Weekly Forex Currency Review 11-01-2013

The ECB is significantly more optimistic surrounding the financial outlook, at least in public which will help underpin Euro sentiment, with rate cuts taken off the agenda for now.  There is also a more confident tone surrounding the Chinese economy, although this optimism could fade very quickly given underlying credit conditions. In this environment, risk appetite could deteriorate quickly again.

Key events for the forthcoming week

Dollar:

The most likely outcome continues to be solid US growth in the short-term even though there has been a persistent trend for mixed economic releases. Federal Reserve policy will continue to be an important short-term focus with some increased expectations over an ending of quantitative easing this year. Member comments will be watched very closely ahead of the end-January meeting. The overall tone is still likely to be broadly dovish which will lessen potential dollar support.  Risk conditions will be watched closely with tensions liable to resume over the US debt-ceiling talks and defensive dollar support may increase again.  

The US currency was unable to break significant technical levels against the Euro and dipped sharply later in the week following the ECB policy meeting with a retreat back towards 1.33.

The latest US employment report was relatively close to expectations with a non-farm payroll increase of 155,000 for December from an upwardly-revised 161,000 gain the previous month. The unemployment rate was static at 7.8% and there was a modest increase in earnings. The data will reinforce expectations of a solid US expansion, but markets were expecting a strong release which lessened the potential for further dollar buying support.

There was a stronger than expected reading for the ISM non-manufacturing index with an increase to 56.1 for December from 54.7 the previous month with a particularly strong reading for the employment report which maintained optimism surrounding the outlook and potential for US out-performance.

The decision to water-down Basel bank capital reserve requirements from 2015 should have some positive impact on risk conditions which would also curb underlying dollar demand.

The Administration formally nominated Jack Lew as the new Treasury Secretary. Any comments on the debt ceiling and fiscal situation will be watched very closely and any remarks on the dollar will also be watched very closely.

US jobless claims were slightly higher than expected at 371,000 in the latest week from a revised 367,000 previously while there was a downward revision to the Philadelphia Fed index for December, but the overall impact was limited

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Structural fears surrounding the Euro-zone will remain lower in the short-term. There has been a further easing of peripheral bond yields with improved investor demand for securities. The ECB is more confidence over the financing risks and appears much less willing to consider a further cut in interest rates. Confidence could, however, unravel quickly, especially with continuing GDP declines in the peripheral economies such as Spain with high levels of unemployment also increasing social tensions. Euro support is therefore liable to fade again quickly on fresh economic fears.

The Euro found firm support close to 1.30 against the US currency and advanced strongly later in the week after the ECB policy meeting.
 
There was a small improvement in Euro-area business confidence, but the unemployment rate increased to a record 11.8%. Data from peripheral economies inevitably remained the key focus with Spanish and Greek unemployment above 25% as youth unemployment remained above 50%. There were further concerns surrounding the substantial political tensions associated with extremely high unemployment levels.

The German industrial data was again weaker than expected with a 2.9% annual decline despite a small monthly recovery which continued to cause some unease surrounding the Euro-zone growth outlook.  There was also uncertainty surrounding German parliamentary support for a Cyprus bailout which had some small negative Euro impact.

There was a stronger than expected Spanish debt auction as the five-year bond yield declined to below 4.00% from 4.20% previously and Spain was also able to sell more than the targeted amount which increased confidence in the peripheral bond market and pushed benchmark yields down further.

As expected, the ECB left interest rates on hold at 0.75%, although there had been some calls for the bank to cut rates.  In the press conference, Draghi remained generally downbeat surrounding immediate growth prospects with a warning that risks were still to the downside and that further balance sheet adjustments were needed. Inflation risks were described as broadly balanced.

The rest of the briefing was significantly more optimistic as Draghi stated that financial conditions had improved to a marked extent. The ECB President stated that the decision to leave interest rates on hold had been unanimous and gave the impression that there had been no calls for rates to be cut, in contrast to the December meeting. Although he refused to rule out the possibility of further rate cuts, markets moved to price-out any reductions during 2013 and this had a strong impact in boosting Euro demand.

The Euro was also boosted by Draghi’s refusal to comment on exchange rates as he pointedly stated that the ECB did not have an unemployment target.

Yen:   

There will be intense pressure for the Bank of Japan to engage in further aggressive policy easing with widespread expectations that the central bank will introduce a revised 2% inflation target at next week’s meeting. There will also be scope for a further monetary easing while the government will announce a further  fiscal expansion. Defensive demand for the yen will also fade if there is a sustained improvement in risk appetite and confidence in the global growth outlook.  A substantial amount of yen negative fundamentals have, however, been priced in which could trigger a sharp correction.

The yen remained under heavy selling pressure during the week with correction attempts quickly attracting selling pressure on the Japanese currency. The US currency pushed to a 29-month high above 89 and the Euro also advanced very strongly during the week.
 
There were widespread expectations that the Bank of Japan would introduce a 2% inflation target at next week’s policy meeting which would trigger a further easing of monetary policy by the central bank.

The yen was also undermined by improved sentiment towards global financial conditions. The Japanese currency was subjected to further heavy selling pressure later in the New York session. Prime Minister Abe stated that the government would launch a JPY10.3trn spending package to boost the economy and there was also pressure on the Bank of Japan to target employment as well as inflation.

The economic data provided no support for the yen with a JPY222bn current account deficit for November, reinforcing fears over the balance of payments position.

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There will be further uncertainty surrounding the UK outlook with particular unease surrounding the consumer spending outlook as incomes remain under pressure and there will be expectations of weak 2013 growth. The balance of payments situation will also come under greater focus with unease over potential funding pressures if there is a sustained decline in defensive Sterling demand. In contrast, there will be Sterling support from the aggressive monetary policies in the US and Japan. Trends in risk appetite will still be important at times and the UK currency will tend to gain some support when confidence in is stronger, but the currency overall will find it difficult to make much headway.

Sterling was able to find support close to 1.60 against the dollar with rallies back to the 1.6150 area while the UK currency was on the defensive against the Euro with a move beyond the 0.82 level.
 
The UK goods deficit declined slightly to GBP9.2bn from GBP9.5bn the previous month with a modest gain for exports. There was still underlying unease surrounding the trade outlook with exports still unable to make much underlying headway and there were also expectations that trade would be a small negative influence on the fourth-quarter UK GDP data.

There were no surprises from the Bank of England as it held interest rates steady at 0.50% and also decided against any further boost to the quantitative easing programme from GBP375bn. The UK currency gained some underlying support from the decision not to expand policy further, especially with expectations that the Federal Reserve will continue to buy bonds in the short-term.

Swiss franc:

The National Bank will remain strongly committed to maintaining the 1.20 minimum Euro level in the short-term, especially with a strong determination to protect competitiveness and avert any serious deterioration in industrial conditions.  The imposition of negative rates by commercial banks will also undermine franc support. An easing of Euro-zone pressures will tend to lessen the potential for defensive capital inflows into the franc, but the currency will gain at times as an alternative to the Japanese currency.

The dollar was unable to sustain a firmer tone against the franc and retreated to lows close to 0.91 later in the week. With the US currency cushioned to some extent by a weaker franc tone on the Euro cross with a move above 1.21.
 
There were reports that the Zurich Canton Bank was setting negative interest rates on Swiss deposits, following the example of some major banks last year and this had a significant impact in weakening the Swiss currency. The ECB shift away from a potential rate cut also undermined the franc.

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The Australian dollar found support below 1.05 against the US currency and pushed to highs near 1.06 despite struggling on the crosses. There was greater optimism surrounding the Chinese economic outlook which also provided some degree of support for the Australian currency.

The domestic data releases provided no support for the currency with a wider than expected trade deficit and a slight decline in retail sales for the month, although international trends tended to dominate.

There will be immediate support from greater optimism surrounding the Chinese outlook, but confidence is liable to fade quickly and limit Australian dollar gains.

Canadian dollar:

The US dollar was unable to push above the 0.99 level against the Canadian currency during the week before re-testing support below 0.9850

There were only limited domestic economic releases with a sharp decline in building permits offsetting the substantial gains seen the previous month while the PMI index edged back above the 50 level for December.

Even with optimism surrounding the fundamentals and potential capital inflows, the Canadian dollar will find it difficult to sustain any significant gains.

Indian rupee:

The rupee was initially able to hold a firm tone during the week and advanced strongly late in the week as there were sharp Euro gains.  The currency pushed to highs near 54.40, the highest since the opening of January.

There was optimism surrounding capital inflows with solid inflows into local stock markets with some expectations that there would be a cut in interest rates. The rupee was still undermined to some extent by strong dollar demand from oil refiners and background doubts surrounding the trade account.

The rupee will gain near-term support from wider Euro resilience and hopes for capital inflows.  It will still be difficult to secure strong local currency gains.

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The Hong Kong dollar edged slightly lower over the week as a whole, although ranges remained very narrow with little movement away from the 7.75 area.

There were further concerns over the threat of rising domestic inflation pressures which would also increase underlying stresses on the currency peg with the HKMA having only limited tools available to tackle the inflationary pressures.
 
Inflation fears are liable to continue, especially with aggressive monetary policies in the US and Japan with medium-term speculation surrounding the Hong Kong peg.

Chinese yuan:

The yuan maintained a generally firm tone over the week and the spot rate briefly pushed to highs close to 6.22. There was evidence that the PBOC was continuing to resist more substantial gains.

Sentiment was boosted by the stronger than expected trade data as exports rose an annual 14%. Overall lending rose firmly for December, but here were important reservations surrounding the underlying data as banking-sector loan growth fell to a three-year low.
 
Despite a more confident tone surrounding the economy, the yuan will find it difficult to make much headway, especially with the PBOC likely to resist gains.

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