Weekly Forex Currency Review 16-12-2011

The Euro-zone debt crisis will continue to be a very important influence and there will also be continuing unease surrounding the potential for global de-leveraging and an underlying shift back into US dollar assets. Liquidity will be weaker in the short-term which will maintain the risk of erratic currency moves during the next two weeks at least.

Key events for the forthcoming week

Dollar:

The latest US economic data has maintained expectations that the economy can avoid recession in the short-term.  The monetary policy implications will be limited as the Fed will maintain interest rates close to zero throughout this period, but there should be some positive impact on capital inflows. Defensive considerations are likely to remain very important in the short-term with further demand for US Treasuries. Any further de-leveraging within the banking sector and fears over the global economy would also be important in supporting the dollar, especially if emerging-market sentiment deteriorates further.    

Confidence in the global economy was generally weaker which helped underpin the dollar as it pushed towards 2011 highs. There was a downgrading of several global banks by Moody’s which damaged sentiment to some extent and IMF Head Lagarde also warned over the threat of a sharp global downturn. In this environment, there was the risk of further de-leveraging in the banking sector and a flow of funds into the dollar. There was also some evidence of capital repatriation by European institutions.

The US industrial production data was weaker than expected with a 0.2% monthly decline for November. In contrast, the New York manufacturing PMI index rose to 9.5 from 0.6 previously while the Philadelphia Fed index also increased. Jobless clams fell to 366,000 in the latest week from 385,000 previously, maintaining a slightly more positive view over US prospects. The US retail sales data was slightly weaker than expected with a headline and core increase of 0.2% for November. Although this dampened optimism to some extent, there was still confidence that the US economy was at least holding its own.  

At the latest Federal Reserve meeting, the FOMC was slightly more optimistic surrounding the economic outlook while expressing expectations that inflation would settle near or slightly below the desired level. There was no policy action and no hint over a move to further quantitative easing although regional Fed President Evans dissented as he wanted additional action. There were also no changes to the communication policy. The Fed was still uneasy over the Euro-zone risks and will be prepared to act as required over the next few months.

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The Euro-zone situation will continue to be monitored very closely in the short-term and confidence will inevitably remain very fragile. The EU Summit did little to improve the prospect of short-term stability, but the ECB actions to provide longer-term liquidity will be important in easing some stresses within the banking sector. There will still be a high degree of uncertainty and there will be pressure on the ECB to cut interest rates further, especially as there will expectations of recession. In this context, the Euro will be undermined by a lack of yield support and structural fears will trigger bouts of strong selling pressure.

The Euro was subjected to heavy selling pressure before finding some respite later in the week. There were persistent doubts surrounding the EU Summit with fears that little progress had actually been made with progress towards tighter fiscal integration not addressing the near-term difficulties. German Chancellor Merkel insisted hat there would be no increase in the ESM fund and markets were concerned that there would be no new mechanisms to help support the Euro-zone economy or alleviate the debt burden. The Greek Finance Minister warned that the budget deficit was wider than expected for the first 11 months of 2011 as recession continued to undermine tax revenue and there was also no deal on a private-sector debt restructuring.

Several non-euro-zone countries expressed doubts surrounding the proposed legislative changes and there were persistent fears that there would be no economic back-up for the fiscal commitments. Bundesbank Head Weidmann again opposed any form of monetary financing by the ECB with a stark warning over the need to maintain central bank independence and avoid printing money.  He also stated that there was growing scepticism surrounding the peripheral bond buying programme within the ECB and was also cautious over the prospect of boosting IMF funding.

The Euro-zone PMI manufacturing index edged higher to 46.9 for December from 46.4 previously with a similar improvement in the services sector. There was relief that the indices had not declined further, although the data still suggested that recession was likely over the next few months. The latest Spanish auction result was also better than expected which helped lower peripheral yields.

Although there was no announcement on credit ratings by Standard & Poor’s, markets remained on high alert as French officials attempted to downplay the potential impact of any cut. ECB President Draghi remained very cautious over the possibility of any additional monetary support by the central bank, but there was further speculation that interest rates would be cut and that the bank would eventually cave-in to demand for action if the situation deteriorated further.

Yen:   

There will be continued defensive support for the Japanese currency, especially with a lack of viable alternatives given the continued Swiss determination to resist currency gains.  There will also be the potential for capital repatriation by major institutions. Competitiveness will be an important factor given a weakening of regional growth and yen appreciation against major rivals and there will also be fears surrounding capital spending.  In this context, there will be further pressure for the Bank of Japan to intervene and weaken the currency.

The dollar found support on dips towards 77.50 against the yen and ground higher to test resistance in the 78 area, but moves were limited. The FOMC meeting provided some degree of support for the US currency as the Fed refrained from further action.

Both currencies tended to move together in line with risk appetite and the yen also secured defensive backing and support on the crosses. There will be further concern surrounding the regional export outlook and this will maintain a high degree of Finance Ministry sensitivity to yen moves. There will be additional pressure for Bank of Japan intervention if the yen strengthens further against regional competitors.

The headline Japanese Tankan business confidence index weakened to -4 in the latest quarter from 2 previously, maintaining fears surrounding the industrial outlook, especially with capital spending plans weak, but there was a stronger than expected reading for the services sector.

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Confidence in the UK economic outlook is liable to deteriorate further with recession fears continuing, especially given the Euro-zone downturn. The budget outlook has weakened further and there will be severe debt implications if there is another recession. There will be speculation over additional Bank of England quantitative easing once the current round of bond purchases is completed in February.  Political tensions with Europe will be potentially important in the medium term. There is still the potential for near-term defensive Sterling demand as an alternative to Euro-zone assets, although these flows could suddenly reverse if there are increased credit-rating fears.

Sterling dipped to lows around 1.54 against the dollar before finding support. There were sharp moves on the crosses as the Euro weakened sharply to nine-month lows below 0.84. There was Sterling buying in relation to corporate dividend payments.

Although there was also evidence of UK demand as a refuge from the Euro-zone. In this context, the controversial UK decision to veto a EU Treaty did not have a negative short-term currency impact. The UK unemployment claimant count increase was lower than expected for November at 3,000 following a revised 2,500 increase the previous month, but there was an underlying increase in unemployment to a 17-year high which maintained unease over the economy.

There was a 0.4% decline in retail sales for November which was slightly worse than expected, although it was offset by an upward revision to October’s data. Markets remained extremely cautious over the data and the UK outlook given reports of weak spending trends. The consumer inflation rate fell to 4.8% for November from 5.0% previously which was in line with market expectations.  

Bank of England MPC member Dale was very cautious over the economic outlook and there will be expectations of further quantitative easing as inflation falls.

There was defensive Sterling demand, although there was also some evidence that it might be fading as there was a lower bid/cover ratio in the latest auction. A call from French ECB Board member Noyer that the UK credit rating should be downgraded did not have a major impact, although it did ensure further political tensions.

Swiss franc:

There will be further concerns over potential recession in the Swiss economy, especially as further Euro-zone stresses will damage exports. There will also be deflation fears  and this combination will maintain National Bank determination to resist any renewed franc appreciation. The bank will also be looking to push the currency weaker and will consider negative interest rates if required. There is still the possibility of a renewed surge of capital into Swiss institutions if Euro-zone fears intensify and the bank’s policies could come under important stress. High volatility is likely to remain an important feature.

The Swiss ZEW business sentiment index weakened to -72.0 for November from -64.3 while there was a larger than expected decline in producer prices of 0.8% for the month which maintained concerns over the threat of recession and deflation.

The National Bank held interest rates close to zero at the latest policy meeting in a 0.00-0.25% range and also left the minimum Euro level unchanged at 1.20.  There had been significant speculation that the central bank would announce an increased minimum level or push interest rates negative and the franc strengthened sharply following the decision to leave policy on hold.

The franc advanced to near 0.9380 against the dollar and 1.2220 against the Euro. Bank officials still expected that the franc would weaken over time, but were encouraged that the extreme over-valuation had been combated successfully.

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The Australian dollar was unable to make any significant headway during the week and weakened significantly with lows below the 0.99 level reflecting a general flows of funds into the US dollar. There was further concerns over the international growth outlook, especially given doubts surrounding the Asian economy while concerns over the implications to a tightening in credit also had an important impact.

The domestic economic data was mixed with a fall in consumer confidence while there was further speculation that the Reserve Bank would look sanction further interest rate cuts during the first quarter of 2012.  

The Australian dollar will continue to be subjected to high volatility and, despite rallies, it is liable to stay under pressure given the underlying trends in risk appetite.

Canadian dollar:

The Canadian dollar was generally on the defensive during the week with lows beyond 1.04 against the US currency before a partial recovery.

There was a general deterioration in risk appetite as concern surrounding the global banking sector increased.  The Canadian currency was still able to resist heavy selling pressure with underlying confidence in the fundamentals.

Although the Canadian dollar will be vulnerable to selling pressure given the global risk conditions, confidence in the fundamentals should limit the damage.

Indian rupee:

The Indian rupee was subjected to heavy selling pressure during the first half of the week and dipped to fresh record lows beyond 54 against the US currency. There was a further flow of funds into the US currency as underlying confidence in emerging markets deteriorated and there was a further flow of funds out of emerging markets.

The Reserve Bank remained reluctant to intervene aggressively, but it did introduce fresh measures to defend the currency with tighter regulations over currency trading and hedging which were designed to stem rupee selling. There was a recovery back through the 54 level even though sentiment remained weak with rates left on hold.

The rupee trends will continue to be influenced strongly by trends in risk appetite and it will be difficult to secure more than a limited short-term recovery.

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The Hong Kong dollar was unable to gain any significant support during the week and dipped to lows  beyond 7.7850 against the US dollar. Trends in risk appetite remained extremely important and there was a further underlying lack of confidence, magnified by a lack of liquidity ahead of the year-end.

There was underlying dollar demand on concerns over the regional growth outlook while doubts surrounding the mainland Chinese economy also increased.

Risk conditions will continue to dominate Hong Kong dollar moves in the short-term Evidence of further weakening in the mainland will also restrain any potential gains.

Chinese yuan:

The PBOC was determined to maintain a steady tone for the yuan and set a series of firm fixings in the 6.335 area against the dollar.  The currency persistently traded at its weakest limit within the permitted band for most of the week which suggested that underlying demand for the yuan was weak, although it did strengthen on Friday.

There were further concerns surrounding the economy with a small recovery in the flash PMI index providing only limited relief. There was increased demand for the dollar and speculation over capital outflows while direct investment levels also fell.

Speculation surrounding a weaker economy and the possibility of further monetary easing will limit the potential for any renewed appreciation of the Chinese currency.