Weekly Forex Currency Review 07-09-2012

Global central bank and government actions will continue to dominate markets in the short-term. The ECB bond-buying plan will provide a boost to near-term confidence surrounding the Euro, but there will be important reservations surrounding the medium-term outlook given economic weakness. Global growth considerations will also remain important with a particular focus on China while the US Federal Reserve faces a crucial policy decision next week.

Key events for the forthcoming week

Dollar:

The most recent US indicators have shown some degree of improvement which will help underpin confidence in the outlook. If this pattern is repeated with the latest payroll data, there will be recued expectations of further Federal Reserve quantitative easing at the September policy meeting.  There will be still be underlying speculation that the Fed will move to adjust policy within the next few months.  There will also be underlying concerns surrounding the underlying fundamental outlook, especially with budget fears.  Concerns surrounding the global economic outlook should still be important in providing underlying dollar protection and curbing underlying selling pressure.

The dollar was unable to make any impression during the week as underlying demand for the currency faded, especially with an improvement in underlying risk appetite.

There was a weaker than expected reading for the ISM manufacturing PMI index for August with a dip to 49.6 from 49.8 the previous month, the third month out of four that the index had been below the pivotal 50.0 level with orders contracting.  There was some relief that the employment component held above the 50 level, but overall confidence surrounding the growth outlook was fragile.

The US data releases were overshadowed to some extent by the ECB decision, but all releases were stronger than expected. The ADP employment report registered a private payrolls increase of 201,000 for August from 163,000 the previous month while jobless claims declining to 365,000 from 377,000 previously. The PMI non-manufacturing report also rose to 53.7 from 52.6. The data helped boost risk appetite, but may also discourage any further quantitative easing by the Federal Reserve.

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The ECB plans to buy peripheral bonds will help stabilise sentiment in the short- term.  There will still be serious concerns surrounding the Spanish outlook with particular fears surrounding the banking sector. There are also still important underlying political concerns as Spain will also be under domestic political pressure not to accept a bailout.  There will also be fears surrounding the underlying growth dynamics which will maintain rising unemployment pressures and there will be pressure for the ECB to cut interest rates further. It will still be difficult for the Euro to sustain any significant advance.

The Euro was able to register net gains for the week with markets optimistic that the ECB bond-buying plans would stabilise near-term conditions. The currency pushed to two-month highs above 1.2650 against the dollar.
 
There was a weak German bund auction as, although yields were the same as for the previous sale at 1.42%, there was a sharp decline in the official bid/cover ratio to 1.1 and technically the auction was uncovered as demand faded. This increased speculation that sentiment towards the peripheral bond markets was improving and defensive bund demand declining which provided a net boost for the Euro.

There was a sharp decline in Spanish and Italian short-term yields and there was also a sharp improvement  in credit default swaps as markets continued to price in ECB action over the coming few weeks. There were further concerns surrounding the Spanish banking sector following the move to provide additional support for Bankia. There were concerns that the funds would be supplied through debt rather than equity which reinforced an underlying lack of confidence in the banking sector.

There was also some nervousness ahead of the German Constitutional Court ESM ruling next week, although the consensus was that there would be a conditional approval which could provide some degree of relief.

The ECB left interest rates on hold at 0.75%, contrary to some expectations that there would be a further cut and the Euro initially rallied in response with a fresh challenge on the 1.2635 resistance area against the dollar. In the press conference, President Draghi was generally downbeat over the economic conditions with a warning that downside risks prevailed. Growth forecasts were cut for the next two years in the latest staff projections, maintaining pessimism surrounding the economic outlook.

Draghi confirmed that the ECB would introduce the Outright Monetary Transactions (OMT) bond-buying scheme. The plan was in line with the succession of leaks supplied to the media over the past few days. The ECB will be prepared to intervene in the secondary market and buy bonds with a maturity of up to three years. There would be no formal limit on the amount of intervention and the purchases will be fully sterilised. The ECB is also prepared to give up creditor seniority on the new bonds and Bundesbank head Weidmann dissented against the plan.

A key element in the plan was conditionality as there will be no purchases until a country has requested aid and also met conditions attached. In theory, the bank would be prepared to stop purchases if conditions were broken. There were concerns that political factors could delay the plan’s introduction if Spain decided to try and avoid requesting an aid package, but the net impact was a boost in short-term optimism.

Yen:   

The yen will be undermined by higher bond yields elsewhere, at least in the short -term. There will be concerns surrounding the Japanese fundamentals with deteriorating growth prospects and demands for the Bank of Japan to take further action to underpin the economy. Regional growth concerns will also maintain pressure for competitiveness to be sustained.  There is still the potential for underlying yen demand given a lack of confidence in fundamentals elsewhere which should limit net losses.    

The dollar found support near 78.20 against the yen and rallied strongly during the US session with a peak close to the 79 area. The US currency gained important support from the stronger than expected US data as US Treasury bond yields increased.

There was also a significant improvement in risk appetite which curbed demand for the yen on defensive grounds. Risk appetite remained stronger in Asian trading on Friday following the announcement of fresh Chinese infrastructure projects which continued to curb yen demand and the dollar consolidated just below the 79 level.  

Bank of Japan Governor Shirakawa was generally pessimistic surrounding the economic outlook. He did, however, state that it would not buy government bonds for the purpose of monetising public debt and buying foreign bonds would also be tantamount to currency intervention which is not in the bank’s remit. The comments tended to dampen expectations of an aggressive Bank of Japan stance

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There will be further concerns surrounding the UK economic outlook, especially with evidence of weak spending. The latest PMI surveys have, however, provided some important relief and there will also be reduced expectations that the Bank of England will take further near-term action to expend monetary policy further. This shift in expectations will provide some degree of Sterling support. The currency will also tend to gain support if there is an improvement in risk appetite. Underlying Sterling support is still liable to be very fragile.

Sterling challenged 14-week highs against the dollar during the week with a test of resistance above 1.5950 as the UK currency held firm against the Euro.
 
There was a stronger than expected reading for the manufacturing PMI index with an increase to 49.5 for August from a revised 45.2 the previous month. There was a stagnation in orders, although this did represent a monthly improvement.

There was a weaker than expected construction PMI index for August with a decline to 49.0 from 50.9 the previous month which maintained concerns surrounding the construction sector. There was, however, a leaked report that the services PMI index for August with a stronger than expected reading of 53.7 from 51.0 previously.

The services data was important in providing net support for Sterling with hopes that the third-quarter trend for the economy as a whole would be stronger than expected. There were further concerns surrounding the housing sector following a weaker than expected Halifax house-price index with a further 0.4% monthly decline for August.

The Bank of England held interest rates on hold at 0.50% following the latest policy meeting while the amount of quantitative easing was also left on hold at £375bn. The decision was in line with expectations and provided only a slight boost to Sterling.

Swiss franc:

There will be further concerns over potential deflation within the economy and there will be continuing pressure on the National Bank to maintain the minimum Euro level. Any sustained relief for the Euro-zone could ease capital inflows into the Swiss franc and ease pressure on the Swiss National Bank and this could encourage the bank to take advantage of the situation and push the minimum level higher. Underlying uncertainty will remain an important element.

The dollar dipped weaker against the franc during the week, but a franc weakening against the Euro to lows beyond 1.21 was important in providing some cushion to the US currency as it held above the 0.95 level.  

There was a weaker than expected GDP reading with a 0.1% contraction for the second quarter following a revised 0.5% gain the previous quarter. There will be further concerns surrounding the threat of deflation and recession fears will intensify the determination to resist renewed franc gains against the Euro.

There was some speculation that the central bank would look to raise the minimum Euro level as the rise in reserves was lower than expected for the latest month.

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The Australian dollar initially remained under pressure during the week with a retreat to six-week lows below 1.02 against the US dollar. Domestically, there were further concerns surrounding the growth outlook with a series of weak PMI releases.

There was a mixed reading for the employment report with a drop in unemployment to 5.1% from 5.2%, but there was a decline in employment of over 8,000. There was no change in interest rates with the RBA maintaining a wait and see attitude.

After weakening on global growth concerns, the currency recovered ground firmly as the US currency came under pressure and risk appetite improved. There was also a boost following the announcement of Chinese infrastructure projects.

Unease surrounding the regional economy and weakness in key commodity prices is likely to curb any strong recovery in the Australian dollar.

Canadian dollar:

The Canadian dollar was able to find support on dips to beyond 0.99 against the US currency and rallied to a peak near 0.98 later in the week.

The Bank of Canada left interest rates on hold at 1.0% and was slightly more cautious surrounding the growth outlook. The currency gained support from optimism surrounding the domestic fundamentals and oil prices held firm which provided support as the US currency was subjected to further selling pressure.

Even with high oil prices, concerns surrounding the global economy will tend to limit scope for Canadian dollar gains, although losses for the currency should be limited.

Indian rupee:

The rupee initially came under pressure and weakened to test support in the 56 area against the US dollar. There were further concerns surrounding the growth outlook following a relatively weak GDP reading and there were further doubts surrounding the regional growth environment. The currency was also undermined by persistent dollar demand from oil importers, especially with a weaker underlying trade account.

The currency gained ground following the ECB policy meeting with a combination of improved risk appetite and a generally weaker US currency.

Even with an improvement in near-term risk conditions, persistent doubts surrounding the regional economy and the impact of high energy costs will limit rupee support.

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The Hong Kong dollar was trapped within narrow ranges during the week, generally holding just weaker than the 7.7550 area against the US currency.

The currency gained some support from expectations of further action to boost the Chinese economy as infrastructure projects were announced. There was also an improved tone to risk appetite following the ECB policy action to introduce a fresh bond-buying scheme.
 
Despite immediate relief, concerns surrounding regional growth trends should prevent any serious near-term pressure on the stronger limit of the Hong Kong currency band.  

Chinese yuan:

After a hesitant tone initially, the yuan was able to gain ground later in the week with a move to near 6.34 against the US dollar. There was a generally weaker US tone which provided support and encouraged the PBOC to set the mid point stronger.

After a weaker than expected PMI reading early in the week and major concerns surrounding the growth outlook, there was some optimism later in the week as the government pledged a series of new infrastructure projects to underpin the economy.

There is little scope for yuan gains given that there will be further important concerns surrounding growth and pressure for competitiveness to be sustained.

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