Weekly Forex Currency Review 04-01-2013

Following the drama surrounding the US fiscal cliff talks, monetary and currency policies will remain a very important focus. The Federal Reserve will maintain a very loose monetary policy for now, butt he latest Fed minutes have injected a greater mood of uncertainty and the possibility of a tightening. The Bank of Japan will also be under intense pressure to boost policy further.  The ECB will also consider further action to underpin the economy which will ensure very loose monetary conditions and may serve to lessen the threat of a severe deterioration in risk appetite.

Key events for the forthcoming week

Dollar:

The US fiscal deal has eased immediate fears surrounding a disorderly policy tightening. Nevertheless, there will still be a significant policy tightening which will have some impact in curbing consumer spending growth.  The deal was also only a stop-gap measure and there will be further political confrontation surrounding spending cuts and the debt ceiling. There will be uncertainties surrounding the growth outlook and risk conditions. There is a very dovish Federal Reserve committee for 2013, but the latest minutes will spark some speculation that there will be some tightening later in 2013. Net longer-term yields should be dollar supportive for the US currency.  

After initial weakness following the US budget deal, the dollar found support near 1.33 against the Euro and rallied strongly against European currencies

Following the deal to avert the immediate US fiscal crisis, there was a renewed consideration of the longer-term outlook. There were further concerns that the spending issue would have to be tackled again before the end of February and Congress will also have to tackle the debt-ceiling issue with the potential for further tense negotiations. There was some reassessment of risk considerations which also curbed dollar selling.

As far as the US data releases were concerned, there was an increase in the ISM manufacturing index to 50.7 from 49.5 which provided some degree of relief.
The ADP employment data was stronger than expected with a gain of 215,000 private-sector jobs for December from a revised 118,000 previously. Although there was a higher than expected release for jobless claims, there was greater optimism surrounding the US payroll report.

The latest FOMC minutes stated that some members were concerned surrounding risks associated with further quantitative easing, especially as it would make it more difficult to secure an eventual exit strategy. In this context, several members wanted to scale-back bond purchases well before the end of 2013. There was still some degree of caution surrounding the labour market, but there was shift in expectations on potential tightening this year as markets had been primed for a very dovish tone.

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Structural fears surrounding the Euro-zone have eased for now which will lessen the potential for aggressive selling pressure.  There will still be a high degree of unease surrounding the growth outlook and there will also be pressure for the ECB to relax monetary policy further.  The bank will still be uneasy over the prospect of negative deposit rates and there will also be opposition from the Bundesbank.  Any friction within the ECB will tend to undermine confidence in the Euro.  There is also less scope for capital repatriation which will tend to lessen scope for Euro buying and a Spanish aid request would be likely to provide only initial currency relief.

The Euro was unable to sustain an initial advance following the New Year break and retreated sharply towards the 1.30 level against the dollar.
 
Italy’s lower house approved the 2013 budget in parliament and, as expected Prime Minister Monti submitted his resignation.  There were some suggestions that he could stand for election in forthcoming elections, but uncertainty remained high.

The final Euro-zone PMI data was slightly weaker than expected with a dip to 46.1 from 46.3 as there was a dip in the German index with an improvement in the Italian index offset by a weaker Italian outcome. The data maintained some degree of unease surrounding the Euro-zone outlook which dampened Euro demand.

There was some speculation that capital repatriation associated with the year-end Euro demand to bolster balance sheets had eased. An easing of flows could be significant in triggering a wider loss of Euro support.

There was further speculation that the ECB could consider a cut in interest rates at the January meeting, but a higher than expected German inflation reading increased speculation that there would be Bundesbank opposition to any rate cut and there would also be unease within the Council over any move to set a negative deposit rate.

Although a surprise decline in Spanish unemployment, provided some relief, there were concerns that the fall reflected longer-term unemployed leaving the labour market rather than any real improvement in conditions.  The German labour-market data was close to expectations with a 3,000 unemployment increase for December.

The latest money-supply data recorded an eighth successive decline in private lending which maintained unease over the outlook, but there was a small increase in banking-sector deposits in Italy and Spain which provided some relief. Spain’s admission that it was using social security funds to buy government bonds also unsettled confidence and sparked expectations of a bailout soon.

Yen:   

There will be intense pressure for the Bank of Japan to engage in further aggressive policy easing with the next policy meeting due in the third week of January.  The government is also planning a further round of aggressive fiscal stimulus in an attempt to ease deflationary pressure. These factors combined will tend to have a negative impact on the yen, especially with a lack of confidence in the Japanese fundamentals. The Japanese currency will still gain some degree of support when risk appetite deteriorates and there will also be pressure for a limited correction after recent sharp losses.

The yen remained extremely weak as it dipped to the lowest levels in more than two years against the dollar. Incoming Prime Minster Abe continued aggressive calls for deflation to be tackled and warned that he would look to change the central bank Act which ensures independence if the Bank of Japan fails to meet inflation targets.

Expectations that there would be aggressive action to ease deflation risks through aggressive monetary and fiscal policies continued to have a negative impact on the yen.  Weak underlying yen sentiment was offset by pressures for a technical correction following sharp losses and the dollar consolidated above the 87 level with Japanese markets still closed for a holiday.

The dollar found strong support on dips and pushed back above 87 with initial support from the stronger than expected US ADP report. There was further buying support following the Fed minutes with a shift in expectations. Japanese markets re-opened following the new-year break which triggered a fresh round of yen selling, particularly with a widening in yield spreads to the highest level since April. The dollar pushed to a fresh 29-month high above 87.75 against the Japanese currency.

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There will be mixed expectations surrounding the UK outlook with a divergence in analyst expectations and mixed data. Overall, there is slightly reduced fear surrounding the threat of another slide into recession, especially with some evidence that consumer lending is improving. In relative terms, the UK currency will also gain some support on relative grounds with expectations of loose monetary policies in the US and Euro-zone.  The UK currency will tend to lose ground when risk appetite deteriorates and will struggle to make further significant headway against the US currency.

Sterling initially spiked higher against the US currency following the New Year break before hitting strong selling pressure with a retreat to lows below 1.61 .
 
The UK data was significantly stronger than expected with an increase in the PMI manufacturing data to 51.4 for December from a revised 49.2 the previous month which was the highest figure for 16 months. The data also provided some degree of optimism surrounding the UK economy which provided underlying Sterling backing.

There was initial Sterling support from an improvement in international risk appetite as the UK equity market tested the highs from mid 2011, but there was a slightly more cautious tone later in the week which pushed Sterling lower.

The latest PMI construction report was weaker than expected with a decline to a six-month low of 48.7 from 49.3 the previous month. The data dampened optimism triggered by the stronger than expected manufacturing release and the latest services-sector data will be watched very closely on Friday and will have an important impact on underlying sentiment.

Swiss franc:

The National Bank will remain strongly committed to maintaining the 1.20 minimum Euro level in the short-term, especially with a strong determination to protect competitiveness and avert any serious deterioration in industrial conditions. Aggressive policy relaxation elsewhere will maintain the risk that upward pressure on the franc will intensify again as investors look for a safe-haven, especially if the Japanese yen is subjected to further selling.

The Euro held relatively steady against the franc, but was unable to hold above 1.21. After finding support around seven-month lows, the US currency pushed to a fresh 3-week high above 0.9280 as the dollar secured wider support.

The latest PMI report recorded an increase to 49.5 for December from 48.5 previously. In contrast, the latest KOF index retreated to 1.28 for the month from 1.50 previously which will maintain unease surrounding business confidence and pressure for franc gains to be resisted.

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The Australian dollar continued to probe resistance above 1.05 against the dollar, but it was unable to sustain the gains and retreated back to below this resistance area late in the week. The currency drew initial support from gains in risk appetite following the US fiscal deal before the mood turned more cautious again as enthusiasm faded.

There was a slightly more optimistic tone surrounding the Chinese outlook which provided some support for the Australian currency. The domestic PMI indices were still generally lacklustre amid fears over a further slowdown with a significant deterioration in the services-sector index.

Despite potential reserve diversification, the Australian dollar will find it difficult to sustain gains, especially as Chinese economic sentiment is liable to deteriorate again.

Canadian dollar:

After finding support on dips towards parity, the Canadian dollar was able to recover ground and move back to the 0.9840 area on a general improvement in risk appetite following the US fiscal deal.

The US currency was resilient at lower levels and moved higher as markets turned significantly more cautious while the Fed minutes provided net US support.  

Even with near-term resilience and optimism surrounding the fundamentals, the Canadian dollar will find it difficult to sustain any significant gains.

Indian rupee:

The Indian rupee secured a positive tone around the new-year period and advanced to three-week highs beyond 54.50 against the US dollar before the mood turned more cautious with a move to the 55 area.

There were hopes surrounding a potential interest-rate cut by the central bank which provided some underlying support for the currency. In contrast, there were further uncertainties surrounding the outlook for the current account and budget deficits which hampered underlying rupee demand.

Overall, there is likely to be scope for only limited rupee gains given wider risk conditions, especially as domestic growth concerns are liable to increase again.

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The Hong Kong dollar maintained a very tone and continued to test the 7.75 band limit, although liquidity levels were inevitably much lower than normal during the New Year period.

There was further speculation over the potential for medium-term capital inflows and an increase in domestic inflation fears which would also increase underlying stresses on the currency peg. Underlying inflation concerns will be fuelled by sharp gains in equity markets during the holiday period.
 
Inflation fears are liable to continue and medium-term speculation surrounding the Hong Kong peg with a potentially radical change in policies is likely to continue.

Chinese yuan:

The yuan maintained a generally robust tone ahead of the new year break and consolidated close to the 6.23 area as the PBOC continued to resist gains in relatively subdued conditions with little change following the new-year break.

There was a slightly more optimistic tone surrounding the Chinese economy as the PMI indices held above the 50 level amid signs of strengthening activity. There was still an underlying sense of caution, especially with concerns over the credit and debt risks and shadow banking.

The yuan will find it difficult to make much headway from current levels as the more optimistic tone surrounding the Chinese economy is likely to fade.

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