Weekly Forex Currency Review 14-06-2013

08.30 AM GMT Overall strategy:  Federal Reserve policies and the global growth trajectory will tend to dominate market trends in the short-term with an extremely important Fed meeting next week. There will be a weaker dollar and recovery in risk assets if the Fed takes a very dovish tone, although this could provide only short-term relief for the growth outlook given underlying credit stresses. Overall, the Fed will attempt to take a balanced tone.

Key events for the forthcoming week

Market analysis

Dollar:

The US economic data has generally been slightly more optimistic and suggests moderate growth, although uncertainty remains high. There will be further uncertainty surrounding Fed policy, especially as data releases have not been decisive in either direction. There is a suspicion that the Fed is looking to taper bond purchases later this year and will need a lot of convincing to abandon this strategy, but interest rates will remain extremely low. The net implications are liable to be positive for the US dollar, especially with the potential for further selling in emerging markets, while the currency is now less vulnerable to an unwinding of short-term speculative positions.   

The dollar remained on the defensive during the week and retreated to a four-month low on a trade-weighted basis as the Euro pushed above 1.3350.
 
The headline US payroll report was slightly stronger than expected with an employment increase of 175,000 for May compared with estimates around 165,000. There was a slight downward revision to April’s data to 149,000 from 165,000 previously and the unemployment rate also edged higher to 7.6% from 7.5% previously. The data provided relief, but did not trigger a sustained dollar rally.

The dollar received a brief boost as Standard & Poor’s revised the US credit rating outlook to stable from negative. The rating is already at AA+ following the previous downgrade with little immediate chance of an upgrade back to AAA.

Federal Reserve policies remain an important underlying focus with comments from Regional Fed President Bullard watched closely. He stated that monetary policy was being buffeted by the impact of an improving economy and low inflation. He expressed some concerns over the inflation outlook with the risk that persistently low inflation could prevent a policy tightening. The overall comments still suggested that the Fed would prefer to scale-back bond purchases within the next few months, but is concerned that the economy is not strong enough.

The latest US retail sales data was slightly stronger than expected with a headline advance of 0.6% for May compared with expectations of 0.4% with a core sales increase of 0.3%. The jobless claims data registered a decline to 334,000 in the latest reporting week from 346,000 previously which provided some relief surrounding labour-market trends with claims at a five-year low.

Federal Reserve policy remained a crucial talking point ahead of next week’s FOMC meeting with uncertainty a key factor, especially given mixed US data releases. There has been increased speculation that the Federal Reserve is looking to taper bond purchases late in 2013 and will take a lot of dissuading from this policy. Markets remained on high alert for any unofficial briefing by Fed officials.

There was a media article during US trading suggesting that the Fed would push back against market expectations of a near-term rise interest rates which pushed the dollar weaker in US trading as the Euro moved back above 1.3350.

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There have been some tentative signs of improvement in countries such as Spain, but peripheral economies still remain extremely vulnerable. There will also be growing fears surrounding the Italian outlook as economic and political tensions continue to increase. Although some headline market pressures have eased, the underlying financial situation remains precarious. There is a high risk of further major stresses unless there is a shift in policies. In this context, the ECB refusal to take further action will not provide longer-term Euro support.

The Euro was partially side-lined during the week with the ECB decision not to provide additional monetary support still providing some underlying support for the Euro. There were still important underlying tensions, especially surrounding Italy.
 
There was a slightly weaker than expected Sentix investor confidence reading of -11.6 for May from -15.6 the previous month and the Italian industrial production data was also weaker than expected. The impact was offset by a stronger than expected French industrial reading with little net impact.

The German Constitutional Court started its hearings on the ECB’s Outright Monetary Transactions policy with a two-day meeting to deliberate on the plan’s legality. ECB member Asmussen defended the policy and the Euro gained support when he stated that bond buying must be unlimited and concentrated on the necessity of the scheme. German Bundesbank head Weidmann presented the bank’s case against OMT stating that it blurred the distinction between fiscal and monetary policy.

Yen:

The Bank of Japan will remain committed to an aggressive policy easing. There is, however, evidence of important concerns within the bank over the impact of bond-market instability, especially as this would increase the risk of a major debt-financing crisis given the size of the fiscal deficit. There is, therefore, likely to be a slightly more cautious tone which will curb yen selling. The yen will also gain important support if there is no reversal in the current trend of net capital repatriation. The principal feature is likely to be a sustained increase in yen volatility over the next few weeks.  

There was very heavy yen volatility during the week as a dollar rally faded quickly and the yen pushed to 10-week highs beyond 94 before correcting slightly.
 
As expected, the Bank of Japan left monetary policy on hold at the latest policy meeting while the economic assessment was increased for the sixth successive time. Former top Finance Ministry official Sakakibara expressed major doubts over realism surrounding the 2% inflation target.

After a brief recovery, there was another severe bout of volatility in Asia on Thursday. The Nikkei index dipped sharply lower with losses of over 6% which took the benchmark index to below levels seen in early April. The dollar lost support at the 95 level which triggered substantial stop-loss yen buying which pushed it to below 94.  There were reports from central bank officials that inflation caused solely by a weaker yen would harm the economy. The latest capital account data again reported capital flows back to Japan which triggered further yen buying.

The dollar secured a boost from better than expected economic data and there was also a recovery in equity markets later in the session. Given the overall economic developments, however, the US currency found it very difficult to make much headway in very choppy trading conditions.

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Confidence in the economic outlook is likely to remain slightly stronger in the short -term with expectations of a solid second-quarter GDP gain. There will, therefore, be reduced expectations of a near-term expansion of quantitative easing. There will still be an important element of uncertainty given the arrival of Carney as new Bank of England Governor.  The underlying balance of payments position also remains extremely vulnerable and Sterling will tend to lose ground when there is a deterioration in risk appetite. Overall, it will be difficult to sustain Sterling gains much above current levels.

Sterling held firm against the Euro during the week and pushed to four-month highs above 1.57 against the US dollar. Technically, Sterling briefly pushed above the 200-day moving average for the first time since January.
 
The latest industrial production data was slightly stronger than expected with a 0.4% gain for April following a 0.7% increase the previous month. The latest NIESR data estimated GDP growth of 0.6% in the three months to May following a revised 1.0% gain previously.

The latest UK economic data again had a positive tone which helped underpin Sterling. There was an 8,600 decline in the claimant count for May following a revised 11,800 decline the previous month. This was the lowest rate for two years as the ILO unemployment rate held at 7.8%. There was also a limited recovery in the rate of earnings growth to 1.3% from a revised 0.6% previously which helped ease concerns surrounding consumer spending although the data still suggested an important squeeze on purchasing power.

Bank of England MPC member Fisher continued to expect an expansionary monetary policy. He was, however, more optimistic surrounding the second-quarter GDP growth data, maintaining a general mood of optimism surrounding the short-term growth outlook. Markets overall continued to scale back expectations of a more aggressive Bank of England policy which helped underpin Sterling and the bank also warned over the risk of longer-term increase in inflation expectations.

Swiss franc:

Price action over the past few weeks suggests that there is still scope for defensive franc support when global risk appetite deteriorates, especially with uncertainty surrounding yen trends. The National Bank remains wary of potential deflationary pressure and will continue to enforce the Euro minimum level in the short-term, especially with export prospects still undermined by weak demand within the Euro-zone. The dollar should be resilient against the franc.
 
The dollar remained on the defensive against the franc and retreated to lows below 0.92 while the franc made net gains against the Euro despite high volatility.
 
Underlying speculation that the National Bank could raise the 1.20 Euro minimum level next year did not have a major impact, but markets will stay on high alert for any hints of a policy shift.

Risk conditions remained important with the franc losing ground quite sharply as equity markets rallied. Some recovery in commodity currencies also sapped franc support with volatility likely to remain a key feature in the short-term as the policy debate continues.  

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The Australian dollar was again subjected to high volatility during the week. There was a 31-month low against the dollar below 0.94 before a sharp recovery to above 0.96.  The currency gained support from an improvement in risk appetite even though commodity prices remained generally fragile and there were further concerns surrounding the Chinese outlook.

The economic data was generally slightly stronger than expected with a small employment gain of 1,100 coming as a relief given expectations of a decline. There was also an improvement in consumer confidence according to the latest release.

The Australian dollar will continue to experience high volatility in the short-term. The overall internal and external growth outlook will maintain underlying vulnerability.

Canadian dollar:

The Canadian dollar maintained a firmer tone against the US currency as USD/CAD dipped towards the 1.0150 area during the middle of the week.

The local currency drew support from the stronger than expected employment data released the previous week and also recovered from over-sold conditions.

Given the overall global growth and commodity prices outlook, together with some fundamental doubts,  the Canadian dollar will find it difficult to gain strong support.

Indian rupee:

The rupee was subjected to heavy selling pressure over the first half of the week, sliding to record lows beyond 59 against the dollar. Underlying emerging-market confidence deteriorated which had an important negative impact, especially with the rupee vulnerable to current account concerns

There was a recovery later in the week, sparked initially by reports of Reserve Bank intervention. Fitch also somewhat surprisingly upgraded the ratings outlook to stable from negative while there was a modest recovery in wider emerging sentiment.

With continuing unease surrounding emerging-market assets as a whole and the Indian current account deficit, the rupee will find it difficult o regain much ground.

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The Hong Kong dollar remained weaker than the 7.76 level against the dollar during the week, but found support weaker than 7.7650 as ranges remained generally narrow.

There was some pressure for the Hong Kong currency to be re-pegged against the Chinese yuan rather than the US dollar and this will remain a key medium-term policy debate. Wider emerging stresses did not have a major impact, although they did curb currency support to some extent

Pressure for a longer-term Hong Kong dollar link to the yuan will remain a significant underlying market influence even with short-term commitment to the existing peg.

Chinese yuan:

The Chinese yuan was unable to make any significant headway during the week. The PBOC did set a stronger fixing rate, but the market tended to push the currency weaker with an increase in dollar demand from the commercial banks to comply with new currency regulations limiting positions

There were further hints from senior policymakers that the administration would see financial stability and easing underlying stresses in the banking sector as a greater priority that attempting to sustain very strong growth rates.

A weaker capital account position will be important in restraining the Chinese yuan with little scope for any significant gains, especially with weaker export growth.

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