Weekly Forex Currency Review 04-05-2012

The Euro-zone policy focus will remain an important short-term focus given an increase in fears surrounding the Spanish outlook in particular.  There will be an extremely important focus on whether the downturn is concentrated within the Euro-zone or whether there is a wider retreat for the global economy.  The Federal Reserve is on hold in the short-term, but there will still be expectations that the central bank will sanction further action if required and the US economy falters.

Key events for the forthcoming week

Dollar:

There have been a series of mixed data releases over the past month and there will be net concerns over a slowdown in the economy, especially if there is a weaker than expected payroll report. The Federal Reserve will maintain a policy of extremely low interest rates, but it is likely to hold off from fresh quantitative easing for now and there should still be expectations that the US economy will out-perform in the short-term. Global growth trends will be important and the US currency will gain some important support if global growth conditions deteriorate with a generally firm tone likely.   

The dollar found support at lower levels during the week and was able to make some headway during the week as a whole with EUR/USD weakening towards 1.31 although gains were measured as there were mixed US data releases.
 
The latest US ISM manufacturing index was stronger than expected with an increase to a 10-month high of 54.8 for April from 53.4 previously, contrary to expectations of a modest decline. All the main components showed healthy gains for the month which helped alleviate immediate concerns surrounding the US outlook, especially as markets were braced for a more subdued report.

There was a decline in jobless claims to 365,000 in the latest week from 392,000 the previous week which provided some relief to economic sentiment.  In contrast, there was a decline in the latest ISM services-sector report to 53.5 from 56.0 previously. There was a decline in the export and employment components for the index, although they were still comfortably above the 50 level. The latest ADP employment report was weaker than expected with a 119,000 increase for April following a revised 201,000 gain previously. Federal Reserve speakers during the week continued to indicate that policy was on hold in the short-term.

Unease surrounding the global economic outlook also had some influence n triggering defensive dollar demand, especially given the Euro-zone stresses

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There will be major concerns surrounding the economic outlook in the short-term, especially with a notable deterioration in the April PMI data. There will be further concerns surrounding the peripheral growth outlook and this will inevitably intensify stresses within the banking sector, especially as bad debts will continue to increase.  There will be strong pressure for the ECB to take a more aggressive policy and political factors will be extremely important, especially if there is a change in President for France. Evidence of a policy shift could provide some Euro support, although there is still likely to be underlying depreciation with the potential for sharp losses.

The Euro was subjected to heavy selling pressure in Europe on Wednesday due to a combination of fundamental and technical factors, although there was solid support at lower levels with no major support levels broken.  

The final Euro-zone PMI manufacturing index edged lower to 45.9 from a flash estimate of 46.0, although principal attention focussed on the peripheral economies as the Italian index deteriorated sharply for April.  There were also depressed readings for the Spanish and Greek economies which maintained fears over the outlook with the Spanish economy confirmed as in recession.

The German unemployment data was weaker than expected with an increase of 19,000 for April. There were further defensive inflows into German bonds as yields dipped to record lows on capital flight from peripheral economies.

As expected, the ECB left interest rates on hold and the press conference was the main focus.  Although President Draghi continued to reference downside growth risks he also stated that there were some signs of stabilisation during the first quarter.  These remarks were somewhat surprising given very weak surveys for April. Draghi also stated that there had been no discussion surrounding specific interest rate cuts.

The net impact was to dampen expectations of a further near-term cut in interest rates which helped underpin the Euro, especially with a covering of short positions following the inability to break 1.31 support.  There will still be major concerns surrounding the economic outlook and the overall impression was that the ECB was looking to shift the focus back onto political action to boost the growth outlook.

There were political uncertainties surrounding the French and Greece elections this weekend with fears that the pro-austerity Greek parties would not be able to secure a majority.  There were also uncertainties over the French-German relationship if Holland wins in France.

Yen:   

The Bank of Japan will inevitably remain an important focus with pressure for even more action to boost demand and weaken the currency.  There will also be important political pressure from the Finance Ministry.  There will be a longer-term lack of confidence in the fundamentals, especially given the debt profile. From a shorter-term perspective, there will be pressure for a weaker yen if regional currencies depreciate.  There will still be important defensive yen demand at times if there is a renewed deterioration in global risk appetite.

The dollar found support below 80 against the yen during the week and moved back above this level, although it was difficult to maintain momentum given mixed US economic data as advances quickly met resistance.

The yen was hampered by a Moody’s report which warned over the negative impact of any delay in raising the sales tax. There will be further pressure from the Japanese Finance Ministry for yen gains to be resisted which discouraged yen buying.

Japanese markets were closed for the Golden Week holidays for much of the week which continued to stifle activity. The dollar was unable to gain any fresh support in Asian trading on Friday with concerns surrounding the Asian economic outlook important in curbing selling pressure on the Japanese currency as risk conditions remained very cautious ahead of the US employment report. 

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There will be further UK economic uncertainty as the business surveys have been generally optimistic and in contrast to the official data. Monetary policy will remain an important focus and there will continue to be a high degree of uncertainty. There should be reduced expectations of further quantitative easing which will provide some Sterling support.  Safe-haven considerations will remain important and there will be further defensive Sterling demand given Euro-zone fears. There will, however, be unease surrounding the banking sector and a wider deterioration in risk conditions could trigger rapid capital outflows.

Sterling held firm against the dollar during the week and pushed to 22-month highs against the Euro as there was further evidence of defensive demand for the currency.
 
The latest PMI manufacturing survey was weaker than expected with a decline to 50.5 for April from a revised 51.9. The latest PMI services-sector index was weaker than expected with a decline to 53.5 from 55.3 the previous month. Although this was significantly worse than expected, the impact was offset by a rise in the business expectations component to a 25-month high as hiring intentions strengthened.

There was a solid rise in UK lending for March, but there was a further decline in money supply which will increase fears surrounding the growth outlook as credit conditions remained extremely tight. Although there has been speculation over defensive inflows, official data recorded net capital outflows of gilts for February and March.  The Nationwide reported a 0.2% decline in house prices for April with a sharper decline reported in the Halifax survey.

Although there was still a high degree of uncertainty, the net result from this week’s surveys was reduced expectations surrounding further Bank of England quantitative easing which helped underpin sentiment.  

Swiss franc:

There is still the potential for further defensive flows into the Swiss currency in the short-term, especially with increased Euro-zone structural fears and a lack of attractive alternatives and there is a risk that the 1.20 minimum Euro level will come under severe pressure. The central bank is likely to hold firm in the short-term with unlimited intervention when required. There will be a recycling of Euros into other currencies which will tend to keep the Euro under pressure on the crosses which will underpin the franc.

The dollar found support on dips towards the 0.9050 level against the franc and moved back to the 0.9150 region while the Euro was trapped very close to the 1.20 minimum level.

The latest Swiss PMI report was sharply weaker than expected with a decline to 46.9 for April from 51.1 previously which will maintain pressure on the National Bank to resist any renewed franc gains

The Euro was unable to make any significant headway against the Swiss currency even with the ECB taking a slightly less dovish stance than had been expected. There was still an important lack of confidence in the underlying Euro-zone fundamentals which maintained the potential for defensive capital inflows into the Swiss currency

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The Australian dollar was firmly on the defensive during the week as a whole. After hitting resistance above the 1.0450 level against the US dollar, the currency was subjected to heavy selling with lows just below the 1.0250 level.

The Reserve Bank was more aggressive than expected with a 0.50% cut in interest rates to 3.75% from 4.25%.  The bank action increased unease over the domestic economy and was significant in undermining currency support.

The domestic data provided no support with a weak readings for the housing sector and a sharp decline in the latest services-sector PMI data.

A lack of confidence in the domestic economy and unease surrounding the regional outlook are likely to keep the Australian dollar generally on the defensive.

Canadian dollar:

The Canadian dollar was unable to sustain a position close to 0.98 against the US currency during the week and dipped back to the 0.99 region, although it was broadly resilient. There was a weaker than expected reading for the latest GDP data which triggered some degree of caution over the outlook and there was unease over very high consumer debt levels.

There was a decline in oil prices which also had some negative impact on the Canadian currency as risk conditions remained cautious.

Although the Canadian dollar should be broadly resilient, unease surrounding the debt profile and doubts over commodity-price trends will tend to block any advance.

Indian rupee:

The rupee remained under pressure during the week and retreated to a four-month low beyond 53.20 against the US currency. There were fresh concerns surrounding the domestic fundamentals with a focus on the trade and budget deficits. The current account deficit is likely to be around 4% of GDP this year and latest trade data was weaker than expected with a March deficit of US$13.9bn.

There was solid US demand from importers and oil refiners together with general caution towards risk appetite which contributed to the negative rupee tone. There was no evidence of sustained intervention by the Reserve Bank.

With further concerns surrounding the domestic fundamentals and regional economic outlook, the rupee is likely to remain generally on the defensive.

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The Hong Kong dollar maintained a firm tone during the week, although the most notable feature was the persistence of narrow ranges. The Hong Kong currency was unable to strengthen towards the 7.7550 area while there was some support on dips towards 7.76.  Low US interest rates were significant in curbing Hong Kong selling.

Low US rates will provide underlying Hong Kong dollar support. Uncertainty surrounding the Chinese outlook will curb speculation over a long-term policy shift.  

Chinese yuan:

The PBOC maintained its policy of setting strong yuan mid points with record highs just beyond the 6.27 level. As has been the pattern since the yuan trading band was widened, the spot rate remained significantly weaker than the fixing rate with the yuan weaker than 6.30.

There was a further suspicion that the PBOC was setting strong rates ahead of and during US China talks. US Treasury Secretary Geithner stated that the reform measures was promising which helped ease tensions to some extent.

There were further uncertainties surrounding the economic outlook with no clear tone from the latest PMI surveys, although there was some relief that the data tended to show some slight improvement.

The PBOC will want to maintain a firm currency for now, but a weaker capital account and economic doubts are likely to keep the yuan on the defensive.

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