Weekly Forex Currency Review 15-07-2011

Immediate confidence in the Euro-zone and US economies will remain very weak. The Euro still looks to be at higher risk over the next few weeks as a whole given the underlying debt structure and major barriers to a convincing solution. There will be further unease surrounding the global growth outlook with a particular focus on the Chinese prospects as debt and inflation uncertainties increase with international risk appetite likely to be extremely fragile.  

Key events for the forthcoming week

Dollar:

Confidence in the economy will remain fragile in the short-term with fresh concerns over the outlook for consumer spending, especially after the much weaker than expected employment report released at the end of last week.  The Federal Reserve will not take any additional policy action at this time, but interest rates will certainly remain at very low levels and there will be speculation over additional quantitative easing later in 2011. The debt-ceiling negotiations will be watched very closely in the short-term and without a quick resolution, confidence is liable to deteriorate quickly. The US currency can still gain some net support on defensive grounds, particularly with the Euro-zone extremely vulnerable, but the dollar will find it difficult to advance very far.

The dollar was initially undermined by the much weaker than expected US employment data at the end of last week before strengthening rapidly as Euro fears intensified. The dollar retreated again, but did secure a net advance for the week against the Euro in choppy trading conditions.

The headline US retail sales data was close to expectations with a 0.1% monthly increase while underlying sales were unchanged. Jobless claims fell to 405,000 in the latest week from 427,000 previously. The trade deficit rose to a 30-month high of US$50.2bn from a revised US$43.5bn previously as oil imports rose strongly and there will be a negative impact on US GDP estimates.

The FOMC minutes from June’s meeting reported that there was a high degree of uncertainty over growth and inflation prospects. Exit strategies were discussed in length, but FOMC members also admitted that plans might need to be changed.

In testimony to the US House of Representatives on the semi-annual monetary report, Fed Chairman Bernanke remained generally downbeat over the economy with warnings that the period of economic weakness was lasting longer than expected. Bernanke also stated that the Fed would consider providing more monetary stimulus if the economy deteriorates further. The comments reinforced speculation that there could be further quantitative easing which also put the dollar firmly on the defensive.

Dollar sentiment was undermined further by Moody’s announcement that it was putting the AAA credit rating under review for a possible downgrade due to the potential default risk associated with failure to raise the debt ceiling. The impact was magnified by the lack of progress in the debt-ceiling negotiations ahead of the August 2nd deadline and Standard & Poor’s also put the US credit rating on negative watch.

In the second part of congressional testimony, Fed Chairman Bernanke stated that inflation was higher than in 2010 and that the Fed was not prepared for further action at this time. These remarks lessened immediate speculation over any additional quantitative easing and the dollar recovered ground.

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The Euro-zone debt crisis will continue to be watched very closely in the short-term, especially as the contagion risks surrounding peripheral economies remain much higher. Although the immediate sense of panic has eased, yields have risen sharply and sentiment has continued to deteriorate. There will need to be a much more decisive stance on the Greek and wider peripheral situation to boost market sentiment and there will be increased expectations that the Euro will break up. In this context, the Euro will find it difficult to gain sustained support from higher interest rates and volatility is liable to remain high.

The Euro came under further heavy selling pressure on Tuesday, retreating to the weakest level since early March below 1.3850 as the Euro-zone debt crisis intensified. There was a fresh surge in peripheral bond yields as Italian benchmark yields briefly increased to above the 6.0% level as panic selling increased. There were also reports that regional Spanish budget deficits were much worse than officially stated which served to further undermine confidence.

There were reports that the ECB was buying EU bonds and there were also reports of strong Chinese interest which helped stabilise confidence with Italian yields returning to below 5.70%. In tandem, the Euro recovered quickly against the dollar.

There was also relief that Italy managed a relatively successful bond auction, but yields still rose substantially from the previous auction, illustrating how much sentiment has shifted and there were still very important fears surrounding the Italian contagion risk with persistent concerns over Spain as well. Austerity measures were approved in the Senate and will now face a Lower-House vote on Friday.

The bank stresses-test results will also be announced on Friday with markets uneasy over the outcome and the methodology used. There was further uncertainty surrounding an emergency EU Summit with Germany still resisting plans and the underlying mood of uncertainty remained an important negative Euro influence.

Yen:   

There will be concerns over the Asian growth outlook which will tend to curb selling pressure on the Japanese currency and the dollar is not well placed to gain on yield grounds. There will also be the potential for capital repatriation from Europe given stresses within the European financial sector. There will be increased concerns over competitiveness. It will be very difficult to gain G7 backing for intervention, but there will certainly be speculation over Bank of Japan action which will deter speculative yen buying.  

The dollar dipped to lows below 80.0 against the yen in European trading on Tuesday and stop-loss selling triggered a decline to the 79.30 area. Volatility remained extremely high and the dollar slumped to fresh lows near 78.50 late in the US session before rebounding.

The rapid yen gains inevitably sparked speculation over G7 intervention, especially given that market conditions were increasingly disorderly. Finance Minister increased verbal rhetoric against yen gains with a warning that the yen’s rise did not reflect fundamentals. There were serious doubts whether G7 would back concerted intervention with March’s post-earthquake action seen as an exceptional event.

Markets remained on high alert over possible intervention to weaken the yen as verbal intervention continued by Japanese Finance Ministry officials. There was still scepticism that there would be any concerted G7 action to weaken the yen.

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Confidence in the economy will remain weak with further concerns over the outlook for consumer spending and the possibility of a wider downturn in growth. Expectations of a loose monetary policy will continue to undermine Sterling yield support. Euro-zone developments will be watched very closely and, although Sterling could gain defensive support initially, sentiment could turn rapidly if contagion spreads to UK debt markets, especially as UK bank-sector vulnerability would become a greater focus.  Sterling is unlikely to make much headway given the yield and risk structure.

The UK consumer inflation data for June was also weaker than expected as the headline rate fell to 4.2% from 4.5% while the core rate retreated to below 3.0%. The decline eased immediate pressure for the Bank of England to raise interest rates which will maintain a lack of Sterling yield support.

The trade deficit was also wider than expected at GBP8.5bn for May from a revised 7.6bn previously. The data will increase doubts over the UK ability to secure growth through exports and will trigger a downgrading of growth prospects. The unemployment claimant count increased by 24,500 for June, the largest increase for over two years. Although there were distortions there will be fears that the rise will increase strains on the budget position as welfare commitments increase.

Sterling found support below 1.58 against the dollar and rallied firmly over the second half of the week as the dollar weakened and Sterling was able to hold its ground.

The Office of Budget Responsibility (OBR) warned that the fiscal position was unsustainable and that further policy tightening would be required over the next few years.  The Euro-zone debt crisis and implications for the UK economy also remained under close scrutiny. Markets at this stage are still seeing some defensive qualities for Sterling as there has been no negative impact on UK bond yields.  Sentiment could still reverse rapidly over the next few weeks.

Swiss franc:

The franc will continue to be influenced very strongly by the Euro-zone stresses and degrees of risk appetite within global markets. An underlying lack of confidence in the Euro-zone will continue to provide net support and any intensifying of the contagion threat could lead to substantial capital inflows.  The currency is heavily over-valued and there will be additional pressure for National Bank action to stem currency appreciation. Volatility is set to remain at highly-elevated levels in the short-term.  

The Euro failed to gain any sustained relief against the franc during the week and from a high above 1.17, retreated to fresh record lows below 1.15 before finding some support. The US currency also came under heavy selling pressure and fell sharply to fresh record lows below 0.81 as confidence surrounding the Euro and dollar collapsed which triggered renewed safe-haven flows into the Swiss franc.

National Bank member Jordan stated that he was very concerned about the franc developments and insisted that the bank could take action if there was any threat to price stability.  These comments appeared to be in conflict with comments by bank President Hildebrand. The bank rejected any move to link the currency with the Euro.

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The Australian dollar came under heavy selling pressure as risk appetite deteriorated but, as has been the case throughout the past few weeks, there was a swift rebound for the currency as buying interest remained solid. From lows near 1.05 against the dollar it moved back to test resistance levels above 1.0750 before retreating once again.

Higher than expected Chinese inflation figure undermined demand for the currency to some extent, but there was some relief following the GDP data. A small decline in business and consumer confidence did not have a major impact with markets focussed primarily on international developments.  

The domestic and international risk profile suggest that risks surrounding the  Australian dollar will tend to increase over the next few weeks.

Canadian dollar:

The Canadian dollar found support on retreats to near 0.98 against the US dollar during the week and pushed to highs near 0.9550 before stalling. After initial declines triggered by a deterioration in risk appetite, there was a recovery in risk conditions which underpinned the currency as sentiment remained firm.

The domestic data provided support for the currency with an increase in housing starts and a slightly more optimistic business confidence survey.

The Canadian fundamentals should remain broadly favourable, but the Canadian dollar is unlikely to make gains given the overall international risk profile.

Indian rupee:

The rupee dipped to lows near 45.0 against the US currency during the week, but rallied back to the 44.50 area late in the week as ranges were still relatively subdued.
Although equity markets were subjected to heavy selling pressure at times, there was a continuing tone of resilience due to hopes for additional capital inflows.

There were doubts whether the Reserve Bank would increase interest rates again late in July which triggered some uncertainty. The bomb explosions in Mumbai did not have a major market impact.

Underlying risk conditions will make it difficult for the rupee to gain. The currency should be able to remain resilient given hopes for equity-related capital inflows.

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The Hong Kong dollar weakened during the week with lows close to the 7.80 area against the US dollar. The currency was undermined by a deterioration in risk appetite as equity markets were subjected to heavy selling pressure.

The HKMA reported that there would be no change to monetary policy and there were hopes that monetary deposits could be stabilised. There was uncertainty surrounding the mainland Chinese economic policies which hampered flows to some extent with the currency unable to strengthen back through 7.79.

The Hong Kong dollar will gain support when risk appetite improves, but the theme of uncertainty surrounding regional economic trends will limit any potential advance.

Chinese yuan:

The Chinese yuan was unable to break through the 6.45 area against the US dollar during the week and settled slightly weaker during the week.

The latest Chinese consumer inflation data was stronger than expected with a rise to 6.4% from 5.5% previously which increased doubts over the outlook for monetary policy amid pressure for further interest rate increases. There was also unease over the local-government debt financing outlook and risk of economic instability.

There will be a growing threat of instability and fears surrounding the Chinese economy which will test the central bank’s ability to maintain a stable yuan.