Weekly Forex Currency Review 20-01-2012

The ECB has continued to have some success in easing credit conditions within the Euro-zone and there has been some lessening of the global dollar shortage while fear surrounding the growth outlook has eased slightly. In this environment, risk conditions could remain slightly more favourable initially which will also lessen defensive US dollar demand, but it will be difficult to secure a sustained improvement given the global risks with a particular focus on the Chinese outlook.

Key events for the forthcoming week

Dollar:

The underlying data tone has remained firm with solid manufacturing expansion and continued recovery in the housing sector which will maintain expectations of solid growth. The dollar will be in a position to gain yield support, but the impact will be lessened by the Federal Reserve determination to maintain a loose monetary policy.  Defensive considerations will remain important and the dollar will lose potential support when fears surrounding the Euro-zone and global economies improve, especially if Libor rates decline.  Caution is still liable to prevail, especially given the Asian economic risks and this should be important in curbing underlying dollar selling pressure.   

The dollar strengthened sharply at the end of last week following the Standard & Poor’s downgrading of France, but it weakened steadily during the current week as the Euro recovered ground and there was a decline in defensive US demand.

The New York manufacturing PMI index was stronger than expected with an increase to 13.5 for January from 8.2 previously, maintaining the generally robust tone of recent economic releases. The data had some impact in underpinning risk appetite and this also tended to dampen defensive US demand to some extent with markets also on alert for comments from Fed officials ahead of next week’s FOMC meeting.

Housing starts were slightly below expectations at an annual rate of 0.66mn with permits unchanged for the month. In contrast, there was a sharp drop in jobless claims to 352,000 in the latest week from 402,000 previously while the Philadelphia Fed index edged lower to 7.3 from 10.3 previously.  Headline consumer prices were unchanged for December with core prices rising 0.1% which did not have a major market impact as the monetary implications remain limited.

The latest Treasury flows data recorded an increase in long-term inflows into the US which provided some relief, although Chinese bond holdings continued to decline.

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The ECB has had success in easing liquidity pressures within the financial sector and this should also ease pressure within the banking sector to some extent. There will also be relief that underlying demand for bonds has held relatively firm during the opening 2012 auctions.  There has been some encouraging news from the German economy, but recession conditions are liable to prevail within the peripheral economies which will maintain economic and political pressures. There will also be fears surrounding a Greek default. There will also be pressure for a further decline in ECB interest rates which will curb Euro yield support.

The Euro was subjected to heavy selling pressure on reports of the French Standard & Poor’s downgrade with a cut for Austria also damaging as the EFSF was then stripped of its AAA rating. The Euro recovered from 16-month lows near 1.26 as a covering of short positions was a notable feature.
 
The German ZEW data was significantly stronger than expected with the headline business confidence index advancing to a six-month high of -21.6 from -53.8 previously and this was the strongest ever recorded one-month advance. There was also a decline in Spanish yields in the latest bond auction which helped underpin sentiment to some extent. There were still major fears surrounding divergence within the Euro-zone area with German economic gains not matched elsewhere and there were also concerns surrounding political divergence following the French AAA credit-rating downgrade which will put additional medium-term strains on the Euro.

There were further talks between the Greek government and major bond holders as they battled to secure a debt-restructuring deal. Even if a deal can be put together, there will be fears that it will be deemed as a default by the credit-rating agencies. Fitch warned in blunt language that Greece was insolvent and would default.

There were reports that the IMF was seeking additional funds to bolster its defences against the Euro-zone crisis. After some initial confusion surrounding amounts, the IMF suggested that it would look to increase funding by an additional US$600bn which would take the total commitment to USD1.0trn. There was, however, no indication of how these funds would be sourced, especially with US opposition to any increase in its contribution.

The latest Spanish debt auction was again stronger than expected in terms of investor interest which helped underpin Euro confidence with a solid French auction also maintaining expectations that the aggressive ECB policy stance was having a positive impact on liquidity which was also helping sustaining investor demand for securities with a positive impact on equity prices for the European banks.

Yen:   

There will be further concerns surrounding the industrial outlook even though there has been some relief that conditions within the Asian economy are showing some signs of stabilisation. Capital account trends will remain very important and there will be a reluctance to allocate funds overseas, especially with fears surrounding the Euro-zone outlook.  Competitiveness pressures will continue to be important and there will be pressure for intervention. The Bank of Japan will still face important opposition, especially with a lack of support from the US.  Overall, near-term yen losses could still be measured.

The dollar found support in the 76.70 area against the yen and with a sharp move to  a high near 77.30 as the yen lost ground on the crosses. The currency gained additional yield support following the better than expected US jobless claims data which had a significant impact in pushing the currency higher.

Cross-related moved were also important as the Euro maintained a corrective tone against the yen on technical grounds as it attempted to recover the 100 level. There were also some reservations surrounding the threat of intervention which curbed yen buying on any approach to the 76.50 area against the dollar.

The Chinese manufacturing PMI index held below the 50 level which dampened risk enthusiasm slightly during the Asian session on Friday. 

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Confidence in the UK economic outlook will inevitably remain extremely fragile with particular concerns surrounding the outlook for retail spending. There will be further concerns surrounding the banking sector as lending levels will remain weak. There will be expectations of further Bank of England quantitative easing within the next 2-3 months which will keep yield support at very low levels. While Sterling can sustain defensive support as a refuge from Euro-zone fears, the UK currency can maintain a firm tone, although there is still a risk that capital flows will reverse quickly if UK fears intensify.

Sterling found support on dips to below 1.53 against the dollar and rallied to near 1.55 as the US currency retreated. Sterling corrected back to near 0.84 against the Euro.
 
The latest report from the ITEM forecasting club suggested that the UK might already be in recession as the Euro-zone crisis had a negative impact on business confidence.   The group was, however, optimistic that a deep recession would be avoided.

Headline consumer inflation fell to 4.2% in December from 4.8% previously and there was a smaller decline in the core rate to 3.0% from 3.2%. The headline rate will continue to fall sharply in the short-term as 2011 tax increases come out of the calculation and retail discounting will also have an important impact.

The latest unemployment claimant count was again better than expected with the increase for December held to 1,200 after a revised 200 increase the previous month. The unemployment data was less favourable as there was an increase to a 16-year high of 8.4% from 8.3% and youth unemployment continued to increase.

Elsewhere, the Nationwide consumer confidence index fell to 38 for December from 40 previously and this was the second lowest figure on record. There were further expectations that the Bank of England would move towards additional quantitative easing at one of the next two meetings given fears over weak spending and lending.

There was further evidence of overseas demand for UK bonds as the yield on benchmark bonds fell to fresh record lows near 1.90%.  

Swiss franc:

National Bank policies will remain extremely important in the short-term, especially with a new Chairman following the resignation of Hildebrand. There will be some further speculation that the bank would be less willing to maintain the existing Euro minimum level, but there is a strong probability that the bank will maintain a very tough stance in the short-term. There will also be further pressure for the bank to raise the minimum level given the competitiveness pressures. Volatility will maintain an important threat in the short-term.

The dollar was unable to gain any fresh traction and dipped to test support near the 0.94 level.  Principal interest focussed on the crosses as the Euro briefly spiked higher to the 1.2130 area before sliding back to 1.2080. There was immediate speculation over intervention, but there was strong evidence that the move was due to a mis-quoting of rates and there was no evidence of open intervention by the National Bank.

The ZEW business confidence index improved to -50.1 for December from -72 which maintained some degree of optimism that the economy could register some net improvement, but pressure for a higher Euro minimum will continue.

The Swiss Finance Ministry continued to insist that a fair range for the franc against the Euro was 1.35-1.40. There were no policy moves by the National Bank and no major comments on the currency during the week.

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The Australian dollar was able to resist downward pressure and advanced to challenge levels above 1.04 against the US dollar. Risk conditions remained a very important influence and the currency gained support from an easing of fear surrounding the global outlook, especially after the better than expected Chinese economic data.

There was a much weaker than expected labour-market release as employment fell by close to 30,000 for December which undermined confidence. Although the unemployment did edge slightly lower, there was further expectations of further interest rate cuts.  

The Australian dollar will continue to be subjected to high volatility and unease over the Chinese outlook is liable to cap gains near current levels.

Canadian dollar:

The Canadian dollar gained support from international considerations during the week and did challenge resistance levels beyond 1.01, but there was selling interest at elevated levels. Risk appetite was firm and commodity prices also secured fresh buying support.

The Bank of Canada interest rate decision was in line with expectations as rates were left on hold at 1.0%. The bank was slightly less pessimistic surrounding the global economic outlook, but there was no suggestion of higher interest rates for now.

The Canadian currency should prove to be broadly resilient in the short-term, although it will be difficult to extend gains much further.

Indian rupee:

The rupee maintained a stronger tone during the week and advanced consistently with a challenge on resistance levels near the 50 level against the US dollar.

There was a sustained reversal in capital-account trends and reports that net inflows so far in 2012 had exceeded US$4.0bn, in sharp contrast to the outflows seen during the fourth quarter of 2011. There was importer buying of dollars near the 50 level which slowed the rupee’s advance.

It will be difficult for the rupee to extend the recovery much further given the underlying risk profile and uncertainties surrounding the Indian economy.

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The Hong Kong dollar maintained a firm tone during the week and advanced to a high near 7.7620 against the US dollar. The currency gained support from a firmer trend in international risk appetite.

There were also expectations that the Chinese central bank would relax monetary policy which helped underpin confidence in the Hong Kong currency. Trading volumes dipped sharply late in the week ahead of the New Year holidays.

Risk conditions will remain very important and near-term improvement will help support the currency. Medium-term speculation should also help to limit losses.

Chinese yuan:

The yuan was little changed over the week as a whole with the currency consolidating in the 6.32 area against the US dollar. The PBOC took a cautious stance ahead of the week-long lunar new-year holiday, although there were strong expectations of further monetary easing within the next few weeks.

The latest GDP data was slightly stronger than expected even though the quarterly advance was still the slowest for over two years. The latest Manufacturing PMI releases also remained below the benchmark 50.0 level amid expectations of a further deterioration in the property sector.

Speculation surrounding a weaker economy and the potential for further monetary easing is likely to curb any significant near-term yuan strengthening.

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