Weekly Forex Currency Review 10-02-2012

The immediate threat of a Greek debt default may have been eased by the latest deal, but the situation is far from secure as there will be intense opposition to the agreement within Greece and major reservations throughout the Euro area.  A renewed default threat would be a serious test for the generally more confident tone surrounding risk appetite and confidence in the global economy, especially if confidence in the Chinese outlook deteriorates further.

Key events for the forthcoming week

Dollar:

Confidence in near-term growth prospects should remain firm, especially after the employment data and this will have some positive impact on sentiment. Monetary policy will, however, remain a very important stumbling block for the dollar, especially with the Fed maintaining a dovish stance and expecting that short-term rates will remain at very low levels until 2014.  There will also be longer-term budget fears which will remain a negative influence. The dollar’s correlation with degrees of confidence in the global economy will remain high and it will stay vulnerable when confidence in the global economy is higher.

The dollar was on the defensive for much of the week, but it was able to resist major losses and secured a limited recovery as the Euro and commodity currencies were unable to hold their best levels later in the week.

Following stronger than expected labour-market data at the end of last week, the US jobless claims was better than expected with a decline to 358,000 in the latest week from 373,000 previously, maintaining the recent underlying improvement. The dollar still found it difficult to gain any additional support given the Federal Reserve stance. There was strong demand at the latest Treasury bond auction which suggests underlying confidence in the global outlook may still be very fragile. The US economic indicators were relatively minor, but maintained a firm tone as consumer credit rose by a further US$19.8bn  and consumer confidence improved.  

Although this suggests solid growth, the data impact was limited and tended to be overshadowed by comments from Fed Chairman Bernanke. His remarks were broadly unchanged from last week with no concession to the payroll data as he stated that the data was understating the unemployment problem. Regional Fed President Williams stated that further quantitative easing would be a close call and took a generally dovish tone while Lacker stated that further easing was unlikely. Markets will maintain expectations of a dovish tone given the overall FOMC composition.

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The German economy is still performing well and there has been some evidence of stabilisation in the Euro-zone as a whole.  The outlook is still very weak, however, and fears surrounding the peripheral economies will inevitably stay very weak as the peripheral economies remain trapped in recession. Any Greek deal is unlikely to provide sustained relief, especially as there will be major doubts surrounding implementation of further austerity measures. The ECB will remain under pressure to provide further relief in the form of lower interest rates and aggressive repo operations. The net capital-account trends are likely to remain broadly negative for the Euro.

The Euro attempted to regain more ground during the week and did test important resistance levels against the US currency before buying support faded above 1.33.

Greek talks dominated for much of the week as wrangling over an agreement continued. There were reports that the ECB would be willing to exchange its Greek debt holdings with the EFSF which boosted sentiment.  There were also comments from several officials that the Euro would be able to survive without Greece in the single currency and speculation that reduced fear surrounding the consequences of a Greek exit would encourage a hard line.

As expected, the ECB left interest rates on hold at 1.0% at the monthly meeting. In the press conference following the decision, there was a slight adjustment in the tone from bank President Draghi. The economic outlook was subject to high uncertainty and downside risks which was a slightly more positive statement than last time when the downside risks were described as ‘substantial’. There were still expectations that the ECB would be prepared to cut interest rates again if the outlook deteriorated. Draghi refused to comment on the issue of Greek bonds.

Ahead of the Euro-group meeting in Brussels, the Greek government stated that it would accept the conditions for a EUR130bn second loan package to prevent a debt default. The government will still need to find an extra EUR350bn in savings to meet troika demands and will also need rapid parliamentary approval for the measures.  Two coalition party members resigned immediately following the deal and there will inevitably be a hostile response within Greece.  These uncertainties prevented the Euro from gaining much traction and it again failed to hold above the 1.33 level.

Yen:

There will be further concerns surrounding the industrial and trade outlook with profit warnings from key exporters having a further negative impact. There will also be further pressure on the Bank of Japan and Finance Ministry to alleviate stress through a weaker exchange rate. There will be increased speculation over further covert action to weaken the yen after the moves seen during the fourth quarter. This will discourage aggressive yen buying even though its effectiveness will be doubted.  The yen will advance if underlying risk appetite deteriorates.

The dollar found support close below 77 against the yen during the week and pushed steadily higher during the US session with a peak near 77.70. The US currency received some support on yield grounds following the latest jobless claims data and strong demand at the bond auction also had a positive impact and reduced speculation over a move to the 75 area triggered position adjustment. The yen was broadly weaker on the crosses as the Euro aimed to break above technical resistance levels.

The latest quarterly Japanese intervention report indicated that Japan intervened covertly as well as openly during the fourth quarter.  There will be further pressure on the Bank of Japan to intervene and prevent renewed yen appreciation.  There would be US opposition which will encourage further covert action, although its doubtful whether this would have much market impact without a shift in fundamentals.

There will still be a high degree of caution over the global growth outlook and reservations over selling the yen aggressively, especially after the latest Chinese trade data recorded a downturn in exports and imports.

The Japanese economic data was weaker than expected with machinery orders falling 7.1% for December following a 14.8% increase previously.  Companies are expecting a recovery in the first quarter of 2012, although recent profit warnings from key electronics companies could put this in doubt. 

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There will be further concerns surrounding the consumer spending outlook. Business surveys have been generally mixed and fears over recession have eased slightly following more robust business surveys. The Bank of England decision to expand quantitative easing should not have a major impact for now, especially with other central banks maintaining a very aggressive monetary stance. The Euro-zone situation will be watched very closely and there will be the potential for defensive capital inflows if fear intensifies again.

Sterling tested 5-month highs above 1.59 against the dollar during the week before drifting lower as it also lost momentum against the Euro as the single currency recovered back to near the 0.84 level.

The Monetary Policy Committee (MPC) announced a further GBP50bn increase in quantitative easing while interest rates were unchanged at 0.50% which was broadly in line with market expectations. In justifying the decision, the bank stated that weak growth was likely to push inflation below the 2.0% target on a two-year horizon and there was market speculation that there had been splits within the MPC. Sterling initially advanced on relief that even larger additional quantitative easing had been resisted before drifting weaker again.

The economic data was mixed as a recovery in December manufacturing output failed to prevent a decline for the quarter while the NIESR estimated that that the economy shrank 0.2% in the three months to January.

Swiss franc:

National Bank policies will remain an extremely important focus in the short-term as the debate surrounding the Euro minimum level continues. The bank has remained determined to block gains and there is likely to be some reduction in speculation over renewed franc appreciation. The situation will, however, remain very finely balanced and any renewed fears surrounding the Euro could trigger renewed capital flows into the Swiss currency.

The dollar dipped weaker against the franc to test support below 0.91 before a slight recovery while the Euro found support below 1.2050 against the Swiss currency.

Interim National Bank Chairman Jordan repeated that the bank would resist forcefully any attempt to strengthen the franc and that gains beyond 1.20 would not be tolerated. The rhetoric was broadly in line with recent comments from bank officials, but there were also some hints that more aggressive action might be taken in the form of negative interest rates which did have an impact in closing long franc positions.

The ECB maintained a relatively neutral tone in the interest rate decision and there was relief that some form of Greek deal had been secured. In this environment, there was little immediate reason for a fresh surge in defensive franc buying, although markets will inevitably remain cautious given market uncertainties.

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The Australian dollar maintained a very strong tone over the first half of the week with a move to fresh six-month highs above the 1.08 level against the US dollar. The Reserve Bank left interest rates on hold at 4.25%, contrary to expectations of a further cut with the bank less pessimistic surrounding the global growth outlook.

Risk appetite was also firm which helped underpin the Australian currency as underlying dollar demand remained weaker. The currency failed to sustain its best levels as there was a more cautious tone surrounding risk appetite, especially after the latest Chinese trade data. The central bank also stated that lower inflation would give the it scope to cut rates if necessary.

The Australian dollar will continue to be subjected to high volatility and will find it difficult o sustain  apposition near current levels.

Canadian dollar:

The Canadian dollar traded stronger than parity as underlying US demand remained weaker, but it was unable to hold stronger than 0.9950 against the US dollar.

There was little impetus from the domestic fundamentals with a stronger than expected PMI reading helping to boost confidence in the fundamentals while there was also a stronger than expected reading for building permits.

The Canadian currency should prove to be broadly resilient, although it will be difficult to sustain gains beyond parity given the underlying risk profile.

Indian rupee:

The rupee was unable to make further headway during the week and consolidated stronger than the 50 level with a generally subdued US currency performance limiting the risk of a more substantial correction.

There was solid dollar demand from importers which curbed rupee support and there was also evidence that capital inflows following the liberalisation of capital controls were starting to fade. There was also further uncertainty over the domestic economic outlook which limited buying support.

The rupee will be hampered by underlying doubts surrounding the Asian economic outlook and will find it difficult to extend gains.

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The Hong Kong dollar maintained a generally firm tone during the week and tested resistance beyond 7.7550 before edging slightly weaker. The US currency was generally on the defensive which limited demand and risk appetite was firm which encouraged a flow of funds into the local equity market.

There was still an element of caution surrounding the Chinese economic outlook as a whole, especially after the stronger than expected inflation report and this did provide some US dollar support late in the week.

Risk conditions will tend to dominate and any fresh doubts surrounding the Chinese outlook would limit the potential for further Hong Kong dollar gains.

Chinese yuan:

The yuan maintained a firm tone over the week as the PBOC also discouraged any significant weakness in the currency with the yuan fixed at a new multi-year high beyond 6.30  against the dollar on Friday. There was speculation that the Chinese authorities were looking for a firm currency ahead of Vice-President Xi’s US visit.

Economic uncertainty continued, especially as inflation rose to 4.5% from 4.1%, although the Lunar new-year timing may have been an important influence. The trade surplus for January was much higher than expected as imports fell.

Currency regulator SAFE warned that it expected the current account position to weaken this year with the possibility of limited capital outflows which maintained speculation that there would be reduced underlying upward pressure on the currency.

The yuan is likely to be hampered by further speculation over a sharp slowdown in growth, especially if capital outflows persist.

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