Weekly Forex Currency Review 19-08-2011

Fear is likely to remain the dominant short-term market influence. There will be further concerns surrounding the global economy and there will also be further fear over the Euro-zone as pressures increase within the financial sector. Markets will find it difficult to find defensive plays, especially with resistance to currency gains by the Swiss National Bank.

Key events for the forthcoming week

Dollar:

There will be further concerns over the economic outlook as confidence remains extremely fragile with sentiment undermined by weak manufacturing surveys. Low interest rates will help support spending and construction, but there will still be additional speculation that the Federal Reserve will ultimately move towards additional quantitative easing.  The dollar will, therefore, remain vulnerable on fundamentals grounds, but there will be defensive support as fears surrounding the global outlook increase. The dollar will also gain support if funding pressures increase and there should be a solid near-term tone.

There was little confidence in the US economy during the week, but the US currency did gain renewed defensive support as risk appetite deteriorated again with the Euro weakening to lows below 1.43 from a peak just above 1.45.
 
The US jobless claims data was slightly higher than expected at 408,000 in the latest reporting week, but the main surprise was in the Philadelphia Fed survey. The index declined sharply to -30.7 for August from 3.2 previously with all the main components deteriorating and this was the lowest reading since 2009. With existing home sales also weaker, the data reinforced market fears over the economy even though regional indices can give a misleading impression of national trends.

Headline consumer prices rose 0.5% for July which was also significantly higher than expected to give a 3.6% annual increase and there was a core reading of 0.2%. The combination of weaker growth and higher headline inflation will create significant discomfort within the Federal Reserve and comments from key officials will remain under close scrutiny in the short-term.

There was further unease surrounding the European banking sector, especially with further reports that some banks were having problems in securing necessary liquidity. There was a further increase in Libor rates and there will be some dollar support on structural grounds, although central bank liquidity provisions should prevent major difficulties. US 10-year Treasury note yields also dipped to record lows below 2%, a clear indication of defensive demand. Ratings agency Fitch affirmed its AAA rating for the US and a stable outlook, in sharp contrast to the Standard & Poor’s analysis.

There was criticism of the Federal Reserve’s policies from regional Presidents Plosser and Fisher who stated that it was not the Fed’s role to protect stock-market investors.

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Underlying confidence surrounding the Euro-zone economy will remain weak. There will be further concerns surrounding the sovereign-debt issues and the debt problems will intensify if there is a further downturn in economic activity. The ECB will be forced to maintain peripheral bond buying in the short-term and will also be under pressure to reverse recent interest rate increases. There will be further demands for faster political progress to alleviate pressure on the ECB, but there will be strong resistance to further support, especially within Germany.  High volatility is likely to remain the key market factor.    

The Euro proved resilient during the week, but retreated over the second half as risk appetite deteriorated and structural fears increased. The Euro-zone GDP data was weaker than expected with German second-quarter growth of 0.1% compared with expectations of a 0.5% gain and this helped drag Euro-zone GDP expansion to 0.2% from 0.8% previously.

There was further market speculation over the issuance of Eurobonds ahead of the meeting between German Chancellor Merkel and French President Sarkozy. In the event, the meeting rejected the issuance of bonds at this stage with a concentration on measures to strengthen governance such as tighter rules on budget deficits. There was also further strong political opposition to Eurobonds from the German coalition FDP partners and there is also substantial opposition within Merkel’s CDU party as well as countries such as Finland and the Netherlands.

The headline Euro-zone inflation rate was confirmed at 2.5%, but there was a significantly weaker than expected reading for the core rate which fell to 1.2%. Diminishing inflation and weaker growth will maintain pressure for the ECB to switch to an easier monetary policy.

The ECB announced it bought EUR22bn in peripheral bonds over the previous week.
The bank also continued to discourage short selling in peripheral bonds by its presence either as a buyer or potential buyer. There was also evidence of tensions in the banking sector as a bank tapped the ECB 7-day emergency liquidity facility for the first time since February.

There were reports that Finland was looking for additional collateral on loans to Greece. As equity markets came under heavy selling pressure, the Euro fell sharply to lows around 1.4270 before correcting higher. There was a further suspicion of sovereign Euro buying at lower levels which protected the currency.

Yen:   

The yen will continue to gain important defensive support from a lack of confidence in the US and Euro-zone economies and the currency will also gain fresh support if wider confidence in the global economy deteriorates further, especially with the potential for increased flows into Japan as Switzerland blocks currency gains. There will be the potential for further Bank of Japan intervention, but the effectiveness will be limited if there is no wider G7 backing for the move. Defensive considerations will tend to dominate in the near term.    

The dollar was again trapped with very narrow ranges against the yen with both currencies gaining some degree of defensive support as the Japanese currency advanced strongly against the Euro and Australian dollar late in the week.

Finance Minister Noda continued to warn over one-sided markets and there was the threat of intervention, but he repeated that action needed to surprise markets to be effective and there was no evidence of actual intervention. The dollar spiked higher in Asia on Friday with a high near 76.90, but it quickly retreated back to the 76.50 area.

The latest trade data was slightly weaker than expected as exports recorded a drop of 3.3%, the fifth successive decline with a sharp drop in shipments to the US.

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There will be further concerns over the growth outlook with little prospect of relief within the domestic economy and the global outlook has also deteriorated further.  The Bank of England will not increase interest rates in the short-term and there will be further speculation over additional quantitative easing if there is any further deterioration in business confidence. Sterling can gain some defensive support from being outside the Euro-zone, but this backing could prove to be extremely fragile given fears over the banking sector and yields support will remain extremely weak.  

Sterling maintained a firm tone during the week with a 14-week high against the dollar and it also strengthened against the Euro.
 
Headline consumer inflation rose to 4.4% for July from 4.2% while the core rate rose to 3.1% from 2.8%. With inflation again outside the 1-3% range, Bank of England Governor King was forced to write a letter of explanation to the Chancellor.  King remained concerned over the inflation outlook, but was more worried over the potentially severe risks posed to the economy by the Euro-zone crisis.

The latest employment data was weaker than expected as the unemployment claimant count rose 37,100 for July, the largest increase for two years after a revised 31,300 increase the previous month as unemployment rose to 7.9% from 7.7%. Retail sales rose 0.2% for July. Real yields remained highly negative as the 10-year benchmark gilt yield fell to below 2.45% with Sterling gaining some defensive support from its position outside the Euro-zone.

The Bank of England minutes recorded a 9-0 vote for unchanged interest rates at the August meeting as Weale and Dale dropped their preference for higher interest rates and this was the first unanimous vote on interest rates since May 2010. There were further concerns over the economy, but the majority of members did not consider that it was appropriate to expand quantitative easing at this time.

Swiss franc:

The Swiss authorities will remain extremely concerned over the impact of a very strong franc and there is likely to be further action to drive interest rates even further into negative territory.  The use of any form of peg will be a last-resort option given the determination to maintain an independent policy. The measures will have some effect, but there is still likely to be a defensive flow of assets into the Swiss franc if global economic conditions further. The franc will also gain strong support if Euro-zone fears intensify again, but markets will also watch the Swiss banking sector closely.  

The dollar found support below 0.78 against the franc and strengthened sharply to a peak near 0.80 while the Euro also rallied strongly to a high near 1.15 on Tuesday . The franc lost support on an improvement in risk appetite, although the main focus was still on potential measures to address franc strength by the Swiss government with further speculation that a peg could be introduced.

The National Bank announced that it would increase sight deposits further to CHF200bn from CHF120bn and would also consider intervention in the swaps market in order to push interest rates deeper into negative territory.
The decision not to move to a peg triggered a sharp market reversal as the franc advanced strongly. There was further franc volatility during the week and the currency was unable to sustain gains triggered by a fresh deterioration in risk appetite.

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The Australian dollar rallied during the middle of the week as it attempted to take advantage of calmer market conditions and a stabilisation in risk appetite. The currency pushed to a high around 1.06 against the dollar, but it was then subjected to renewed selling pressure as fears increased again with a move back towards 1.03 as trends in global equity markets remained a dominant influence.

The Reserve Bank minutes confirmed that the government is less confident towards the economy with an increase in global risks and there was further speculation that the bank would shift towards a looser monetary policy within the next few months.

The international risk profile is liable to remain extremely fragile and this will limit any scope for Australian dollar gains, especially if commodity prices fall.

Canadian dollar:

The Canadian dollar initially found a firmer tone during the week and strengthened to just beyond the 0.98 level against the US currency, but it was unable to sustain the gains and weakened back late in the week with lows beyond 0.99 as equity markets were subjected to fresh selling pressure.

There was still underlying confidence in the fundamentals which helped curb selling pressure and there were no major domestic data releases during the week.

The Canadian dollar is likely to be undermined by reduced tolerance of risk and global growth fears which will curb the potential for an advance.

Indian rupee:

The rupee remained under pressure during the week and again dipped to test six-month lows near 45.75 against the US currency, although losses were contained.

There were further fears surrounding the economic growth outlook, especially as risk appetite deteriorated. There were also fears surrounding the Indian growth outlook which dampened confidence, although there were also hopes that the Reserve Bank would be able to halt interest rate increases.

The rupee should remain broadly resilient, but there is little chance of without an improvement in global risk appetite and recovery in growth hopes.

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The Hong Kong dollar recovered strongly during the first half of the week with a peak just beyond 7.7850 against the US currency as risk appetite improved. The Chinese authorities also announced that there would be additional investment into the economy and there were measures to draw funds back into Hong Kong deposits.

Risk appetite deteriorated again late in the week as equity markets came under pressure and the Hong Kong currency weakened back towards the 7.80 area.

The Hong Kong dollar trend will remain closely correlated with risk appetite. Optimism over long-term capital flows should limit selling pressure.

Chinese yuan:

The Chinese yuan maintained a strong tone during the first half of the week with gains to beyond the 6.38 level against the US currency.  The yuan was unable to sustain the gains and drifted slightly weaker during the second half of the week as the central bank also signalled a period of consolidation after firm gains.

Nevertheless, there were further rumours that the central bank would move to widen the yuan’s trading band, possibly within the next few weeks. There was also speculation that the central bank would resist further monetary tightening as doubts over the domestic and regional economic outlook increased.

Although there will be the potential for further near-term yuan gains, uncertainty is liable to increase as capital outflows are also liable to increase.