Weekly Forex Currency Review 03-08-2012

Global central bank and government action will inevitably be extremely important in the short-term. The ECB will move closer to sanctioning additional and potentially decisive action to support the Euro-zone and through quantitative easing and there will be further speculation of Federal Reserve action as part of a co-ordinated response.  There will still be important political stresses, especially within Spain and Germany as uncertainty remains at very high levels.

Key events for the forthcoming week

Date	Time (GMT)	Data release/event
Friday August 3rd	12.30	US Non-farm payrolls
Tuesday August 7th	04.30	Australia interest rate decision
Wednesday August 8th	09.30	Bank of England inflation report

Dollar:

The evidence overall has continued to suggest that the economy has faltered over the past few weeks with generally soft data releases and subdued retail sales. The Federal Reserve has indicated that it will take further action if the economy continues to deteriorate and there will be speculation of additional quantitative easing in September, potentially as part of co-ordinated global action.  A lack of yield support will curb dollar support, especially when risk appetite holds firm. International influences will remain extremely important and the net pressure for de-leveraging, together with central bank demand for dollars should provide important underlying protection for the currency.

The dollar regained some support over the second half of the week following the Federal Reserve and ECB policy meetings, although it struggled to gain strong support given expectations of further Fed action.

As far as the US economic data is concerned, there was a 163,000 increase in ADP employment for July from a revised 176,000 previously which was significantly above expectations. The ISM manufacturing index improved marginally from the previous month, but it held below the benchmark 50.0 level for the second successive month which fuelled expectations of a slowdown in the US and global economy as manufacturing releases remained generally depressed.

There was a stronger than expected reading for consumer confidence at 65.9 for July from a revised 62.7 previously while there was a 0.7% decline in the Case-Shiller house-price index in the year to May. The Chicago PMI index increased to 53.7 for the month from 52.9 previously. There was a subdued reading for consumer spending.

The Federal Reserve left policy on hold at the latest FOMC meeting with another 11-1 vote for rates to be left on hold as Lacker dissented again, this time objecting to the stated expectations that rates would be left at extremely low levels through 2014.  There were no hints of any further policy action by the Fed and no further extension to 2015, although it promised to monitor developments closely. There were also concerns surrounding the economy which was deemed to have decelerated with a slowdown in consumer spending.  In this context, there will be the scope for fresh measures to be taken if the economy deteriorates further and inevitably the global economic trends will also be watched very closely as the Fed edges closer to action.

The US jobless claims data was slightly better than expected with an increase to 365,000 in the latest week from 358,000 previously. There was caution ahead of the pivotal US payroll data on Friday and a weak figure would intensify speculation over Federal Reserve quantitative easing in September.

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Confidence surrounding the Spanish and Italian economies will remain very fragile in the short-term and there will still be fears that Greece will be forced to exit the Euro area.  The ECB has indicated that it is prepared to take additional aggressive action to push yields down. This will, however, be dependent on political developments and a request for assistance from Spain and there will also be resistance from the Bundesbank and German government.  If the ECB and governments can salvage the Euro area broadly intact then the most likely outcome is that policy shifts will push the Euro sharply weaker.  

Euro volatility increased during the week and there were net losses with a test of support close to 1.2150 against the US dollar before a recovery.
 
There were further fears surrounding the Greek situation with Finance Ministry officials stating that Greece was running out of cash. The Euro found support in the 1.2250 area against the dollar ahead of the ECB interest rate decision on Thursday and pushed higher. Interest rates were left on hold at 0.75% following the latest council meeting and the Euro pushed to challenge resistance levels above 1.23 with a further spike higher ahead of the press conference as markets anticipated aggressive market action to underpin the Euro-zone.

In the press conference, President Draghi stated that the bank may move to start open-market operations. Draghi did not state whether any intervention would be sterilised or unsterilized. He stated that action could be taken within the next few weeks. There was, however, a clear intent over conditionality and insistence that governments would need to seek aid from the EFSF before there could be action.

There was initial market disappointment over Draghi’s comments who had hoped for more decisive action. Spanish and Italian bond yields rose sharply and the Euro was subjected to heavy selling pressure. There were clear signs that the Bundesbank had not agreed to radical proposals and that further negotiations would need to take place. There will also be an important focus on Spain and Italy as they will need to apply for a bailout before the ECB steps in to the market. Spain will effectively have to accept a sovereign bailout and prolonged austerity for ECB action to take effect.

The economic assessment was generally downbeat with further warnings over the downside to activity. Draghi stated that an interest rate cut had been discussed, but this was not the time for action. There will be expectations of a rate cut in September.

Yen:

Unease over the global economy will tend to support defensive capital inflows into the Japanese currency, especially with continuing fears surrounding the Euro-zone outlook.  Any further monetary easing by the Federal Reserve and ECB would also tend to trigger additional inflows into the Japanese currency. With inflation fears persisting, there will be additional pressure for further monetary easing by the Bank of Japan.  Regional competitiveness factors will also be extremely important with pressure for yen gains to be resisted, especially if the Chinese yuan weakens further.     

The dollar was unable to make any much headway against the yen and dipped to test support below 78. Technical considerations proved important with evidence of stop-loss selling in the Euro/yen cross pushing the Japanese currency stronger at times.

There will still be the potential for underlying yen buying support on defensive grounds, especially with speculation that the Federal Reserve and ECB will take action to expand monetary policy over the next few weeks. There will be expectations that the Bank of Japan will be forced to intervene aggressively to prevent yen gains.

Finance Minister Azumi rejected calls for the Bank of Japan to buy foreign bonds in order to help weaken the yen as this would be contrary to the bank’s statutes and this had some impact in underpinning the yen.

There was a decline in Japanese unemployment for the month, butt he household spending increase was slightly lower than expected and the PMI manufacturing index was slightly lower at 47.9 from 49.9 previously, maintaining doubts over the outlook.

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There will be further concerns surrounding the UK economic outlook with the manufacturing data recording a three-year low for July which will increase fears that the economy will be undermined by weak Euro-zone demand. There will be further speculation that the Bank of England will take additional action to boost demand through an interest rate cut or additional quantitative easing. There is still the potential for safe-haven Sterling demand in the context of Euro-zone fears, although these capital flows prove to be extremely volatile and Sterling could prove to be vulnerable if domestic fears intensify.

Sterling hit resistance close to 1.57 against the dollar and retreated to test support below 1.55 while the UK currency also retreated to three-week lows against the Euro.
 
The latest consumer credit data was weaker than expected with a subdued reading for consumer lending over the month and a drop in mortgage lending.  There was also a sharp decline in money supply for June which will increase fears over the outlook

The PMI index for the manufacturing sector was much weaker than expected with a reading of 45.4 from 48.4 the previous month. This was the lowest reading for 38 months and will reinforce fears surrounding the economic outlook. There was some relief in the latest economic data with the CIPS construction data moving back to above the 50 level for July

There were no changes in interest rates or quantitative easing at the latest Bank of England policy meeting which was in line with market expectations. There were expectations that the bank would take further action within the next few months given the economic weakness. The AAA rating was confirmed for now by two agencies.

Swiss franc:

With confidence in the Euro-zone outlook remaining extremely weak, defensive flows into the Swiss currency are likely to continue. The National Bank will still be forced to defend the minimum Euro level and there will be strong demands for the bank to consider capital controls or negative official interest rates if intervention is forced to remain at extremely high levels given fears that the central bank balance sheet will be destabilised. For now, the central bank is likely to stand firm and resist pressure.

The dollar pushed back to test resistance above 0.99 against the franc before edging lower while the Euro found it very hard to sustain any significant gains.

The latest Swiss National Bank reserves data reported that there was a substantial increase in the proportion of Euro reserves held by the bank which will maintain the risk of further underlying selling by the bank to rebalance reserves.

Expectations that the ECB will move towards quantitative easing could trigger renewed capital flows into the Swiss currency and maintain pressure on the 1.20 minimum level. The Swiss PMI index edged higher to 48.6 for July from 48.1 the previous month which will provide only limited relief.

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The Australian dollar was subjected to volatile trading during the week and was able to resist substantial selling pressure with support on dips towards the 1.04 level against the US currency.

There were no immediate measures by the Federal Reserve or ECB, but expectations of future action helped underpin risk appetite and boosted the Australian currency. Domestically, a stronger than expected reading for retail sales and the trade account also provided support and helped offset unease surrounding the global economy.

Although there will be expectations of central bank action to support the global economy, the Australian dollar will find it difficult to sustain any further gains.

Canadian dollar:

The Canadian dollar maintained a generally firm tone during the week and pushed to challenge resistance levels near parity. The currency was unable to extend gains through this level with losses following the ECB policy meeting

A weaker than expected GDP report also dampened expectations surrounding the growth outlook which curbed Canadian dollar support.

Although losses should be contained, concerns surrounding the global economy and commodity-price trends will tend to limit scope for Canadian dollar gains.

Indian rupee:

The rupee proved resilient for much of the week before weakening back through the 56 level against the US dollar. There was disappointment surrounding the ECB meeting and a loss in regional equity markets also undermined rupee demand.

There was optimism surrounding reform efforts by the government which underpinned sentiment. There were, however, fears surrounding the Monsoon outlook with low rainfall levels maintaining fears surrounding the outlook.  

Persistent doubts surrounding the regional economy will continue to limit the scope for rupee gains even if increased confidence surrounding reforms is sustained.

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The Hong Kong dollar was confined to narrow ranges during the week, but there was support just beyond the 7.7550 area with small net gains.

The currency failed to gain much support when risk appetite improved there were still important concerns surrounding the Chinese economy and risk conditions also faltered late in the week.

Unease surrounding the Chinese economy should prevent serious near-term pressure on the peg with the US Federal Reserve policies providing support.  

Chinese yuan:

The Chinese yuan was on the defensive for much of the week but it did find support beyond the 6.37 level against the US dollar. There was evidence of stronger corporate yuan demand which helped underpinned the currency.

There was still underlying evidence of a weaker capital account and the central bank resisted a stronger currency amid continuing expectations that there would be a further easing of monetary policy over the next few weeks. Given the weakness in key export markets, there were also expectations that the central bank would resist any significant yuan gains to help preserve competitiveness.  

The yuan is likely to be subjected to further underlying selling pressure, especially with speculation that the PBOC will look to underpin the export sector.

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