Weekly Forex Currency Review 03-02-2012

Central bank policies will remain an extremely important focus in the short-term and aggressive liquidity operations will help underpin risk appetite globally with reduced fear surrounding the growth outlook. Concerns are liable to return again quickly given the underlying pressure for de-leveraging in the financial sector and high risks surrounding the Chinese economy. There will be further fears surrounding the Greek situation as some form of default remains unavoidable.

Key events for the forthcoming week 

Dollar:

The latest data releases continue to indicate solid US growth is likely in the short-term, although there have been some concerns that momentum will fade over the next few months.  The Federal Reserve has reinforced its commitment to maintaining very low interest rates and this will be important in curbing any significant yield support for the dollar. Global influences will remain very important and defensive US currency demand will also stay lower when there is increased optimism that central bank liquidity will underpin growth.  Confidence is still liable to fluctuate sharply at times and, given pressure for financial de-leveraging, the dollar should be able to resist heavy losses.

The dollar was generally weaker as an improvement in risk appetite helped curb defensive demand for the currency while yield conditions failed to improve further. Month-end flows triggered fresh volatility with the Euro hitting resistance above the 1.32 area while the dollar found some support at 2-month lows.  

The early US economic data was generally weaker than expected with a decline in consumer confidence to 61.1 for January from a revised 64.8 previously, in sharp contrast to expectations of a gain. The Chicago PMI index also weakened to 60.2 for the month from 62.2 previously.  The data had a significant impact in undermining risk appetite which provided some defensive dollar support.

The US ADP employment report was slightly weaker than expected with a 170,000 increase for January, but there was still a strong two-month increase following a revised 292,000 gain the previous month. The ISM index rose to 54.1 from a revised 53.1 the previous month. Employment and order components were firm. The other US economic data did not have a major impact with a decline in jobless claims to 367,000 in the latest week from 379,000 previously.

There were divergent views from regional Fed Presidents who are not on the FOMC this year with Fisher stating his opposition to any further quantitative easing while Evans maintained his dovish tone and promoted the case for further monetary action.

Fed Chairman Berrnanke took a more balanced approach in Congressional testimony and was keen to emphasis that the Fed would not abandon the inflation target, although is tone may well have been aimed at placating Republican fears.

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The Euro-zone data as a whole has shown some improvement, but the gains have again been focussed to a large extent in Germany as peripheral economies remain stuck in recession.  Although the ECB has managed to avert the immediate threat of a severe credit crunch, underlying financial conditions are likely to remain extremely tough and there will be strong pressure for the ECB to cut interest rates again.  It will also be extremely difficult for Greece to avoid a default with Portugal also exposed to a contagion threat. The policy mix will tend to undermine the Euro unless there is increased speculation surrounding the possibility of a hard, smaller Euro area being formed.

The Euro retained a corrective and firmer tone against the dollar and did move to 2012 highs before stalling as it struggled for traction on the crosses.
 
The Euro-zone PMI manufacturing index edged higher in the final reading with Germany a notable gainer. Optimism was tempered by the fact that indices in Greece, Spain and Italy all remained substantially below the 50 threshold. The flash Euro-zone consumer inflation estimate was unchanged at 2.7% for January and markets still expected that the ECB would look to cut interest rates further this quarter.

There was further speculation over an imminent Greek private-sector debt restructuring deal, although again there was no actual announcement of a deal. There was also some relief surrounding Portuguese debt following a satisfactory bill auction, but yields remained close to record highs as confidence remained very fragile.

Given the Greek debt profile, either the government will have to find additional savings which, politically, will be extremely difficult or there will need to be even bigger losses for private creditors. Any such deal for creditors would be regarded as an effective default by the ratings agencies.  There were further concerns surrounding Portugal’s default risk as yields rose to fresh record highs.

There was further downward pressure on the Euro following comments from Euro-group Head Juncker that the Greek debt restructuring situation was ‘ultra-difficult’. Following numerous reports over the past week that a deal was extremely close, the comments inevitably dampened optimism surrounding the near-term situation. More seriously, there were fears that any restructuring deal would still not provide a durable solution given the underlying debt burden. In this context, there were also fears that Greece could still face a Euro exit.

Yen:

There will be further concerns surrounding the industrial and trade outlook with profit warnings from important companies reinforcing fears surrounding the competitive situation. There will be pressure for the Bank of Japan to intervene, although it will be difficult to secure international backing which will limit the effectiveness of any action.  There will also be pressure for the Bank of Japan to take a more aggressive stance on quantitative easing.  There will still be scope for defensive inflows into Japan, especially given fears over the Euro-zone outlook and the yen may still be able to avoid heavy selling pressure.

The dollar dipped sharply before finding support just above the 76 level against the yen while rallies were very limited and capped below the 76.50 area as the Euro hit strong selling pressure close to 102. The US employment data will be watched closely and a firm release would help support the US currency to some extent.

Markets are also on high alert over intervention by the Bank of Japan and fear over action is deterring aggressive dollar selling. Finance Minister Azumi continued to intervene verbally and stated that Japan will act firmly to counter speculation, but there was no evidence of actual intervention.

The problem for the Japanese authorities is that there is little evidence of underlying yen selling even when risk appetite strengthens and this suggests that there is robust underlying demand for the currency as Euro-zone fears continue. 

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Confidence in the UK economy will remain weak with particular concerns surrounding consumer spending.  There will also be continuing fears over fragile Euro-zone demand and the weakness in monetary data will be of particular concern to the Bank of England. There will, therefore, be continued speculation over additional quantitative easing within the next few weeks. The immediate impact on Sterling may be limited, especially as there is still the potential for defensive inflows into the UK if Euro-zone fears intensify, but there will be concerns surrounding the medium-term currency outlook.

Sterling maintained a firm tone against the dollar for much of the week and pushed to a five-month high above 1.5850 before stalling.  UK currency moves are still influenced strongly by trends in risk appetite and a firm global tone helped boost the UK equity market as well as Sterling against the Euro.

The PMI manufacturing data was stronger than expected with an increase to 52.1 for January from a revised 49.7 although confidence was still fragile and the data is likely to have been distorted by favourable weather conditions.  The Nationwide house-price index recorded a 0.2% decline for the second consecutive month, maintaining the recent soft tone in the housing sector.

The latest consumer lending data was weaker than expected with a decline in consumer credit for December and there was also a further sharp monthly drop in money supply. Although the data may have been distorted by special factors, there will be further concerns over banking-sector vulnerability and a lack of lending.

Bank of England MPC member Posen was slightly more optimistic surrounding the economic outlook, but he still proposed additional quantitative easing of around GBP75bn. The currency impact of further easing on this scale should be measured, with uncertainty a key feature ahead of next week’s Bank of England policy meeting.

Swiss franc:

National Bank policies will remain an extremely important focus in the short-term, especially with the Euro sitting uncomfortably close to the 1.20 minimum level set by the bank.  There will be further verbal intervention to support he Euro and the potential for actual intervention to defend this level, especially as industrial fears remain at an extremely high level. There is still the risk of a sustained attack on the Euro, especially if fears over the banking sector return. There will be potential merger-related flows out of Switzerland which would undermine the franc and ease appreciation pressures.

The dollar found support on dips to the 0.9130 area against the franc while major resistance levels remained intact.  Euro moves were again an important focus as the currency fluctuated around the 1.2050 region.

There was further market speculation that the National Bank will be less committed to defending the Euro minimum level, especially with no permanent Chairman in place. Acting-head Jordan maintained the standard line in comments on Thursday with comments that the minimum level would be defended with the utmost determination. Any intensification of the Greek crisis could severely test the bank’s resolve.

The latest Swiss PMI data was weaker than expected with a decline to 47.3 for January from a revised 49.1 previously which will cause additional concern given that Euro-zone indices were generally stronger for the month.

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The Australian dollar maintained a strong tone during the week and challenged levels above the 1.07 level against the US currency.  International risk appetite was stronger which helped underpin the local currency as fears surrounding the international growth outlook eased.

Domestically, there was a slide in building approvals following a strong gain the previous month while new home sales declined. The PMI data was more encouraging than in recent months as the manufacturing and services indices were both above 50.

The Australian dollar will continue to be subjected to high volatility and much of the favourable news looks to have been priced in at current valuations.

Canadian dollar:

The Canadian dollar continued to gain support from a weaker US currency and pushed to highs beyond the parity level for the first time since the end of October. International trends dominated as the Canadian currency took advantage of US vulnerability and a generally robust tone in risk appetite.

The domestic data was weaker than expected with a second successive monthly GDP decline for November while there was a decline in producer prices which will ease any pressure for higher Bank of Canada interest rates.  

The Canadian currency should prove to be broadly resilient, although it will be difficult to extend gains much beyond parity, especially if oil prices fall.

Indian rupee:

The rupee was able to make further headway during the week and pushed to 3-month highs against the dollar with brief gains to beyond the 49 level. Overall risk appetite was firmer which helped underpin the rupee, especially with the US currency generally weaker.

There were net capital inflows of near US$5.7bn for January which has underpinned the currency and there has also been greater optimism that inflation has peaked.

The rupee will find it difficult to extend gains much further given the underlying risk profile and uncertainties surrounding the Indian economy.

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The Hong Kong dollar maintained a firm tone during the week and continued to test resistance levels beyond 7.76 against the US currency with a peak in the 7.756 area. Underlying dollar demand was weaker as international risk appetite was stronger which helped underpin the local currency.  

Risk conditions will tend to dominate and any fresh doubts surrounding the Chinese outlook would limit potential Hong Kong dollar gains from current levels.

Chinese yuan:

Chinese markets re-opened following the new-year break, although trading conditions were still relatively subdued. The yuan maintained a firmer tone against the dollar as the PBOC guided it stronger and the currency also gained support from a weaker US tone generally. There was little interest in pushing the currency much beyond 6.30 even with the Euro remaining firm.

The latest PMI readings were mixed as the official index moved above the 50 level even though the underlying components were generally weak. Although there had been speculation over a move to cut reserve ratio requirements, but there was no move by the central bank. Reserves fell during the fourth quarter for the first time in 10 years which had some impact in curbing yuan demand.

The yuan will find it difficult to make strong headway given the evidence of capital outflows and persistent unease surrounding the property sector.

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