Weekly Forex Currency Review 16-11-2012

US fiscal policy will continue to be an important short-term focus with key negotiations between Congress and the House of Representatives over the next few weeks and there will inevitably be the threat of brinkmanship which will tend to unsettle markets and undermine risk appetite. There will also be continuing unease surrounding the Euro-zone and doubts over the sustainability of any Chinese improvement which will continue to fuel the cautious tone.

Key events for the forthcoming week

Dollar:

There will be further uncertainty surrounding the US economic outlook, especially with significant distortions from the recent hurricane, but there will general expectations of solid growth. The Federal Reserve will remain committed to a very expansionary monetary policy and there is the possibility of extra bond purchases next year, limiting yield support.  Fiscal policy will remain an important focus with Congress and the Administration negotiation to avoid automatic tightening next year. Concerns surrounding the fundamentals will be offset by a potential deterioration in risk appetite. Fears surrounding the global growth outlook should also provide some dollar protection.

The dollar secured slight gains over the week as a whole, primarily reflecting the impact of yen weakness and the US currency found it difficult to secure further advances against European currencies.
 
The headline US retail sales report was weaker than expected with a 0.3% decline while underling sales were unchanged, although this followed a series of robust reports and there was still a mood of cautious optimism surrounding consumer spending. Underlying uncertainty surrounding fiscal policy remained an important factor as Congress and the Administration geared up for crucial negotiations.

The Federal Reserve Minutes suggested that additional bond purchases might be considered once Operation Twist is completed at the end of December.  Some members expressed concerns surrounding the potential inflation outlook. There was a detailed discussion surrounding potential communication for exit strategies and whether to set numerical targets such a specific unemployment rate which could trigger a lifting of the Federal Funds rate. There is a strong probability that the Fed will eventually move towards guidance on economic conditions.

Data later in the week was weaker than expected, although there are likely to be distortions from the impact of Hurricane Sandy. Jobless claims were substantially higher than expected at 439,000 in the latest week from a revised 361,000 previously which was an 18-month high. The Philadelphia Fed index dipped to -10.7 from 5.7 previously while the New York index was also in negative territory for the month.

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There will be further uncertainty surrounding the Greek situation as the underlying debt situation remains unsustainable even if the next loan tranche is granted.  There will be major political stresses as the economy continues to contract with the government close to collapse. There will also be major concerns surrounding the Spanish outlook as conditions continue to deteriorate. Even if Germany has the political and economic commitment to keep the Euro together, the currency is likely to under-perform due to fears over the growth outlook.   

Confidence in the Euro-zone remains weak with severe economic and political stresses as there were no resolution of underlying issues. There was still a reluctance to sell the currency aggressively as it found support below 1.27 against the dollar.
 
The German ZEW survey was weaker than expected with a decline to -15.7 for October following three successive monthly gains. The deterioration was not a major surprise after a recent run of weaker than expected data, but did maintain fears surrounding the German economic outlook. If Germany weakens, then there will inevitably be fears surrounding the Euro-zone as a whole.

There was speculation from German media sources that Greece could be given a one-off loan tranche payment of EUR44bn which pushed the Euro sharply higher. Inevitably, the reports were denied by the German Finance Ministry which stated that no decision had been made.

Uncertainty will continue ahead of another Euro-group meeting expected on November 20th. Greece did raise additional funds through the latest four-week Treasury bill auction to stave-off immediate default. There will still be major fears surrounding the outlook, especially with the economy still contracting. There were also further concerns surrounding the Spanish economy as benchmark yields moved close to the 6.0% level.

The Euro-zone third-quarter GDP data was slightly better than expected, but there was still a 0.1% decline for the three-month period which confirmed that the economy was technically back in recession for the first time since 2009 as peripheral economies continued to contract.

There was uncertainty surrounding longer-term Greek prospects with ECB council member Coene stating that a write-off of official debt was likely to happen eventually, a point of view which will be contested very aggressively by the German government.

There was some speculation that the Spanish government would look secure aid from the IMF and circumvent the Euro-zone in order to lessen the burden of conditionality. Spanish uncertainty tended to discourage aggressive Euro selling given the possibility of a spike higher despite an important lack of confidence in the fundamentals.

Yen: 

There will be major concerns surrounding the Japanese economy with particular fears surrounding the corporate sector as exports and profits remain under intense pressure. The political situation will be very important as the LDP which is likely to win power if there is an early election has pledged to push for more aggressive monetary easing and a weaker yen. The Japanese currency could still gain some degree of support from a deterioration in global risk appetite, especially with the potential for capital repatriation.

The yen weakened sharply during the week as a whole with lows beyond 81.40 against the US currency, the weakest level since late April. The Japanese currency also weakened to lows close to 104 against the Euro.

There was increased speculation that the government would dissolve parliament and call early elections with a vote likely to be held on December 16th. There are expectations that the DPJ will be subjected to heavy losses at the election due to deadlock on securing economic reforms. This damaged the yen due to speculation that a new LDP-led government would push for a higher inflation target and force the Bank of Japan into additional quantitative easing.

The yen was subjected to renewed selling pressure after LDP leader Abe called for unlimited monetary easing to support the economy and co-operation with the Bank of Japan to weaken the Japanese currency.  Political developments will be watched very closely as any decision not to hold fresh elections could trigger a sharp reversal of positions and trigger renewed gains.

The yen still gained some degree of protection from underlying fragility in risk appetite with further concerns surrounding the Japanese and Asian economies.

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The Bank of England may resist further quantitative easing in the short-term which could underpin Sterling. Economic concerns are, however, likely to increase again with speculation that there will be another GDP contraction for the fourth quarter. There will be concerns that the AAA credit rating will be lost which could trigger a substantial outflow of capital. There should still be some degree of protection from fears surrounding the Euro-zone outlook, but Sterling is liable to have a weaker tone given domestic fundamental concerns.

Sterling dipped to test support levels below 1.5850 against the dollar and also retreated to beyond 0.8050 against the Euro, but did prove resilient at lower levels
The latest unemployment claimant count registered a 10,100 increase for October after a small increase the previous month and this was the highest increase for over 12 months. There was a decline in the unemployment rate to 7.8% from 7.9%.

In the latest inflation report, the Bank of England increased inflation forecasts slightly while cutting the 2013 GDP growth estimate to around 1.2% from 1.8% previously. There were also warnings from the Governor that GDP could contract for the fourth quarter which increased speculation that the UK could suffer a triple-dip recession.

King denied that the bank was running out of options and stated that further quantitative easing could be considered, although the overall impression was one of uncertainty. Ratings Agency Moody’s stated that the AAA credit rating could be lost if the December Autumn Statement suggests that policies are unsustainable.

The latest retail sales report was weaker than expected with a 0.8% decline in sales for October following a revised 0.5% gain the previous month. The data reinforced concerns surrounding the growth outlook following Bank of England warnings earlier in the week that there could be another GDP contraction for the fourth quarter.

Swiss franc:

There has been some underlying reduction in defensive flows into the Swiss currency, but there are still major uncertainties surrounding the situation, especially as recent Treasury bill auctions have continued to record negative interest rates.  Sustained yen weakness could also increase defensive capital inflows into the Swiss currency. The National Bank will remain strongly committed to the minimum Euro level in the short-term.

The dollar was unable to move above resistance in the 0.95 area against the Swiss franc during the week and retreated back to the 0.94 region. The Euro drifted weaker to the 1.2030 area against the Swiss currency before finding some support as the 1.2000 minimum level started to come back into focus.

Speculation over further downward pressure on the yen will tend to increase the potential for defensive inflows into the Swiss currency as an alternative safe-haven asset, especially with global risk appetite generally fragile.

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The Australian dollar was unable to hold above the 1.0450 level against the US currency during the week and retreated to lows near 1.03 as sentiment deteriorated. The Australian currency was unsettled by a downturn in global equity markets.

Domestically, there was a small decline in business confidence, but this was offset by an improvement in consumer confidence. The currency gained some degree of support from speculation that Global central banks were diversifying into the Australian currency which could be countered by Reserve Bank sales.

The Australian currency will gain some support from potential reserve diversification, but there is evidence that the Reserve Bank will resist further gains.

Canadian dollar:

The Canadian dollar had a generally weaker tone during the week with a US test of resistance close to 1.0050, although underlying ranges were relatively narrow.

There was little in the way of fresh domestic incentives, although there were some concerns surrounding the housing sector.  The currency was undermined slightly by a decline in oil prices with fragile risk appetite also having a negative impact.

The Canadian dollar can prove to be broadly resilient, but net losses are likely against the US currency given growth fears and potential weakness in commodity prices.

Indian rupee:

The rupee dipped to two-month lows close to 55 against the US currency during the week.  Risk appetite was generally fragile during the week with further concerns surrounding the growth outlook.

Trading activity was curbed by Diwali holidays. Sentiment towards the domestic economy was undermined by a weaker than expected reading for industrial production and a record trade deficit which sapped confidence towards the economy.

Given uncertainties over domestic economic policies and regional growth concerns, the Indian rupee is unlikely to make much headway in the short-term.

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After testing the 7.75 area against the US currency, there was slight depreciation back to the 7.7515 area as capital inflows eased slightly.

Hong Kong Financial Secretary Tsang rejected calls for a review of the currency peg, but here was still inevitably speculation over reforms, especially with increased fears surrounding inflation and asset prices.
 
Even if immediate pressures on the band limit ease very slightly in the short-term, medium-term speculation surrounding the Hong Kong peg will continue.

Chinese yuan:

The yuan maintained a strong tone during the week and edged through the 6.23 level against the US currency as the PBOC fixed the yuan beyond the 6.30 level.

There was a wider trade surplus for October which helped underpin confidence to some extent. Political considerations were generally dominant during the week as the new Standing Committee was announced. There was some uncertainty surrounding monetary policy as PBOC head Zhou was not re-appointed.  

International  political pressure for a strong yuan will fade  and there is also likely to be domestic resistance to currency gains as industrial stresses are likely to increase.

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