Weekly Forex Currency Review 13-01-2012

The ECB has had some success in easing credit conditions within the Euro-zone and there has been some lessening of the global dollar shortage. In this environment, risk conditions could remain slightly more favourable initially, but it will be difficult to secure a sustained improvement given the global risks with a particular focus on the Chinese outlook.

 Key events for the forthcoming week

Market analysis

Dollar

Despite some disappointment surrounding the retail sales data, there should be expectations of solid near-term US demand. There is little doubt that the Federal Reserve will maintain a very expansionary monetary policy throughout the year with any talk of tightening unlikely to gain any significant traction.  Attention will also focus on the threat of further medium-term credit-rating downgrades. Defensive considerations will remain extremely important for the US currency and there will be inflows due to underlying de-leveraging in the financial sector, especially as emerging-market confidence is liable to remain weaker.  In this context, the dollar should be able to avoid substantial selling pressure.    

The dollar strengthened sharply at times, but it was unable to sustain the gains and dipped late in the week as the Euro recovered and defensive US demand eased. The latest positioning data also suggested that the US currency was at its most over-bought since the first quarter of 2010 and this also led to caution over further dollar buying.

The headline US payroll data was stronger than expected with an increase in non-farm payrolls of 200,000 after a revised 100,000 gain the previous month while there was another unemployment decline to 8.5% from 8.7%. There were solid private-sector employment gains with notable expansion in the transport sector which also boosted confidence in the economy. The dollar gained ground following the payroll data and pushed to a fresh 16-month high just beyond 1.27 against the Euro.

There were still cautious comments from Federal Reserve member Dudley who maintained a generally dovish stance on policy and there was also speculation that the Fed would look to block any further significant dollar appreciation due to a potential negative impact on exports. The US Federal Reserve Beige book reported further modest growth over the past few weeks which maintained expectations of US out-performance in the short term and this did provide background dollar support.

The headline increase in retail sales was, however, held to 0.1% while there was a core monthly decline of 0.2%. In addition, there was an increase in jobless claims to 399,000 in the latest week, in contrast to recent declines. The dollar gained some initial defensive support following the data releases, but then retreated as the Euro again benefitted from short covering.

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The Euro-zone outlook will remain weak in the short term with further concerns surrounding the recession threat, especially with fears surrounding the peripheral economies.  There has been some decline in bond yields which will help stabilise conditions to some extent.  The depth of recession and deflation pressures will, however, be extremely difficult to reverse.  There will also be continuing fears surrounding the sovereign-debt outlook and severe vulnerability within the banking sector.  There will be pressure for the ECB to cut interest rates further over the next few months. Even if this salvages the Euro, the currency is liable to be generally weak over the next few months.

There was still a high degree of unease surrounding the Euro-zone banking sector, especially as Italian banks’ dependence on the ECB for funding increased sharply for December.  There was also a record amount of funds parked at the ECB which continued to suggest very little confidence in the sector.

The latest German auction for six-month bills registered healthy investor interest. The main feature was that yields were actually negative for the first time. Although there was a technical change, the fact that investors were prepared to pay to hold German securities also illustrated the break-down in trust.

There were comments from ratings agency Fitch that the ECB needed to do more to prevent a cataclysmic collapse of the Euro which pushed the Euro sharply lower and there were further rumours surrounding a French credit-rating downgrade by Standard & Poor’s in rumour-driven trade.

There were well-received bond auctions from Spain and Italy ahead of the ECB meeting which provided underlying Euro support as peripheral yields fell sharply with the Euro recovering from lows below 1.27.

As expected, the ECB left interest rates on hold at 1.0% at the latest council meeting following cuts at the previous two meetings. Bank president Draghi stated that there was tentative evidence that the massive liquidity operations were having some success in easing credit conditions. Draghi also stated that there were signs that economic activity was stabilising. There were no suggestions that the bank was looking to cut rates again in the very short term, but markets continued to expect further action.

There was further unease surrounding the Greek situation with continuing obstacles to a debt-restructuring deal. Two senior members of the German governing CDU party also stated that a Greek exit from the Euro area could be manageable.

Yen

Underlying confidence in the Japanese economy will remain weak with continuing doubts whether there will be a sustainable improvement in conditions, especially if there is a downturn in regional demand.  There will be pressure for the Bank of Japan to intervene and weaken the currency, particularly if output levels deteriorate. There would be further US opposition to sustained yen selling which would limit its effectiveness. There will still be caution surrounding the global economy and this will help protect the yen with a reluctance to commit substantial capital outflows while repatriation will remain an important element. Near-term yen losses could, therefore, still be limited.

The dollar failed to make any significant headway against the yen over the week and was generally trapped below 77. Main attention focussed on the crosses as the yen reached a fresh 11-year high against the Euro beyond 97.50 before a limited correction. The weaker than expected US retail sales data had a negative impact and pushed the currency weaker as the dollar failed to gain any additional yield support.

Global risk appetite has been able to stabilise which may curb aggressive yen support, but sentiment remains very fragile and there is a reluctance to push funds out of Japan while repatriation from Europe also remains a threat.

Markets remained on high alert for comments from the Bank of Japan given the possibility of intervention to weaken the yen and the latest speculative positioning data will be watched very closely over the weekend.

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Confidence in the UK economic outlook will inevitably remain extremely fragile.  The latest survey evidence has, however, been mixed and some signs of resilience will lessen immediate fears surrounding a fresh slide into recession.  There is still the potential for further action by the Bank of England to expand quantitative easing, especially if there is a fresh deterioration in the Euro-zone outlook.  Defensive considerations will inevitably remain important and there will be some further inflows into the UK as a refuge from the Euro.  Yields are extremely low, however,  and there could be a rapid reversal in capital flows.

Sterling registered net losses against the dollar, briefly dipping to 3-month lows below 1.53 and also lost ground against the Euro after the recent strong run with the Euro moving back above the 0.83 level.

The latest UK data release were slightly better than expected with the RICS house-price index improving to -16% for December from -17% previously. There was also a stronger than expected reading for the BRC retail sales report with a 2.2% increase in the year to December which may ease immediate fears surrounding retail spending.

The trade data was slightly worse than expected with a GBP8.6bn goods deficit for November from a revised GBP7.9bn previously. The impact was limited as there should still be a narrower deficit for the fourth quarter.

There was a 0.6% decline in industrial production for November as energy output fell and a small decline in manufacturing production.  The data is liable to trigger some downward revision to fourth-quarter GDP estimates and the NIESR reported that there was a 0.1% economic expansion for the quarter.

The Bank of England left unchanged interest rates on hold at 0.50% at the latest policy meeting and rates have been left on hold for close to three years. The amount of quantitative easing was also left on hold at GBP275bn for the month. There was further speculation that the Bank of England could announce additional quantitative easing following the conclusion of the existing programme.

Swiss franc

The economic developments have been over-shadowed to some extent by the resignation of National Bank Chairman Hildebrand. There will be further unease over the impact of recent franc strength on the economy and there will be concerns surrounding recession which will maintain pressure for the central bank to combat franc strength.  There will be strong pressure for the National Bank to keep the minimum Euro level in place in the short term, but there is an increased risk that the 1.20 level will come under attack given the increased policy doubts.

The dollar was blocked in the 0.96 region against the Swiss franc during the week and dipped to test support in the 0.94 region. The Euro dipped weaker against the franc with a test of support below 1.21.

Ahead of scheduled parliamentary testimony, National Bank Chairman Hildebrand resigned due to the damage being caused to the bank’s reputation by the allegations surrounding currency transactions by his wife. The Euro came under pressure and dipped to lows near 1.21 on speculation that the bank will now be less committed to the minimum 1.20 Euro level. 

There was no evidence of direct National Bank intervention and no additional rhetoric from the central bank. There was still speculation of covert action by the central bank given that it will not want the markets to sense weakness and attack the Euro.

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The Australian dollar found support on dips towards the 1.02 area against the US currency during the week while there was tough resistance on moves to the 1.04 area as markets looked to test range limits. There was some steadying in global risk conditions which help underpin the Australian currency as generally robust data lessened fears surrounding the global growth outlook.

There was a stronger than expected reading for building approvals which helped underpin confidence in the economic outlook, although there were still expectations that the Reserve Bank would cut interest rates further.  

The Australian dollar will continue to be subjected to high volatility and uncertainty surrounding China is likely to curb any significant gains for the Australian dollar.

Canadian dollar

The Canadian dollar hit resistance on any move towards the 1.01 area against the US currency during the week, but losses were held in the 1.03 area. Risk conditions were satisfactory, although oil-price volatility did have an impact.

The Bank of Canada policy decision will be watched closely next week to assess whether the bank s more confident over the global growth outlook.

The Canadian currency should prove to be broadly resilient in the short term, especially if tensions with Iran put renewed upward pressure on energy prices.

Indian rupee

The rupee advanced to a five-week high just beyond 51.50 against the US dollar.  There was a tentative improvement in risk appetite which helped boost demand for the rupee, especially with greater optimism over potential capital inflows.

There was a stronger than expected reading for industrial production which helped underpin confidence. The latest central bank data recorded larger than expected intervention of close to US$3.0bn for November which increased speculation that the bank was taking currency weakness more seriously than expected.

It will be difficult to secure more than a limited short-term rupee recovery given the underlying risk profile and uncertainties surrounding the Indian economy.

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The Hong Kong dollar has maintained a stronger tone over the past week and tested levels beyond 7.77 against the US dollar, although it was unable to make strong gains.

There was a tentative recovery in risk appetite which helped support the currency, especially as Chinese equity markets attempted to rally. There was evidence of some US dollar corporate demand which curbed further losses for the US currency

Risk conditions will remain very important Hong Kong dollar trends. Medium-term trends and speculation should limit losses for the currency.

Chinese yuan

The PBOC took a more circumspect attitude towards the yuan during the week and the currency consolidated in the 6.32 region against the US currency as there was no strong pressure for appreciation.

The latest inflation rate dipped to 4.1% from 4.2% previously and there was a stronger than expected trade surplus for December, although import growth moderated. There was further speculation that reserve requirement ratios would be lowered further

Speculation surrounding a weaker economy and the potential for further monetary easing is likely to prevent any significant near-term strengthening for the yuan.