Weekly Forex Currency Review 20-04-2012

The Euro-zone structural outlook will inevitably continue as an important focus with important concerns that conditions within Spain will deteriorate further given major vulnerabilities within the banking sector. Monetary policy will also be a key short-term focus with the Federal Reserve and Bank of Japan both holding policy meetings during the next week with speculation over additional policy action. Fears over de-leveraging within the banking sector will tend to dampen risk appetite.

Key events for the forthcoming week

Dollar: 

The latest US economic data has maintained a generally weaker tone with declines in regional PMI surveys and a significant rise in jobless claims. Immediate fears have been eased by solid retail spending data, but there will be some unease over a potential slowdown. These uncertainties will ensure a strong focus on Federal Reserve policies with a key FOMC meeting due next week. The dollar will be vulnerable to sharp selling pressure if there is any move to expand quantitative easing while hints over action would trigger more moderate losses. The overall lack of viable alternatives and global de-leveraging should still provide important US currency protection.

The dollar was unable to make much headway during the week, although there was solid buying support on dips as ranges were relatively narrow.

The US retail sales data was slightly stronger than expected with an increase of 0.8% for the headline and core numbers which will maintain a broadly optimistic tone towards consumer spending. In contrast, there was a decline in the latest NAHB housing index to 25 from 28 previously which will increase the focus on Tuesday’s housing-starts data amid suspicion that the sector was slowing.

There was a decline in housing starts in the latest data to an annual rate of 0.65mn from 0.69mn previously. Unease over a slowdown in the sector was offset by a rise in permits to a 4-year high and the overall impact was limited. There was no change in industrial production for the month which was weaker than expected.

The latest US jobless claims was again weaker than expected with a figure of 386,000 in the latest week from a revised 388,000 previously which was the highest level since January. The other US data was also weaker than expected as existing home sales dropped to an annual rate of 4.48mn from 4.60mn previously. There was also a decline in the Philadelphia Fed index to 8.5 for April from 12.5 which was also the weakest since January as new orders were weak.

The data had a negative impact on risk appetite which provided some support for the dollar on defensive grounds. There was also renewed speculation that the Fed could consider further quantitative easing.

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The Euro-zone structural fears have been thrown back into sharp focus by the stresses in Spain and the tone of unease is likely to remain an important feature. There will be particular fears surrounding the banking sector and fears surrounding peripheral vulnerability in general. The ECB will be under pressure to re-activate the peripheral bond buying programme and there will be speculation over additional LTRO operations. The Euro will gain net support from expectations over capital repatriation, but underlying investment flows will make it very difficult for the Euro to sustain any gains.

The Euro was broadly resilient during the week and found strong buying support on dips to below the 1.30 level against the US currency.

The German ZEW index was stronger than expected with a further small increase to 23.4 for April from 22.3 previously, in contrast to expectations of a measured retreat. The ZEW also commented that there had been no noticeable deterioration in replies received later in the survey period which eased fears surrounding the outlook. The IFO index also registered a sixth successive monthly gain. The final Euro-zone March inflation rate recorded a small increase to 2.7% from the 2.6% flash estimate.

There were further major concerns surrounding the Spanish outlook as benchmark bond yields rose back to near the 6.0% level. There was also an increase in credit default swaps to a record high just below the 500 basis point level. There were further concerns surrounding the banking sector as non-performing loans rose to an 18-year high, reinforcing fears over a negative spiral of falling house prices and further bad debts. In this environment, there were further declines for the local bourse.

The Italian government stated that the growth and fiscal outlook was weaker than expected which further undermined sentiment. Tensions were illustrated by a decline in German yields to 0.14% at the latest 2-year bond auction. There was a report from ratings agency Moody’s that Spanish and Italian borrowing costs were already at unsustainable levels from a medium-term perspective.

There was a bid/cover ratio above 2.0 at the Spanish 10-year bond auction which provided some relief, although it was a relatively small auction and there was an increase in yields to 5.74% from below 5.50% previously.

Yen:  

There will be further concerns over structural weakness in the Japanese economy especially with Japan registering a record trade deficit in the latest fiscal year. Import demand will remain strong which will tend to undermine the yen and maintain pressure for competitiveness to be retained. There will be strong pressure for the Bank of Japan to relax monetary policy further in the near term. There could still be underlying yen support from fears surrounding the regional growth outlook and general risk aversion.

The dollar pushed higher during the week with a peak above 81.50 as the yen was generally vulnerable on the crosses as the Euro regained ground.

Comments from Bank of Japan member Nishimura reinforced expectations that there could be a further relaxation of monetary policy at next week’s monetary policy meeting which would further undermine support for the yen, especially if the Federal Reserve held policy steady.

The latest trade data recorded an annual increase in exports which helped lessen the impact of a record trade deficit for the year. Bank of Japan Governor Shirakawa reiterated that the bank was committed to powerful monetary easing which reinforced speculation that there could be further policy measures and the dollar moved back to the 81.50 region.

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Confidence surrounding the UK economy is likely to remain slightly stronger in the short-term. There has also been a shift in Bank of England expectations with reduced speculation surrounding further quantitative easing after Posen’s decision to move away from backing further action. The UK currency will also be in a position to gain support from a lack of confidence in the Euro-zone and potential defensive inflows. The UK situation is still very fragile and the currency will be generally vulnerable when global risk appetite deteriorates.

Sterling maintained a robust tone as the trade-weighted index advanced to 18-month highs with the UK currency at a five-month peak against the dollar.

The headline UK inflation rate rose slightly to 3.5% for March from 3.4% previously as prices failed to match the declines seen last year. The latest unemployment data was stronger than expected with an increase in the claimant count of 3,600 in the latest month from a revised 4,500 previously while the unemployment rate dipped to 8.3% from 8.4%, which was the first decline since the third quarter of 2011.

The Bank of England MPC quantitative easing vote was surprising with a 8-1 vote for keeping the total bond purchases on hold at GBP325bn. In particular, markets reacted strongly to Posen’s decision to vote for the majority and drop the call for further monetary action as he has been consistently the most dovish committee member.

The bank was more concerned over the inflation outlook and the risk of stubbornly high price pressures. The central bank was still concerned over the risks of recession, but the net outcome was a drop in expectations surrounding further quantitative easing. The shift in expectations pushed Sterling to fresh 20-month high beyond 0.82 against the Euro.

Posen confirmed that he had taken a different stance than that in 2011 with reduced fears surrounding a sharp deterioration in economic conditions. Posen also stated that the economy was stronger than would be registered in the official growth data.

Swiss franc:

There is the potential for further defensive flows into the Swiss currency in the short-term, especially with increased Euro-zone structural fears. The National Bank may continue to be tested more severely in the short-term as markets again attempt to take out the 1.20 minimum level. The central bank is likely to hold the line in the short-term. A lack of attractive alternatives should still provide net support for the Swiss currency and any reversal in policy could trigger a surge in volatility with sharp franc gains, although this is not the most likely outcome.

The dollar was unable to extend gains above 0.92 against the Swiss franc during the week while the Euro was unable to move significantly away from the 1.20 level.

The latest ZEW business confidence index recorded an increase to 2.1 for April from 0.0 previously. The National Bank was the main focus of attention with Jordan appointed as permanent chairman. He reinforced his commitment to the current policy and the determination to defend the 1.20 minimum Euro level. There was some renewed speculation that the bank could raise the minimum level.

There was further speculation over defensive capital inflows into the franc as Euro-zone structural fears remained an important focus. There were reports of the BIS Euro/dollar selling on behalf of the National Bank which suggested that there had been persistent intervention to protect the 1.20 minimum level.

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The Australian dollar was unable to make much impression on the US currency during the week with resistance above the 1.04 level, although selling pressure was restrained. The Reserve Bank of Australia minutes from April’s meeting reinforced speculation that the central bank would cut interest rates at the May policy meeting.

Underlying risk appetite was also generally fragile which curbed Australian dollar demand and there were further doubts surrounding the regional economy.

Expectations over further domestic interest rate cuts and Chinese economic doubts are likely to keep the Australian dollar generally on the defensive.

Canadian dollar:

The Canadian dollar found support weaker than parity against the US currency during the week and advanced to highs beyond 0.99 before retreating again.

The Bank of Canada left interest rates on hold at 1.00% following the latest policy meeting, but the central bank warned that pressures for monetary tightening was gradually increasing and there was market speculation that the central bank could act to tighten policy as early as June.

Doubts over the global growth outlook and lower commodity prices pulled the currency from highs as uncertainty remained a key factor.

Although the Canadian dollar should be broadly resilient, there will be doubts over commodity-price trends which will tend to limit the scope for gains.

Indian rupee:

The rupee remained under pressure during the week and retreated to 14-week lows beyond 52 against the US currency. There was strong US demand from importers and oil refiners which contributed to the negative rupee tone. There were also underlying concerns surrounding the trade outlook and regional growth doubts persisted

The Reserve Bank cut interest rates by a larger than expected 0.50% to 8.00%, but there were doubts over the scope for further near-term cuts. There were suspicions that the central bank had intervened to sell the US currency.

With further uncertainties likely surrounding the economic outlook, the Indian currency is likely to remain generally on the defensive.

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The Hong Kong dollar pushed to highs around 7.7560 against the US currency during the week, but it was unable to sustain the gains and it retreated back to the 7.7625 area as ranges were generally narrow.

An underlying soft tone for US economic data had an impact in keeping US yields low which provided some net protection for the Hong Kong currency.

Low US interest rates will provide underlying Hong Kong dollar support. Continuing uncertainty surrounding the Chinese outlook will tend to curb any gains.

Chinese yuan:

The PBOC announced that it would double the yuan trading band with the currency now allowed to trade in a 1.0% daily range surrounding the mid point set by the central bank. Despite the band widening, the bank kept tight control of the rate as it fluctuated around the 6.30 area against the dollar. A weaker reading for foreign direct investment had some negative impact on sentiment.

There were further doubts surrounding the economic outlook, especially with reports that house prices were falling. There were also rumours that there would be a further cut in reserve ratio requirements to help support the economy.

Despite a widening of the permitted trading band, the PBOC is likely to be happy to keep the yuan within relatively narrow ranges given major economic uncertainties.

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