Weekly Forex Currency Review 05-04-2012

After some respite following the Greek loan deal, Euro-zone structural fears have tended to increase again over the past week with a renewed focus on Spain as the restrictive budget undermined confidence in the economy and Euro.  There is an important risk that these fears will intensify over the next few weeks. There will be near-term optimism that the US economy will out-perform in the short-term which should provide some net dollar support as global central banks maintain very loose monetary policies.

Key events for the forthcoming week

Dollar:

Underlying confidence in the US economy should remain firm in the short-term, especially if there is a robust reading for the latest employment data.  There will be reduced expectations that the Federal Reserve will embark on further quantitative easing which will help underpin yield support.  There will still be important doubts surrounding the medium-term outlook and the Fed will move quickly to embark on fresh action if there is evidence that demand is faltering again.  The global growth outlook will also have an important impact on the dollar. Persistent doubts surrounding the Asian and Euro-zone outlook will tend to underpin the US currency.

The dollar dipped significantly at the beginning of the week, but there was solid buying support on dips and there were net gains for the week as a whole against European currencies, although it was difficult to secure strong gains.
 
The FOMC minutes from March confirmed that the committee was slightly more optimistic surrounding the economic outlook.  The net outlook was to downplay the potential for further quantitative easing unless there was a renewed slowdown in the economy.  The underlying policy stance was still broadly dovish with most members still expecting rates to be left at extremely low levels until 2014 and some nervousness that economic conditions would deteriorate again. The economic releases will be watched closely for further evidence on underlying economic conditions.

The market had been positioned for a slightly more dovish Fed tone and there was a sharp rally in the US currency following the release.

The US ADP report was close to market expectations with a 209,000 increase in jobs for March following a revised 230,000 increase previously.  The data will maintain optimism over a solid near-term expansion and continue to dampen any immediate expectations of further quantitative easing. Regional Fed President Williams, however, stated that further easing was not off the table. The ISM non-manufacturing index edged lower to 56.0 from 57.3 previously.

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There will be renewed concerns surrounding peripheral economies in the short-term as recession continues to bite. Spain will inevitably be an important focus, especially with severe doubts over the 2012 budget. There will also be major concerns over the banking sector and speculation that a bailout will be required. The ECB will have to maintain an expansionary monetary policy and there will also be speculation that core inflation rates will be allowed to drift higher to help ease peripheral strains. This would tend to weaken the Euro directly and also risk an increase in political tensions.

The Euro was unable to break resistance levels above the 1.3350 against the dollar during the week and dipped sharply during the week with a test of support near 1.31.

Euro-zone unemployment increased to a fresh record high of 10.8% for March from 10.7% previously.  Although the data was in line with expectations, there were further concerns surrounding structural weaknesses, especially with youth unemployment continuing to increase to record highs.  The elevated unemployment levels will also increase concerns over potential social tensions.
 
There were further concern surrounding the Spanish economy with major doubts surrounding the effectiveness and sustainability of current economic policies.  The latest bond auctions recorded weaker demand compared with previous sales and there was a sharp rise in short-term yields.  The net effect was to trigger a further increase in market yields with 10-year yields rising towards 5.70%. There was also a slide in Spanish equities to the lowest level since November. Italian yields also rose during the day, maintaining fears surrounding renewed structural vulnerability.

The economic data was generally uninspiring with a decline in retail sales and smaller than expected increase in German factory orders, although there were upward revisions to previous data.  

As expected, the ECB left interest rates on hold at 1.00% following the latest policy meeting. In the press conference, President Draghi stated that there were still downside risks to the growth outlook and that monetary policy would need to remain very accommodative. Although there would be near-term inflation risks associated with the rise in oil prices, he also stated that medium-term inflation remained firmly anchored.  The comments increased speculation that the ECB will tolerate some increase in inflation within core Euro-zone economies in order to provide a boost to weaker economies which will tend to undermine the Euro.

Yen:

The Japanese data has been mixed over the past few weeks and there will be further pressure on the Bank of Japan relax monetary policy further if there is any renewed upward pressure on the yen.  The yen will still tend to gain support if there is a further deterioration in risk appetite and increased fears surrounding the global growth outlook. Investment flows will be watched very closely in the short-term with expectations that capital outflows will increase at the start of the new fiscal year. If these outflows are not forthcoming, there will be the potential for fresh upward pressure on the yen.

The dollar pushed sharply higher at times during the week, but failed to sustain the gains. The Japanese Tankan business confidence index was unchanged for the second quarter, in contrast to expectations for an increase and the weaker than expected outcome increased speculation that the Bank of Japan could act to loosen monetary policy further and the dollar pushed to highs above 83.

There had been a sharp shift in market positioning in favour of short yen positions and fresh yen gains triggered significant stop-loss yen buying, especially on the crosses.  Markets also took a generally more sceptical surrounding risk appetite with doubts surrounding the Chinese PMI data.

There was a significant move higher in US Treasury yields following the FOMC minutes and this also had an important impact in pushing the dollar stronger with another peak just below the 83 level before selling increased again.

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The most recent PMI surveys have all been stronger than expected and this will have a significant impact in underpinning near-term sentiment. There will also be reduced expectations of further quantitative easing by the Bank of England, although there will still be a high degree of uncertainty. Renewed stresses within the Euro-zone could trigger fresh defensive capital flows into Sterling, but the UK currency will be generally vulnerable if there a sustained deterioration in international risk appetite.

Sterling pushed to challenge resistance levels above 1.60 against the dollar for the first time since November and, although it retreated back below this level, the currency was broadly resilient and there was a further advance against the Euro.

The UK PMI manufacturing index rose to 52.1 from a  revised 51.5 previously which was the highest reading for 10 months. The data will help underpin confidence in the economy to some extent, but there will also be concerns that the gains in output were due to a large extent by inventory accumulation, especially in the consumer sector which increases the risk that future output will stall.

The UK services PMI index was stronger than expected with a rise to 55.3 for March following a figure of 53.8 previously as business confidence continued to improve.  All the PMI indices have been stronger than expected this week which will maintain a mood of greater confidence surrounding the economy.  The Halifax house-price index recorded a 2.2% increase for March, although this was primarily due to buying support before tax reliefs ended.

The data will also reinforce expectations that the Bank of England will resist any further move to expand quantitative easing at the latest policy meeting with the announcement due on Thursday.

Swiss franc:

The National Bank may be tested more severely in the short-term with the Euro now dangerously close to the 1.20 minimum level.  There is likely to be a strong defence of this level in the very short-term as a break would be a very serious setback for central bank credibility.  If the Euro is unable to move significantly higher, medium-term expectations of losses will tend to intensify again, especially if structural fears surrounding the Euro-zone increase.
The dollar found support close to 0.90 against the franc and moved back above 0.91 with gains curbed by the Euro’s inability to make any headway as it edged closer to the 1.20 level.

The Swiss PMI index rose to 51.1 for March from 49 previously which will help ease growth fears slightly. At the margin, industrial expansion would lessen pressure for franc gains to be resisted, although the positive impact will be limited.  Markets will be very nervous over central bank action if the Euro slides closer to the 1.20 level.  
The dollar found support in the 0.91 region against the franc on Wednesday and pushed to highs in the 0.9175 region before nudging slightly weaker later in the US session.

National Bank member Danthine reiterated that the franc was overvalued and that the minimum level was a valuable tool to prevent further deterioration in competitiveness. The latest cabinet meeting was watched closely, especially with some speculation that a new permanent President would be announced, but there was no immediate announcement following the meeting.  The latest consumer prices data was stronger than expected with a 0.6% monthly increase.

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The Australian dollar was again on the defensive during the week and retreated to 3-month lows below 1.0250 against the US currency before a tentative recovery.

The currency briefly advanced strongly following a stronger than expected official Chinese PMI reading, but was unable to sustain the advance as risk appetite was generally weaker.

Domestically, the Reserve Bank held interest rates at 4.25% at the latest policy meeting, but hinted strongly that there would be a reduction in May which undermined the currency. A sharp decline in building approvals and a second successive trade deficit also undermined confidence.

With expectations over further interest rate cuts and unease surrounding the Chinese economic outlook, the Australian dollar is liable to remain generally on the defensive.

Canadian dollar:

In a similar pattern to the previous week, the Canadian dollar found support weaker than parity against the US dollar while there was resistance beyond the 0.99 level with little in the way of major developments.

There was support at times from firmer oil prices and rising equity markets, but oil prices dipped sharply over the second half of the week as US inventories rose strongly.

Although the Canadian dollar should be broadly resilient, there is likely to be some unease over the implications of subdued global demand and domestic lending levels.

Indian rupee:

The rupee recovered ground early in the week as global risk appetite spiked higher and the currency advanced to two-week highs.

There was renewed selling pressure later in the week as risk appetite tended to falter again and the US currency gained ground. There was also persistently high dollar demand from oil importers which restrained the local currency.

The rupee is likely to remain generally on the defensive given concerns surrounding the regional economic outlook and the impact of high oil prices.

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The Hong Kong dollar was confined to relatively narrow ranges during the week as big swings in risk appetite did not have a major impact on the currency. It was unable to strengthen through the 7.76 level early in the week and retreated back to beyond 7.7650 as regional sentiment dipped again later in the week. Chinese market holidays had an important impact in curbing activity.

Continuing uncertainty surrounding the Chinese outlook will tend to curb Hong Kong dollar support with longer-term policies also an important focus.

Chinese yuan:

The yuan traded with a slightly weaker bias over the week as a whole, although activity was very subdued with market holidays for the first three days of the week. The PBOC fixed the currency weaker on Thursday as markets re-opened and the spot rate dipped to the 8.31 area against the US dollar.

There was relief surrounding the official PMI release, but underlying concerns surrounding the outlook and risk of a hard landing persisted which dampened confidence and there were also reports of large international currency demand.

The yuan is likely to be hampered by persistent doubts surrounding the economic outlook despite stronger than expected official PMI data.

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