Weekly Forex Currency Review 09-09-2011

The financial sector will continue to be an important focus in the short-term with further speculation that liquidity and solvency will deteriorate further which could cause severe stresses within Europe.  Currency regimes and management will also be a very important focus following the Swiss National Bank move to set a minimum rate against the Euro and there will be pressure for stronger international co-ordination.  

Key events for the forthcoming week

Dollar:

Confidence in the growth outlook will remain weak, especially after the depressed payroll reading and there will be greater doubts over exports given the international profile. The Federal Reserve will certainly maintain interest rates at very low levels and there will be a discussion of further possible measures at the FOMC meeting later in September. International risk conditions will also be extremely important for the dollar and fears over the growth outlook will provide defensive support. The dollar will also tend to gain support from stresses within the money markets and a structural dollar shortage, although there are tentative signs that these tensions may be peaking. Given the lack of viable alternatives, the dollar should be able to maintain a solid tone.

The US markets were initially sidelined by the US holiday and attention tended to be focussed on events within Europe during the week as the dollar continued to gain some defensive support as the trade-weighted index rose to 10-week highs.
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Following the surprise employment data with zero employment growth for August, the ISM index for the services-sector was stronger than expected with a rise to 53.3 in August from 52.7 previously which provide some relief, although the underlying components were still fragile.

The US jobless claims data was little changed at 414,000 from 412,000 previously, but there was a big improvement in the trade deficit to US$44.8bn for July. Exports were at record levels and will provide some support to the third-quarter GDP data.

President Obama’s pledge of a US$447bn jobs package did not have a significant impact while Fed Chairman Bernanke repeated that the Fed would explore options for further economic support at the forthcoming FOMC meeting.

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The evidence suggests that there will be a further deterioration in growth conditions in the short-term. As well as undermining sentiment, these stresses will also have an important negative impact on the peripheral economies which will make it even more difficult to escape from recession. The current policy structures are unsustainable even if the ECB provides some degree of relief with a more neutral policy. The debt situation and serious stresses within the banking sector will continue to represent very a very important threat to the Euro with a high risk that Greece will be forced to default or leave the Euro.

The Euro remained under pressure during the week as structural fears and an ECB policy shift undermined sentiment. The ECB announced that it had purchased EUR13.3bn in bonds in the latest reporting week from EUR6.7bn previously even though there was still an increase in yields. Benchmark Italian yields rose to above the 5.50% level with confidence also eroded by rumours of a credit-rating downgrade.

There were further stresses within the banking sector as the German Dax weakened to a two-year low while there was also a record amount of cash placed at the ECB and dollar Libor rates also continued to edge higher.

The German Constitutional Court ruled that the original May 2010 Greek bailout was not illegal under the constitution which provided some immediate Euro relief. The court also had important reservations and demanded that parliament should be given greater control and influence over the budget and bailouts.

The Italian Senate approved the amended austerity plan and the debate moved to the Lower House with tensions still high. Greek yields failed to decline significantly amid further concerns over the lack of progress on austerity measures. The German CSU parliamentary leader warned that a Greek exit from the Euro could not be ruled out.

As expected, the ECB left interest rates on hold at 1.50%. The ECB also presented fresh forecasts for the Euro area with modest downward revisions to growth and inflation estimates for 2011 and 2012 with the 2012 GDP range lowered to 1.3% from 1.7%. Trichet stated that the growth risks were now biased to the downside and there had been a significant change in ECB policy stance. Effectively, this meant that there would be no further interest rate increases with the bank moving to a neutral stance while markets priced in a fourth-quarter interest rate cut.

There were further fears surrounding the Euro-zone structural outlook as the Greek situation remained critical. There were further warnings from German and Dutch officials that Greece must meet the deficit-cutting targets in order to receive the next tranche of loan support. The Greek economy, however, contracted by over 7% in the year to the second quarter.

Yen:   

Safe-haven considerations will remain very important in the short-term. The Swiss National Bank action has removed one key global safe haven and this will lead to an increased focus on Japan despite its very weak fundamentals. The government and Bank of Japan will be very anxious over the situation and will look to take further action. There is also the possibility of G7 action to prevent yen appreciation. The yen will continue to gain important protection from a lack of confidence in the global economy and decisive official action will be needed to trigger substantial yen losses.    

The dollar secured net gains over the week, but both currencies tended to move in parallel which curbed movement as the dollar consolidated above 77.
 
From a medium-term perspective, the National Bank determination to weaken the Swiss franc could trigger additional flows into the Japanese currency as an alternative safe-haven. The yen will also continue to gain defensive support from a lack of confidence in the Euro-zone and fears over the global economy.

The Bank of Japan left interest rates on hold below 0.10% following the latest council meeting and did not announce any further quantitative easing. There was some dollar support from the latest trade data while Bernanke did not add to the dovish tone in his speech. Yield support for the US currency was still extremely weak which limited.

The Japanese Finance Minister stated that the central bank was ready to take bold action on the currency and there was speculation over further independent or co-ordinated action to weaken the yen at the G7 meetings starting on Friday.

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Confidence in the economic outlook will remain extremely fragile in the short-term with the services-sector PMI data causing particular alarm. The Bank of England will keep interest rates at extremely low levels and, although it is not likely to make a near-term move to boost quantitative easing, it remains a medium-term option which will curb Sterling buying support. Unease surrounding the banking sector will continue and there will also be additional pressure for a shift in government policies. Give the debt profile, Sterling is also unlikely to secure significant defensive support.

Sterling remained on the defensive against the dollar as it dipped to 7-week lows below 1.60, but there was net support against the Euro with two-week highs near 0.87.

The UK PMI services-sector index fell very sharply to 51.1 for August from 55.4 the previous month. This was the sharpest decline for over 10 years and the lowest reading since the weather-induced dip to below 50 in December 2010.

There was a sharp deterioration in confidence and employment levels also continued to decline. The latest NIESR GDP estimate also showed a sharp slowdown in August to 0.2% from 0.6% previously which dampened expectations of a third-quarter recovery and maintained underlying fears surrounding the economy.

The MPC left interest rates on hold at 0.50% and the total amount of quantitative easing was also unchanged at GBP200bn. There was no statement with the policy decision. There had been some speculation that the bank would consider an increase in quantitative easing and Sterling rallied in relief that policy was unchanged.

Swiss franc:

The National Bank decision to set a floor for the Euro against the franc is an extremely important policy statement and measure. The central bank will be determined to maintain the minimum level in the short-termand markets will also be extremely wary of attacking the bank at this stage. There is still the potential for defensive flows into Swiss assets, especially if Euro-zone fears intensify. If banking-sector fears intensify, the currency could draw heavy buying support, but the franc is likely to be weaker in the very short-term.  

The Swiss National Bank announced on Tuesday that it had set a minimum rate for the Euro against the franc of 1.20. The central bank stated that it could no longer tolerate the severe over-valuation of the currency given the increased risk of recession and deflation within the Swiss economy.

The bank would also intervene without limit to defend the 1.20 level to prevent further franc appreciation. The bank stated that it was acting independently and not in co-ordination with any other central banks.

Inevitably, the franc weakened extremely sharply following the announcement with the Euro advancing to just above the 1.20 level from below 1.11 while the dollar advanced to above 0.8550 which was the strongest level since late May

There was further respect for the National Bank determination to prevent franc gains and there was additional speculation that the central bank was selling options to undermine the franc. Such a policy may be effective in the short-term, but could destabilise the franc in the longer term

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The Australian dollar was unable to sustain a position above 1.07 against the US currency during the week, but it did find support below 1.05 and was generally resilient. Risk appetite remained fragile, but equity markets did look to rally after recent very sharp loses which provided some support to the Australian dollar, especially with commodity prices robust.

The latest PMI services-sector index was stronger than expected with a recovery back above the 50 level, butt here was a further deterioration in the housing sector. The labour-market data was also weaker than expected with an increase in unemployment to 5.3% from 5.1% while employment fell by close to 10,000 for the month.

Although the Australian dollar has proved resilient, domestic and international fears are likely to outweigh any potential safe-haven support for the currency.

Canadian dollar:

The Canadian dollar continued to find support weaker than the 0.99 level against the US dollar during the week, but gains were held to the 0.9820 area with a reluctance to push the currency stronger. There was some relief over risk appetite trends and commodity prices attempted to advance, but underlying sentient remained fragile.

The Bank of Canada held interest rates at 1.0% at the latest monetary meeting and also stated that the pressure for an increase in interest rates had diminished due to the deterioration in global growth prospects.

The Canadian dollar is unlikely to advance significantly given the international risk profile, especially with the Bank of Canada moderating its policy stance.

Indian rupee:

The rupee maintained a weaker tone during the week and there was a decisive break through the 46 area with losses to lows around 46.20 which was a one-year low for the currency. There was a generally stronger US currency tone which undermined the Indian currency and there was stronger than expected demand for the dollar from domestic oil refiners.

The local stock market did show some resilience during the week and there were some hopes that the Reserve Bank would signal a pause in raising interest rates.

The rupee will continue to be hampered by caution over risk. Heavy losses from current levels should be avoided unless credit conditions deteriorate severely.

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The Hong Kong dollar was generally confined to narrow ranges during the week and continued to find support in the 7.80 region against the US currency. There was firm US dollar support in the 7.79 area as underlying risk appetite remained fragile.

There was optimism surrounding forthcoming IPO offerings with expectations of strong capital inflows and very low US interest rates also continued to discourage flows into the US currency.

The Hong Kong dollar should gain near-term protection from IPO-related inflows and speculation over a medium-term peg shift will also underpin the currency.

Chinese yuan:

The Chinese yuan weakened during much of the week and there was a run f five successive lower daily fixes as the US dollar advanced to the 6.39 area. The weaker Euro tone was important in discouraging capital flows into the yuan.

There were further concerns over the inflation outlook even though the August date showed a moderation in the headline rate to 6.2% from 6.5% with fears that pork prices could rise further and uncertainty over monetary policy continued.

The PBOC is likely to maintain its policy of gradual yuan appreciation in the short-termas it balances inflation and growth uncertainties.