Weekly Forex Currency Review 03-05-2013

The main global central banks will remain committed to aggressive stimulus polices in the short-term with no immediate prospect of any tightening. Markets will monitor growth trends very closely with fears that policy action will be ineffective in underpinning demand as underlying credit deleveraging continues.

Key events for the forthcoming week

Dollar:

There have been continuing uncertainties surrounding the US growth outlook with evidence of faltering demand as fiscal tightening takes effect and unease will persist if there is a weaker than expected payroll report. In this context, the Federal Reserve will maintain a highly accommodative policy in the short-term and will be much less willing to consider a scaling-back of bond purchases.  The US economy is, however, still likely to out-perform Europe and global doubts will also help underpin the dollar. An improved trade position will also help underpin the dollar and major losses for the currency look unlikely.

The dollar lost ground in the middle of the week and retreated to two-month lows on a trade-weighted basis before finding support and regaining ground.

The US data was again generally weaker than expected with the ADP employment growth estimate declining to 119,000 for April from a downwardly-revised 131,000 the previous month. The ADP report did reflect weakness seen in the monthly payroll report last month and the data reinforced unease surrounding a weaker labour market. The Chicago PMI index which fell sharply to 49.0 for April from 52.4, the lowest reading since September 2009. There was also a decline in the ISM manufacturing index to 50.7 from 51.3 previously.

The Federal Reserve maintained interest rates at a maximum of 0.25% following the latest FOMC meeting and the rate of bond purchases was also maintained at US$85bn per month. There was again a dissenting voice from Kansas City president George.  The Fed maintained confidence that inflation would remain subdued. There was a slightly more confident that expected assessment of the growth outlook with gains in consumer spending, investment and housing.  There were also comments that the labour-market had shown some signs of improvement. The committee stated that the rate of bond purchases could be increased or decreased depending on the economic developments. The dollar gained some relief over the economic assessment.

In contrast to recent sessions, the US economic data was better than expected even if the impact was over-shadowed by the ECB action. There was a decline in jobless claims to a five-year low of  324,000 in the latest week from a revised 342,000 the previous week. Although the data is erratic on a weekly basis, there will be reduced fears over a sharp deterioration in conditions. The latest monthly payroll data will be watched very closely on Friday for further evidence on underlying trends.

There was also a decline in the trade deficit to US$38.8bn for March from a revised US$43.6bn previously. There will be some concerns surrounding a decline in imports, but there will also be some expectations of an upward revision to the first-quarter GDP data. The Euro was able to stabilise, but unable to move back above 1.31.

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The ECB cut in interest rates will not have a major economic impact. The comments surrounding the possibility of negative deposit rates is important and any move to introduce negative rates would trigger sustained selling pressure on the Euro, although this is likely to be resisted for now.  Growth fears will persist in the short-term and structural fears surrounding the peripheral economic will be a major negative factor for the currency, especially if political tensions intensify.  There will still be some protection from a lack of confidence in other major economies and sentiment will improve if growth conditions stabilise.

The Euro pushed to eight-week highs above 1.32 against the US dollar before retreating sharply following the ECB rate decision.
 
There was further relief that a government had been formed in Italy as parliament debated confidence votes with the Letta winning the votes in parliament.  There were expectations that the administration would agree on a limited reform programme which would help underpin near-term sentiment.

In this environment, there was a further decline in yields at the latest Italian auction. There was a decline in the benchmark 10-year yield to below 4.0% for the first time since October 2010 as the search for yield continued. There will be the threat of tensions between Germany and Italy surrounding austerity programmes and relations between Germany and France remain extremely tense.

The Euro-zone economic releases reinforced concerns surrounding the growth outlook and political pressures.  There was a second successive increase in German unemployment for April and, as far as the Euro-zone as a whole is concerned, the jobless total increased to a fresh record high of 12.1%. There was also a decline in the flash inflation rate estimate to 1.2% from 1.7% previously.

At the latest council meeting, the ECB cut the benchmark repo rate to a fresh record low of 0.50% from 0.75% previously.  In the press conference, Chairman Draghi stated disappointment that expansionary monetary conditions had not translated into improved economic performance.  Importantly, there were comments that the central bank was technically ready to deploy negative interest rates if required. The ECB head also expressed less resistance to the use of negative rates than had been evident in previous comments. Draghi stated that there was a very strong consensus within the council for interest rates to be cut. There were also suggestions that many members had pressed for more aggressive policy action at the meeting.

These comments from Draghi were crucial in reversing the initial Euro gains with speculation over further measures over the next few months and the currency dropped sharply to lows below 1.3050 against the dollar.

Yen: 

The Bank of Japan will continue to sanction an extremely aggressive monetary policy in the short-term as it targets a doubling of the monetary base and trigger an increase in inflation expectations with the intention to boost consumer demand.  There are risks that policy action will destabilise underlying bond markets and there is also the risk that expected capital outflows from Japan will not materialise. Volatility will remain a key feature and the yen is unlikely to sustain significant gains given the policy stance.

The dollar was unable to make a fresh challenge on resistance near 100 against the yen, but found strong support on dips. Activity was dampened by the impact of Golden Week holidays in Japan. The run of disappointing run in the US, dampened expectations of increased yield support for the US dollar.  There were further expectations of capital outflows from Japan once the holidays have been completed, although markets remained cautious over trends..

There were stronger than expected readings for Japan household spending with a 5.2% annual increase and the housing data was stronger and unemployment fell. The positive impact was offset to some extent by weaker readings for retail sales.

The Bank of Japan minutes from April’s policy meeting stated that some members had reservations surrounding the aggressive shift in monetary policy with concerns over the risks of instability in domestic markets.

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There has been some improvement in confidence surrounding the UK outlook as business surveys recover. There will also be reduced expectations of near-term action by the Bank of England to expand quantitative easing. The underlying economic backdrop is still very weak and the UK currency will remain dependent on a lack of confidence in other major currencies to make significant headway, especially with continuing vulnerability in the balance of payments position.  Overall, Sterling is unlikely to make much headway.

Sterling proved resilient during the week as steady data and doubts over other major economies helped underpin Sterling.
 
The latest mortgage approvals and lending data was relatively subdued which will maintain doubts surrounding spending trends and there was also a monthly decline in money supply which will raise concerns within the Bank of England. There were also comments from Chancellor Osborne which suggested that the government would effectively push for further Bank of England action to stimulate the economy.

The latest PMI manufacturing index was stronger than expected with a reading of 49.8 from a revised 48.6 previously . Although still considering a net contraction, there was relief over some limited improvement with output and orders rising for the first time since January. The UK PMI construction index edged to a six-month high of  49.4 for April from 47.2 previously which maintained a slightly more optimistic tone.

There were reduced expectations that the Bank of England would adopt further near-term monetary easing and there will be a further shift in sentiment if there is a stronger than expected reading for the services PMI index due for release on Friday.

Swiss franc:

There will be the potential for additional capital flows into the franc following the ECB rate decision. The impact from the 0.25% rate reduction will be limited, but there will also be concerns over the possible move to negative deposit rates which could have a much more substantial impact. The National Bank will continue to defend the Euro minimum level aggressively in the short-term and will also have to consider negative interest rates if there is any ECB move.
 
The dollar retreated to lows around 0.9250 against the franc before stabilising while the Euro retreated to the 1.22 region during the week.

Expectations of a more dovish Federal Reserve tone and an ECB rate cut continued to provide some background support for the Swiss currency. There was a small increase in the PMI index to 50.2 from 48.3 the previous month. The ECB hint that it could sanction negative interest rates will cause unease within the Swiss National Bank and there is also the potential for capital inflows into the Swiss currency.

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The Australian dollar was unable to push above the 1.04 level against the US currency during the week and dipped sharply to re-test support levels near 1.02.

The domestic data was weaker than expected with depressed readings for the PMI indices while there was also a sharp drop in building approval for the month. There were further concerns surrounding the domestic and international growth outlook with disappointing data from China, maintaining fears surrounding a slowdown.

The Australian dollar will be vulnerable on domestic and international growth concerns, especially as it remains over-valued from a medium-term perspective.

Canadian dollar:

The US dollar remained under pressure during the first half of the week and retreated to lows near 1.0050 before staging a limited rebound. The Canadian currency gained from a generally weaker US unit with some covering of short positions.

The GDP data was stronger than expected with a 0.3% February gain while there was a slightly stronger than expected trade account with a balanced position. The currency retreated after Poloz was named to succeed Carney as Bank of Canada Governor

Uncertainty surrounding the domestic economy and central bank policies, together with global growth doubts will tend to limit Canadian dollar support.

Indian rupee:

The rupee was able to secure a firmer tone during the week and pushed to two-month highs around 53.80 against the US currency before retreating following the RBI meeting. There was optimism surrounding capital inflows into the stock market which helped underpin the currency.

There was a high degree of uncertainty surrounding monetary policy with the Reserve Bank stating that there was only limited space for further monetary easing. The bank announced a 0.25% cut in interest rates to 7.25% which curbed currency support.

Although the rupee will continue to gain some degree of support on expectations of renewed capital inflows, progress is likely to be limited given the risk profile.

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The Hong Kong dollar found support close to 7.7650 against the US currency during the week and strengthened to the 7.76 area as ranges were still relatively narrow.

There were medium-term expectations that the Hong Kong dollar could be pegged to the Chinese yuan and, while the Chinese currency maintains a robust tone, there will be expectations of underlying strength in the Hong Kong currency. With the Federal Reserve maintaining a very accommodative stance, there were persistent fears surrounding the underlying inflation trends.

There will be further uncertainties over the implications for Hong Kong of imported inflation, especially with the US Federal Reserve maintaining very low interest rates.

Chinese yuan:

The Chinese yuan maintained a very solid tone during the week with fresh 19-year highs around 6.1550  against the dollar before a limited correction on Friday as the PBOC was generally content to establish general strengthening while a series of market holidays dampened activity.

There were some concerns surrounding the economy with the PMI index dipping to 50.6 for April from 50.9 previously amid underlying unease surrounding credit risks as the services-sector PMI index also fell over the month.

Despite expectations of a wider trading band, the yuan will find it more difficult to make headway given that underlying concerns surrounding the economy will increase.

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