Weekly Forex Currency Review 13-04-2012

The Euro-zone structural outlook will inevitably be an important focus with important concerns that conditions within Spain will deteriorate further, especially with major vulnerabilities within the banking sector. Even if the immediate situation can be stabilised, there will be additional pressure for policy action from the ECB. There will be scope for defensive dollar support, although there will also be speculation that the Federal Reserve will move towards additional quantitative easing.

Key events for the forthcoming week

Dollar: 

There have been some fresh doubts surrounding the US growth rate following the latest employment data. Nevertheless, there should still be expectations of solid growth in the short-term. The Federal Reserve will keep interest rates at very low levels which will stifle yield support and there will be speculation that any evidence of weakening demand would quickly trigger a fresh round of quantitative easing. These expectations will limit the potential for underlying dollar demand. Global growth conditions will also remain important and there will be defensive US support if fears intensify. Given the net global policy bias, the dollar should be able to avoid heavy selling pressure.

The dollar was unable to sustain gains during the week as markets took a slightly more cautious attitude towards the economy. Risk appetite also tended to stabilise which curbed defensive demand for the US currency as the Euro rallied to 1.32.

The headline US payroll increase was significantly weaker than expected with an increase of 120,000 compared with expectations of an increase above 200,000 and a revised 240,000 gain for the previous month. This was the lowest reading for four months which re-ignited doubts surrounding the US trends. The unemployment rate declined to 8.2% from 8.3% previously, but this reflected a decline in labour-market participation rates rather than large gains in jobs.

There was fresh uncertainty surrounding the outlook for monetary policy with some renewed speculation that the Fed could sanction additional quantitative easing.

the Federal Reserve Beige Book stated that growth conditions were modest to moderate which was the same as the previous two releases.

The latest US data recorded a decline in the US trade deficit to US$46.0bn for February from US$52.5bn the previous month. There was a generally weak reading for imports which helped narrow the deficit, but is also raised speculation that underlying economic demand was weakening. The jobless claims data was also weaker than expected with an increase to 380,000 in the latest week, the highest reading since January.

The US data tended to put downward pressure on US yields while risk appetite was generally solid as equity markets rallied. Although regional Fed President Kocherlakota maintained his stance that interest rates should start to increase this year, the majority of Fed comments remained generally dovish as they were not willing to rule out further quantitative easing if the economy deteriorated.

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There will be renewed concerns surrounding peripheral economies in the short Spain will inevitably be an important focus, especially with increased fears surrounding the banking sector.  A key factor will be relentless pressure for more policy stimulus to prevent the economies getting trapped deeper within recession.  There will, therefore, be speculation over additional policy easing by the ECB.  There will still be the threat of a paradox as any renewed fears over a Euro break up would also lead to expectations of a new hard Euro which would curb selling pressure.  Capital repatriation may also provide net support.

Underlying Euro-zone sentiment initially remained very negative due to a barrage of negative news for the currency. The economic data was weaker than expected with a decline in the Sentix business confidence index to -14.7 for April from -8.2 previous, in contrast to expectations for a further small improvement.

There was further substantial selling pressure on peripheral bond yields during the session with benchmark Spanish yields approaching the 6.0% level for the first time in over three months while Italian yields also rose. There was a sharp widening in yield spreads as German bund yields equalled record lows on defensive demand. Despite the stresses in bond markets, there was no immediate evidence of ECB bond buying in the secondary market.

There was some speculation that the ECB would have to look for more LTRO operations to help stabilise market conditions, especially with fears that liquidity shortages would re-appear in European banking sector.

Later in the week, there was a sharp drop in Spanish yields which helped stabilise market sentiment with some speculation that the ECB could re-start its bond-buying programme. The Euro gained some support from speculation over capital repatriation from European banks to cover balance-sheet vulnerability which boosted net demand for the currency even as confidence deteriorated.  

Yen:

There will be further concerns over structural weakness and a lack of demand within the Japanese economy. Competitiveness will remain an important issue and there will be pressure on the Bank of Japan to resist renewed yen strengthening. In this context, there will be pressure for the central bank to relax policy again at the next monetary meeting. Trends in risk appetite will inevitably remain important and there will be important defensive yen demand if regional growth fears intensify. The support could be short lived given that there would also be pressure for regional devaluation policies.

The dollar weakened following the US employment report and generally remained on the defensive, although there was support in the 80.50 area against the yen.
 
There was also some further disappointment that the Bank of Japan did not relax monetary policy further at the latest policy meeting. This was offset by growing speculation that there would be action to expand policy at the late-April policy meeting. The machinery orders data was stronger than expected with a 4.8% increase for March and risk aversion eased slightly which helped the dollar stabilise in Asia on Tuesday, although it was unable to make significant headway.

The yen was also generally resilient despite renewed speculation that the Bank of Japan would consider a further relaxation of monetary policy at the late-April policy meeting. The latest central bank minutes reported that one member was pushing for additional stimulus which had some negative yen impact.

The currency was also unable to gain significant support from a more cautious attitude towards risk following the Chinese fourth-quarter figure of 8.1% compared to an expected 8.4%. North Korea’s failed rocket launch did not have a major impact.

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Confidence surrounding the UK economy is likely to remain slightly stronger in the short-term following a run of favourable survey evidence. The pattern is still very mixed, however, and there is an important risk of disappointment surrounding growth trends. The UK borrowing and debt situation also remains precarious. In this context, trends in risk appetite will remain important and any deterioration in confidence would tend to undermine Sterling. The UK currency can still gain net support from fears surrounding the Euro-zone with the potential for defensive flows into the bond market.

Sterling held a firm tone during the week and pushed to a 14-month high on a trade-weighted index. The UK currency advanced back towards the 1.60 area against the US dollar and also advanced to 3-month highs against the Euro.

The latest NIESR data suggested that there was GDP growth of 0.1% for the first quarter. This would mean that the UK had escaped a technical recession, but this was a much lower estimate than that derived from recent PMI data. Any figure near 0.1% would be a serious setback for the economy and Sterling. The latest RICS house-price index recorded a reading of -10% for April from -13% previously and this was the best reading since mid 2010. The latest BRC retail sales data recorded a 1.3% increase in the year to March from -0.3% previously.

The trade account registered a GBP8.8bn deficit for February from a revised GBP7.9bn previously as exports declined. Imports held relatively firm which suggested that domestic spending may be resilient and Sterling did not weaken following the data as global issues dominated.

Swiss franc:

The National Bank may continue to be tested more severely in the short-term as markets again attempt to take out the 1.20 minimum level. There will also be the risk of capital flows into Swiss assets if Euro-zone structural fears intensify. The central bank is likely to hold the line in the short-term and there will be the potential for sharp franc losses if the bank manages to trigger stop losses on long positions. A lack of attractive alternatives should still provide net support for the Swiss currency and volatility could intensify.

The dollar was unable to hold above 0.92 against the franc and retreated to lows near 0.91, although ranges were relatively narrow. Principal attention again focussed on the crosses as the Euro was unable to pull significantly away from the 1.20 minimum level. Indeed, the cross briefly dipped to just below this level in Asia on MondayThe price action continues to suggest that the National Bank is intervening to prevent the Euro weakening below the minimum level. There will be further concerns that Euro structural fears will trigger further defensive flows into the Swiss currency with official policy under very close scrutiny.

National Bank interim Chairman Jordan reiterated that the bank would defend the 1.20 minimum level with all available force. He admitted that trading below the 1.20 level could not be excluded on technical grounds, but that the bank was continuing to sell unlimited quantities of francs at that level.

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The Australian dollar found support below the 1.0250 level against the US dollar during the week and rallied firmly over the second half of the week with a move to highs above the 1.04 level. There was a much stronger than expected labour-market report with a 44,000 employment increase as other data did not have a major impact.

There was an improvement in risk appetite which helped underpin the Australian currency, especially as there was a general decline in defensive US dollar demand. A weaker than expected GDP report took some of the gloss from the currency on Friday.

With expectations over further interest rate cuts and doubts surrounding the Chinese economic outlook, the Australian dollar will find it hard to secure significant gains.

Canadian dollar:

The Canadian dollar hit resistance on moves towards the 0.99 area against the US currency, dipping to lows near 1.0050 before recovering back to stronger than parity.

The domestic data was weaker than expected as the trade account reverted to near balance as exports declined which had some negative impact on sentiment, especially as there had been optimism that the US shipments would have risen.

Although the Canadian dollar should be broadly resilient, there will be the risk of greater concerns surrounding domestic debt levels.

Indian rupee:

The rupee was unable to make sustained headway during the week and was generally held weaker than the 51 level against the US dollar as it tested support beyond 51.50.

There were persistent doubts surrounding potential capital inflows which had a significant impact in dampening Indian currency demand. There was some support from a lack of US dollar demand in wider markets. A weaker than expected industrial production report increased speculation that the Reserve Bank could sanction a cut in interest rates at next week’s policy meeting.

There will be further uncertainties surrounding the economic outlook and the currency is likely to remain generally on the defensive given unease over capital inflows.

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The Hong Kong dollar was again confined to relatively narrow ranges during the week. There was support beyond the 7.7650 level against the US currency and it advanced to highs near 7.76 before consolidating. 

There was a mood of caution surrounding the Chinese growth outlook which curbed Hong Kong currency support. Expectations that the US Federal Reserve would maintain a dovish policy was important in curbing any selling pressure.

Continuing uncertainty surrounding the Chinese outlook will tend to curb Hong Kong dollar support with longer-term policies also an important underlying focus.

Chinese yuan:

The yuan was confined to relatively narrow ranges against the US currency during much of the week. The currency was fixed stronger than the 6.30 level against the US dollar on Friday as a generally weaker US currency tone offset the impact of a weaker than expected GDP report. GDP slowed to 8.1% for the fourth quarter of 2011 from 8.9% previously.

Immediate expectations of a looser monetary policy were dampened by the higher than expected consumer inflation report, although there were further rumours surrounding a reduction in reserve ratio requirements.

The PBOC is likely to be happy to keep the yuan within relatively narrow ranges given the high degree of economic uncertainty and doubts surrounding growth trends.

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