Weekly Forex Currency Review 09-03-2012

The immediate attention surrounding Greece and its default threat will ease following the debt swap. There will still be a lack of confidence in the underlying Euro-zone fundamentals given the overall debt profile and expectations that a contractionary fiscal policy will push other vulnerable countries towards eventual default. The underlying Greek situation will also be extremely unstable and unease surrounding the global economy is liable to increase again as Chinese doubts continue to increase.

Key events for the forthcoming week

Dollar:

Assuming there is a relatively solid payroll report, underlying confidence in the US economy should remain firm with expectations that the US will be able to out-perform Europe and this should generate capital inflows.  The potential beneficial impact will still be offset by expectations of a very expansionary Federal Reserve policy and by speculation that there could still be further quantitative easing to help support the economy. The dollar will gain fresh defensive support if there is a renewed deterioration in risk appetite despite the underlying lack of enthusiasm.  

The dollar secured defensive support from a deterioration in risk appetite over the first half of the week. The currency was unable to sustain the advance as confidence in the US currency remained generally fragile with the Euro rallying from lows near 1.31.

The US ISM non-manufacturing index was stronger than expected with an increase to 57.3 for February from 56.8 the previous month, in contrast to expectations of a modest decline for the month. The data maintained a degree of confidence in the short-term US outlook and also reinforced potential US yield support in comparison with the Euro area. The employment component was slightly weaker, but still signalled moderate expansion, underpinning expectations of solid payroll growth.

The US ADP employment report was broadly in line with expectations with private-sector payroll growth estimated at 216,000 for February from a revised 173,000 the previous month. As far as the US jobless claims were concerned, there was an increase to 362,000 in the latest week from 354,000 the previous week which maintained a general tone of optimism towards the consumer conditions.

The positive impact of the economic data was offset by renewed speculation that the Federal Reserve could implement a further limited form of quantitative easing later in 2012 to help support demand conditions.

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Immediate fears surrounding a Greek default have been eased by the private-sector debt rescheduling and approval of a second loan package and confidence will remain slightly stronger in the short-term. There will still be a high degree of fear surrounding the medium-term outlook. The Greek situation is still highly unstable and second-quarter elections will threaten to unravel the deal. Political factors will also be extremely important elsewhere and tensions surrounding France’s presidential election are likely to increase.  The ECB will have to maintain a highly-expansionary monetary policy and the Euro will find it very difficult to make significant headway.

The Spanish decision to target a higher budget deficit for 2012 continued to have political ramifications and stresses amid speculation that there could be wider Euro-zone dissent against the fiscal compact and this helped push the currency weaker before rally on expectations of a successful Greek outcome with highs near 1.33.

There was a stream of media reports surrounding the Greek private-sector debt swap deal ahead of the deadline and there was a generally optimistic tone with reduced fears that the participation rate would be below the 75% threshold which would effectively push Greece into default.  

As expected, the ECB left interest rates on hold at 1.00% following the latest council meeting and President Draghi claimed that there had been no discussion of lowering interest rates. The risks to the economic outlook were still to the downside according to the staff projections while there was an increase in the inflation forecasts. Draghi tended to concentrate on the inflation aspects early in the press conference which gave the Euro a firm tone. Although expressing confidence in the LTRO actions so far, he did express caution over the need for further action at this time.  

There was a further decline in Italian yields during the week which helped underpin confidence in the peripheral economies and also provided some degree of Euro support on reduced fears that Italy would be pushed towards default.

There was official confirmation of the Greek swap late in Asia on Friday with the government securing support of 85.8% of bond-holders. There was disappointment that the threshold for avoiding CAC payments was not reached and the Euro retreated back to the 1.3230 region as the ISDA will meet to discuss a credit event.

Yen:

The yen will remain vulnerable on yield grounds, especially with speculation that the Bank of Japan could ease policy even further to help ease the deflation threat. A weaker currency will also be an important policy objective. The yen will also be vulnerable on longer-term fundamental grounds. Defensive considerations will remain important and any fresh deterioration in risk appetite would still tend to trigger defensive inflows into the Japanese currency.

There was significant defensive support on the yen on defensive grounds as risk appetite deteriorated over the first half of the week. There were particularly sharp yen gains on the crosses with the Euro and Sterling both retreating sharply.  

The dollar found support on retreats towards 80.50 and pushed higher again with two challenges on the 81.75 resistance region.  There was a strong Euro advance against the yen with a peak near the 108.50.

The current account data was weaker than expected with the seasonally-adjusted surplus sliding close to zero while the fourth-quarter GDP data was revised to -0.2% from -0.6% previously. There was a decline in safe-haven yen demand as equity markets rallied from losses earlier in the week and risk appetite generally improved.

A sharper than expected decline in China’s CPI inflation rate to 3.2% also helped underpin risk appetite on Friday, although the impact was offset by weaker industrial data.  The yen again found support near 82 with some caution over extending yen selling ahead of the US employment data.  Finance Minister Azumi stated that he expected the Bank of Japan to maintain an expansionary monetary policy.

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Confidence in the UK economy is likely to remain slightly stronger in the short-term with reduced fears surrounding a slide into recession following a batch of more favourable data. There will also be lower expectations over any further quantitative easing by the Bank of England.  The confidence could still prove to be very brittle given the underlying economic vulnerability and weakness within the banking sector.  Safe-haven considerations will remain important and there will be a reduction in Sterling demand if Euro-zone fears ease.

Sterling edged lower ahead of the UK services-sector PMI index on Monday amid rumours of a weaker than expected release. In the event, the index declined to 53.8 from 56.0 the previous month which triggered initial Sterling weakness and a 10-day low below 1.58 against the dollar.  The impact was limited by an advance in business expectations to a one-year high.  

There were no surprises from the Bank of England interest rate decision with quantitative easing left on hold at GBP325bn while interest rates were also on hold at 0.5%. Rates have now been held at 0.50% for the past three years and the minutes will be watched closely in two-week’s time to assess whether there will be support within the MPC for further quantitative easing.

Sterling gained some support from a recovery in risk appetite, although it was broadly sidelined during the week as attention remained firmly on the Euro area.  The UK currency weakened back to the 0.84 area against the Euro.

Swiss franc:

Fears over the economic outlook are likely to ease slightly in the very short-term and, although the National Bank will remain concerned, the immediate threat of deflation should be reduced. Bank policies will remain an extremely important focus in the short-term and it is likely to remain determined to block franc gains. There is still the risk of a fresh attack on the minimum Euro level, especially if underlying fears surrounding the Euro-zone outlook increase again. The franc could also gain some defensive support as an alternative safe-haven if there is a sustained reduction in confidence surrounding all G3 currencies.

The dollar was unable to move above the 0.92 area against the franc and dipped sharply to lows below 0.91 before some degree of stabilisation. Even with a firmer tone against the dollar, the Euro was trapped near 1.2050 against the franc.

Swiss consumer prices rose 0.3% in February which was slightly above expectations, although there was still a 0.9% annual decline.  Although underlying deflation fears should ease slightly, especially given the strength of energy prices, the National Bank will remain on high alert. The bank stated that intervention to prevent franc gains during 2011 amounted to CHF17.8bn.

The National Bank confirmed that interim Chairman Jordan had been cleared following an investigation surrounding currency transfers and there were no significant franc movement on the news.

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Although the Australian dollar found support on dips to the 1.05 region against the US currency during the week, there was a generally slightly softer tone with resistance levels hard to break down.  Risk appetite attempted to recover over the second half of the week as equity markets rallied and lower Chinese inflation maintained speculation over a further decline in Reserve Ratio Requirements

The Reserve Bank left interest rates on hold at 4.25% at the latest policy meeting and indicated that lower inflation maintained the scope to lower borrowing costs. The economic data had a generally weaker bias as there was weaker than expected GDP growth of 0.4% compared with 0.8% previously while there was a decline in employment of over 15,000 in the latest month following a sharp gain previously. There was also a much weaker than expected trade report and disappointing PMI data.

Although the Australian dollar will gain support if confidence in the global economy remains higher, the net risks suggest a weaker currency tone is likely.

Canadian dollar:

The Canadian dollar retreated to lows beyond parity against the US dollar during the week as risk appetite came under pressure, but it found support at weaker levels and rallied again as the US currency stumbled.

As expected the Bank of Canada left interest rates on hold at 1.00% following the latest policy meeting. Bank Governor Carney was generally slightly more optimistic surrounding the economic outlook.

The Canadian dollar should be broadly resilient on hopes for economic out-performance, especially with a still dovish US Federal Reserve policy.

Indian rupee:

The rupee remained on the defensive for much of the week and dipped to seven-week lows near 50.40 against the US dollar before regaining some ground. There was a general lack of confidence surrounding the equity market which hampered the local currency. There was also further uncertainty surrounding economic reform with fears that the government may not be strong enough to implement measures

There was dollar buying from oil importers, but there was speculation that the Reserve Bank intervened to sell the US currency which helped stabilise the currency.

The rupee will continue to be hampered by high oil prices and doubts surrounding government policies with potentially subdued capital inflows.

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The Hong Kong dollar initially weakened sharply to lows near 7.7650 against the dollar, but there was an equally sharp recovery as it advanced back to test resistance in the 7.7750 zone.

Financial Secretary Tang who is a candidate for Chief Executive continued to voice support for the Hong Kong dollar peg and there was a firmer tone surrounding risk appetite over the second half of the week which helped the currency regain ground.

Risk conditions will tend to overshadow longer-term policy speculation and any fresh doubts surrounding the Chinese outlook would curb Hong Kong dollar support.

Chinese yuan:

The yuan was unable to make headway during the week and dipped to lows beyond 6.32 against the dollar. The PBOC again had an important role to play and weakened the fixing for four successive days which undermined the currency.

The 2012 GDP forecast was downgraded at the National Congress which helped maintain a more cautious attitude towards the economy and the currency. There was speculation that the yuan trading band was set to be widened and also expectations that the currency was moving closer to full convertibility which had some positive impact on capital inflows.

Significant near-term yuan appreciation is likely to be blocked by fears over a sharper slowdown in growth and the risk of less robust capital inflows.

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