Weekly Forex Currency Review 16-03-2012

Overall strategy: The favourable run of economic data has boosted underlying confidence in the US economy and yield support will remain firmer in the short term. There will be continuing expectations that the US economy will out-perform much of Europe and there will also be further concerns surrounding the Chinese outlook on concerns over a potential hard landing. In this environment, there will be the potential for a sharp deterioration in risk appetite if there is any evidence of deterioration in the US outlook with no major areas able to provide strong support.

Key events for the forthcoming week

Dollar: 

There will be further short-term confidence in the US economic outlook following the run of generally favourable data releases, especially after the stronger than expected payroll report. The US currency will gain support from the decision not to consider further quantitative easing at this stage, although the Fed will still maintain a very loose monetary policy. The dollar will also gain support on a downgrading of expectations surrounding other major economies with additional backing realistic if risk appetite deteriorates.

The dollar gained support following the stronger than expected US employment last week and maintained a firm tone over the week as a whole, although there was some slowdown in the gains as key resistance levels were approached. The Euro retreated to lows close to 1.30 as the US yield advantage was sustained.

As expected, the Federal Reserve left interest rates on hold below 0.25% following the latest FOMC meeting. There was a more optimistic stance on the economy with expectations of moderate growth and there was greater confidence in the labour market while financial-market tensions had eased. There was no mention of further quantitative easing, but there was still an expectation that interest rates would remain at exceptionally low levels through 2014.

Regional Fed President Lacker dissented against the interest rate pledge and the lack of quantitative easing references helped boost the dollar. US 10-year yields rose to a 15-week high which helped underpin the dollar.

US jobless claims fell to 351,000 in the latest reporting week from 365,000 previously maintaining a run of generally favourable labour-market data. There were robust readings for the regional PMI indices as the New York Empire index rose to 20.2 from 19.5 the previous month, although there was a dip in the orders component. There was a similar pattern in the Philadelphia Fed index as a rise to 12.5 from 10.2 masked a weaker reading for orders which may trigger some unease over the second-half growth outlook.

There was a stronger than expected reading for long-term capital inflows with a rise to US$101bn for January from US$19.1bn previously. There will be relief that there was a rise in inflows, especially with concerns that China had been shifting funds out of US Treasuries and should provide some fundamental dollar support.

The US currency maintained its yield advantage which helped limit pressure for profit taking and the Euro stalled in the 1.31 with some choppy trading conditions following the reports that some of the Strategic Petroleum Reserve would be released.

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The immediate crisis surrounding Greece has been eased by approval of the PSI deal and second loan package. There will still be an important lack of confidence in the underlying Greek situation and expectations that other weaker economies will slide towards default with political pressures set to increase. There will be strong pressure on the ECB to maintain a very expansionary monetary policy and there will also be concerns that political divisions within the Euro area will intensify. In this environment, the Euro is likely to remain generally on the defensive and vulnerable to underlying depreciation given the policy balance.

There was only limited reaction to the Greek PSI deal finally being completed with some degree of caution ahead of the ISDA announcement on whether a credit event would be declared. The ISDA did declare that a credit event had taken place, although the impact was limited.

There was relief that the Greek situation had been resolved for now despite an important lack of confidence in the medium-term outlook. There was speculation that an additional support package may be required for Greece and there were fears that Portugal would get dragged towards a default in the medium term. There were also further tensions surrounding Spain’s 2012 budget target.

There were persistent doubts surrounding the wider Euro-zone economic outlook. Markets were also expecting the ECB to maintain an aggressive monetary policy to help salvage the banking sector which dampened demand for the Euro. Selling pressure was contained to some extent by a stronger than expected reading for the German ZEW index which strengthened to the highest level since 2010.

Yen:

The yen will remain vulnerable on yield grounds, especially given the increase in US support. There will also be speculation that the Bank of Japan will look to ease monetary policy even further over the next few months. There will also be speculation that there will be competitive regional devaluation as economies look to remain competitive. The yen can still gain support from a lack of confidence in the global economy, especially if there is a wider deterioration in risk appetite and seasonal factors should stem near-term losses.

The dollar maintained a strong tone following the US employment data and pushed to 11-month highs above 84 as yields continued to improve. The US currency was then vulnerable to a significant correction following recent sharp gains. The solid US data releases helped maintain US yield support and also curbed any momentum for the yen with the US currency consolidating around the 83.20 area.

The Bank of Japan held policy steady at the latest policy meeting with no further action following the additional easing last month. There were further expectations that a policy shift in China to curb any further yuan appreciation would also encourage the Bank of Japan to aim for a weaker currency. There was, therefore, increased speculation that Asian economies could get dragged into a policy of competitive devaluations which would tend to benefit the dollar.

There were reports of increased exporter selling and there will also be speculation that the Ministry of Finance has been actively engaged in pushing the yen weaker in order to provide better levels for Japanese companies to hedge export earnings ahead of the fiscal year-end at the end of March.

The latest Bank of Japan minutes recorded that some members had considered the option of a higher 1-2% inflation goal, although the majority view was in line with expectations with the dollar consolidating above 83.25.

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Confidence in the UK economy is likely to remain slightly stronger for now with reduced fears surrounding a slide into recession. There will also be lower expectations over any further quantitative easing by the Bank of England. The confidence could still prove to be very brittle given the underlying economic vulnerability and the potential vulnerability has been illustrated by Fitch’s decision to put the UK AAA rating on negative watch. There will also be further concerns surrounding the banking sector which will limit Sterling support.

Sterling found support close to 1.56 against the dollar during the week and proved generally resilient in the face of a stronger US currency. Sterling was also able to strengthen back to 1-month highs close to 0.83 against the Euro.

There was a 7,200 increase in the UK unemployment claimant count from a revised 7,000 increase the previous month with the unemployment rate unchanged at 8.4%. There was a further decline in average earnings growth to 1.4% from 1.9% according to the latest data with a notable squeeze in government-sector earnings which maintained fears that consumer spending would come under pressure over the next few months which would undermine the wider economy.

There was some negative impact from Fitch’s announcement that the UK credit rating had been put on negative watch. The timing of the announcement was particularly significant with the UK budget due next week. There was speculation that the government would be forced to take a more restrictive stance on fiscal policy to help bolster international confidence. This would maintain expectations that there would be a loose monetary policy which curbed Sterling demand.  

Swiss franc:

Fears over the economic outlook are likely to ease slightly in the very short term with an easing of the deflation threat and an upward revision to GDP growth estimates. The National Bank will remain concerned over franc strength and considers that the currency is substantially over-valued. The most likely outcome is that the bank will continue to resist any renewed appreciation of the currency. Franc support should also be dampened to some extent by an easing of immediate Euro-zone fears, although the shift in sentiment could still prove short lived given the severe structural vulnerabilities.

The Swiss National Bank announced no change to interest rates at the latest policy meeting with interest rates held below 0.25%. The central bank also announced that the minimum 1.20 Euro level would be maintained and that it would be defended aggressively. Interim Bank Chairman Jordan stated that the franc was still very, very strong, maintaining some speculation that the minimum Euro level could be increased over the next few months.

There was still disappointment that there was no move to weaken the franc further at this meeting and the Euro weakened to lows around 1.2065 against the Swiss currency. The dollar was unable to regain the 0.93 level and dipped to test lows near 0.92 following the National Bank meeting.

The Swiss ZEW index rose to a figure of unchanged for February from a figure of -21.2 the previous month which maintained some expectations of an underlying improvement in the economy. The dollar retreated from highs near 0.93 against the franc while the Euro was unable to hold above 1.21.

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The Australian dollar maintained a generally softer tone during the week, butt here was solid support on dips to near the 1.04 level against the US dollar. The housing data was generally weaker than expected with a dip in home loans and housing starts which maintained expectations of a sharp slowdown in the housing sector and illustrated underlying stresses within the economy.

The currency was hampered to some extent by unease surrounding the Chinese growth outlook following a series of more cautious comments from key officials.

The Australian dollar is liable to remain generally vulnerable with fears over the domestic economic outlook and further unease surrounding the Chinese outlook.  

Canadian dollar:

The Canadian dollar was stuck in relatively narrow ranges during the week with US buying support below the 0.99 level. There was some support when equity markets gained ground and the Canadian currency gained support on the crosses as confidence in the North American economy improved.

There was some volatility triggered by shifts in oil prices, but there was a general lack of fresh incentives which curbed ranges.

The Canadian dollar should be resilient on hopes for North American economic out-performance, but valuations remain generally unattractive at current levels.

Indian rupee:

The rupee recovered from 7-week lows against the US dollar, but was unable to make much headway and dipped back through the 50 level as the week progressed. High oil prices continued to have a negative currency impact.

As expected, the Reserve Bank left interest rates unchanged following the latest policy meeting and there was some disappointment over a relatively hawkish tone from the central bank. There was also uncertainty surrounding the fiscal policy which curbed rupee support as the stock market had a generally subdued tone.

The rupee will continue to be hampered by high oil prices with doubts over capital inflows also having an important impact in curbing the potential for currency gains.

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The Hong Kong dollar was confined to narrower ranges during the week and it drifted consistently weaker as it was unable to make a fresh challenge on the 7.7550 level.

There was further uncertainty surrounding the Chinese economy and the weaker yuan also had a significant impact in curbing potential capital flows into the Hong Kong dollar, especially with the US currency gaining support from the less dovish Federal Reserve tone.

Fresh doubts surrounding the Chinese outlook and a generally weaker tone for the yuan would tend to curb Hong Kong dollar support with risk trends also important.

Chinese yuan:

The yuan was again weaker as a combination of factors undermined the currency. There were important comments from premier Wen who stated that the yuan was close to equilibrium and that there was no case for further appreciation. The PBOC also fixed the currency sharply weaker, reinforcing the political message.

The currency was also undermined by a sharp trade deficit for February even though the data had been distorted by the Lunar holiday period. There was further speculation over a sharp slowdown in the Chinese economy which also undermined confidence.

The yuan is likely to maintain a weaker tone in the short term, especially with the government signalling a significant shift in currency policies.  

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