Weekly Forex Currency Review 18-05-2012

The Euro-zone structural vulnerabilities will remain a very important short-term focus, especially as confidence in the banking sector has deteriorated sharply. Any sustained run on the banks or substantial capital outflows would substantially increase the risk of a destabilising break-up in the Euro-zone as a whole. In this appetite, risk appetite is likely to remain generally vulnerable in the short-term.  

Key events for the forthcoming week

Dollar:

Defensive considerations will remain extremely important in the short-term as markets continue to focus on the Euro-zone crisis and global vulnerabilities. There is likely to be further defensive demand for the US currency as the US Treasury market continues to attract support.  The Federal Reserve policies will also be important, especially as there will be further speculation that the Fed will sanction further quantitative easing if there is any fresh deterioration in the economy.  The dollar will, therefore, find it difficult to gain further strong support, especially if forthcoming indicators are weaker than expected.

The dollar advanced firmly against European currencies during the week as Euro-zone fears booted the dollar’s relative appeal, but a slide against the yen held back the overall dollar index. Risk considerations tended to dominate and there was a decline in US Treasury yields to 2012 lows on defensive demand.
 
The US retail sales data was slightly weaker than expected with a 0.1% gain for the headline and underlying increase for April. The US housing starts data was stronger than expected with an increase to an annual rate of 0.72mn for April from 0.70mn previously while permits fell to 0.72mn from 0.77mn, but they were still at the highest level since 2008. A stronger than expected increase in industrial production was offset by a downward revision for the previous month.

There was a much weaker than expected reading for the Philadelphia Fed index as it dipped to -5.8 from 8.5 the previous month while there was a substantial deterioration in most of the major components which raised some doubts over the US outlook.

The Fed minutes confirmed that the FOMC was more optimistic surrounding the growth outlook with the probability of a slow decline in unemployment. Several members did indicate that further monetary accommodation could be required if the economy lost momentum. The Fed also expressed concerns surrounding the fiscal outlook which reminded markets over the underlying risks and there will be increased speculation over quantitative easing.

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There will be further fears surrounding the Euro-zone in the short-term. Failure to form a government and the necessity for a second Greek election will increase fears that Greece will be forced out of the Euro area.  There will be fears surrounding any contagion effect if Greece did exit the Euro area and substantial unease surrounding the financial sector as a whole which will increase the risk of capital flight and a further loss of market confidence. There will be strong pressure for additional ECB support in the form of a third LTRO and political tensions will intensify.  In this context, the Euro is likely to remain generally vulnerable initially, but with the possibility of a sharp rebound.

The Euro was subjected to heavy selling as political and economic fears increased with 4-month lows near 1.2650 against the dollar and it weakened very sharply against the yen as Greek Euro-exit and contagion fears intensified.
 
There were further fears surrounding Spain with major doubts surrounding the banking sector. There was an increase in benchmark Spanish bond yields to above the 6.3% level while the spread over German bunds widened to a record high.  Moody’s also announced a credit-rating downgrade of 26 Italian banks and 16 Spanish banks which reinforced fears surrounding the European banking sector given the sovereign-debt default risk. Fitch downgraded Greece’s sovereign rating to CCC from B-.

Germany secured a stronger than expected first-quarter GDP gain of 0.5%,  allowing a Euro-zone figure of 0.0% which technically avoided a recession. Sentiment was undermined quickly by the fact that it was only the German performance which provided support as Italy for example contracted by 0.8% for the quarter.

Greece was inevitably a very important focus as political negotiations continued with the President holding talks with all major political parties. After protracted discussion, there was an announcement that no government had been formed. A caretaker government was formed and fresh elections will be held on June 17th.

The SYRIZA party remained strongly opposed to the bailout agreement and will campaign for the bailout deal to be abandoned. Failure to form a government increased fears that Greece would be forced to leave the Euro-zone if no concessions are forthcoming. This had an important negative impact on the European banking sector as the lack of collateral continued to create additional stresses.  

There were further fears surrounding the European banking sector which had an important negative impact on the currency.  There were reports of substantial capital withdrawals from the Greek banking sector and there were also reports of substantial outflows from Spanish bank Bankia.

There was intense pressure for the ECB to take additional action to stabilise markets while the political pressure for additional measures was also intense. German Finance Minister Schauble called for a rapid move to political union.

Yen:   

The latest GDP data should provide some degree of support for the yen, especially given upward revisions to previous data. There will still be very important pressure to maintain competitiveness which will reinforce pressure for yen gains to be resisted. Defensive considerations will remain very important and there will be defensive yen demand when risk appetite deteriorates, especially given a lack of viable safe-haven alternatives and a solid tone is likely.    

The yen strengthened during the week, primarily due to safe-haven considerations, although the domestic data was also stronger than expected. The latest Japanese GDP data recorded a quarterly increase of 1.0% which was slightly stronger than expected and the previous release was revised to unchanged from an original -0.6% which also helped underpin yen sentiment.
 
The dollar lost support following the weaker than expected  US Philadelphia Fed index and a break below key support levels triggered further stop-loss US selling as it retreated back below the 80 level.

A lack of confidence in the Euro-zone and weak demand for the US dollar increased defensive demand for the Japanese currency, especially after better than expected GDP data.  The government also increased its assessment of the Japanese economy which provided some support. Risk conditions remained very fragile during Asian trading on Friday which pushed the dollar to lows near 79.25.

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Growth conditions will be undermined by Euro-zone vulnerability and there will also be a high degree of unease surrounding the domestic conditions, especially with income levels under pressure.  There will be speculation over additional Bank of England quantitative easing particularly if Euro fears intensify.  Sterling has gained important support on defensive grounds, although it may prove difficult to sustain buying support given the lack of confidence in the domestic fundamentals. A wider deterioration in risk appetite would increase the risk of international Sterling selling.

Sterling was unable to hold gains through the 0.80 level against the Euro during the week and dipped sharply to 2-month lows around 1.5750 against the dollar.
 
The latest UK unemployment data was stronger than expected with a decline in the claimant count of 13,700 for April following a revised decline the previous month while the unemployment rate declined to 8.2% from 8.3% previously, although the drop was fuelled primarily by an increase in part-time employment.

In its quarterly inflation report, the Bank of England lowered its growth and inflation forecasts for the two-year outlook. The main focus on the report tended to be the bank’s news conference with Governor King stating that there were substantial uncertainties and risks resulting from the Euro-zone crisis. With a lowering of inflation forecasts and warning over the Euro area, there was additional speculation that the central bank would sanction additional quantitative easing.

The scope for defensive UK demand was illustrated by the latest two-year bond auction as yields fell sharply to 0.35% as bidding interest remained strong and benchmark bond yields also fell to record lows.  

There was increased unease surrounding the UK economy given the fears over weak European demand. Wider risk conditions remained very important and an increase in global fear put Sterling under pressure despite Euro-zone defensive inflows.

Swiss franc:

There is still the potential for further defensive flows into the Swiss currency in the short-term, especially with increased Euro-zone structural fears and a lack of attractive global alternatives. There is a risk that the 1.20 minimum Euro level will come under severe pressure, especially if fears surrounding the Euro-zone financial sector intensify. The central bank is likely to hold firm in the short-term with unlimited intervention when required, but any changes in the Euro structure could force a reassessment of the SNB situation.

The Euro remained pinned to the 1.2010 level against the Swiss currency throughout the week and was unable to gain any traction. In this environment, the franc weakened to lows near 0.95 against the US dollar.

There was a 2.3% decline in Swiss producer prices in the year to April, maintaining underlying concerns surrounding the deflation risks.  National Bank Chairman Jordan stated that the franc remained overvalued and there was a further commitment to keeping the minimum 1.20 Euro level in place. The Swiss ZEW business confidence index fell to -4.0 from 2.1 which maintained unease over the growth outlook.

There was further speculation that capital flight from the Euro-zone would put additional pressure on the minimum Euro level and force more aggressive National Bank intervention to prevent franc gains.

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The Australian dollar remained under selling pressure during the week and despite initial support in the parity area, there was fresh selling pressure later in the week with heavy losses to lows near 0.98 against the US currency

The Australian dollar was undermined by a general deterioration in risk appetite as equity markets were subjected to sustained selling pressure.  There were also increased fears surrounding the regional growth outlook which put downward pressure on commodity prices.

There were little in the way of major fresh domestic incentives with the Reserve Bank minutes also not having a major impact on interest rate expectations.  

Unease surrounding the regional outlook and a deterioration in risk appetite are likely to keep the Australian dollar on the defensive in the short-term.

Canadian dollar:

The Canadian dollar briefly pushed back though parity against the US dollar following a much stronger than expected employment report, but it was unable to sustain the gains and retreated steadily to lows beyond 1.02 late n the week.

There were further concerns surrounding the global economy and oil prices retreated to four-month lows which undermined support for the Canadian dollar.  

Concerns surrounding weaker commodity-price trends will tend to undermine the Canadian dollar, especially if domestic debt concerns increase

Indian rupee:

The rupee remained under sustained selling pressure during the week and the net result was a decline to record lows beyond 54.50 against the US dollar. There was a lack of confidence in the domestic fundamentals as trade and budget fears persisted and there were concerns surrounding the reform prospects.

Risk appetite was also weak which undermined potential capital inflows, especially with emerging markets in general under sustained selling pressure. The central bank did intervene which helped drag the currency off its worst levels.

Although the Reserve Bank may have some success in curbing selling pressure, the rupee is liable to remain generally vulnerable in the short-term given risk conditions.

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The Hong Kong dollar was unable to make any headway and tested support beyond 7.77 against the US currency before finding some degree of support. Risk appetite was extremely fragile with declines in the benchmark Hang Seng index  This also had an impact in undermining currency, especially with regional confidence weaker.

Uncertainty surrounding the Chinese outlook and concerns over the regional economic trends will tend to keep the Hong Kong dollar on the defensive for now.  

Chinese yuan:

The yuan remained slightly weaker during the week and the PBOC was compliant in pushing the currency weaker with five consecutive weaker fixes for the currency . There was some easing in immediate political pressures for a stronger yuan which encouraged the PBOC to let the currency drift weaker.

The yuan was undermined by a lack of confidence in the global economy as regional concerns increased and confidence in Chinese growth prospects also weakened.  

Domestic economic doubts are likely to undermine the yuan in the short-term with little scope for gains, especially if regional risk appetite remains weaker.

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