.  There was a stronger than expected reading for fourth quarter GDP which also provided some degree of relief surrounding the outlook.
 
There will still be the potential for capital inflows into the Swiss currency given unease over the impact of extremely expansionary G3 monetary policies.

National Bank interim Chairman Jordan in essence repeated the standard bank rhetoric on the franc with comments that the 1.20 minimum level would be defended with the utmost determination.  

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The Australian dollar found support on dips to the 1.06 region against the US currency during the week while there was tough resistance above the 1.08 level.

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There was mixed domestic data with generally weak measures for the housing sector as home sales fell sharply while there was a solid reading for retail sales.

There was greater optimism surrounding the global economy and risk appetite was firm which helped support the currency with firm commodity prices offering support.

The Australian dollar will gain support if confidence in the global economy remains higher, but a substantial amount of favourable developments have been priced in.

Canadian dollar:

The Canadian dollar traded stronger than parity throughout the week and tested four-month highs beyond 0.99.

The currency gained significant support from a rise in oil prices and there was also a solid influence from risk appetite. The domestic data did not have a significant impact with markets waiting for the next GDP release.

The Canadian dollar should be broadly resilient, especially given high oil prices. Sustained rises in costs would, however, increase fears over the growth outlook.

Indian rupee:

The rupee was held in relatively narrow ranges during the week as conflicting factors tended to narrow ranges with rupee resistance beyond the 49 area. There was an increased focus on oil prices which triggered a direct increase in demand for dollars and also had an important impact in dampening demand for the rupee on concerns that the economy would be subjected to fresh selling pressures.

There was some disappointment over the Federal Reserve stance on potential quantitative easing, although underlying global risk appetite held relatively firm.

The rupee will be hampered by concerns over the impact of high oil prices, especially as energy costs will undermine growth and complicate monetary policy decisions.

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The Hong Kong dollar was unable to make a serious challenge on the 7.75 band limit against the US currency and was generally trapped within narrow ranges. The US currency recovered from its lowest levels which curbed Hong Kong dollar demand Risk appetite was generally solid which helped support the local currency as the bourse made headway.

Risk conditions will remain very important and any fresh doubts surrounding the Chinese outlook would limit the potential an attack on the 7.75 band limit.

Chinese yuan:

The yuan maintained a broadly steady tone over the week with global risk appetite generally firm. The PBOC was content with relatively narrow ranges and also appeared reluctant to let the currency strengthen much beyond the 6.30 level, especially with the dollar recovering from lows against the Euro.

There was some relief that the PMI index held above the 50 level for February and there were also hopes that the National Congress, due to be held over the next week, would announce fresh measures to stimulate the economy. There was still a high degree of uncertainty surrounding the underlying outlook.

The yuan is still likely to be hampered by the threat of a sharp slowdown in growth even if there has been some relief in the most recent data and stock-market trends.

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