Weekly Forex Currency Review 20-07-2012

The Euro-zone stresses and structural vulnerabilities will continue to be an extremely important market focus.  There has been an important movement in bond markets with yields in several countries reduced to below zero as defensive demand increases. If this trend cannot be reversed there will a further increase in speculation that there will be a break-up of the Euro area.

Key events for the forthcoming week:

Dollar:

There has been further evidence of a slowdown within the US economy with a series of generally disappointing data, especially for retail sales. Federal Reserve Chairman Bernanke also took a generally downbeat tone in his congressional testimony which will increase speculation that the Fed will move to sanction additional quantitative easing.  Global considerations will remain very important and the US currency should still gain protection from fears surrounding the international outlook. Defensive demand for the dollar is liable to be enhanced by reduced pressure for reserve diversification away from the US currency.

The dollar weakened for the week as a whole, although there was a recovery from lows as caution surrounding global growth conditions stifled an equity-market recovery.  The dollar was also resilient against the Euro.
 
The US retail sales data was weaker than expected with a headline 0.5% decline for June while underlying sales declined by 0.4% which was the third successive monthly fall which will undermine second-quarter growth estimates. The New York PMI data was slightly more optimistic with a gain to 7.4 from 2.3 previously.

Principal attention surrounded Fed Chairman Bernanke’s testimony to Congress. The Fed chief was concerned over the labour market and was also less confident in the economic outlook with warnings that there had been a deceleration. Bernanke continued to insist that the Fed had tools available and would take further action if required. There were no hints of immediate action, but the more dovish underlying tone suggested a shift towards further measures after the Summer if there was no improvement in the labour market.

There was a 6.9% increase in US housing starts to an annual rate of 760,000 which was offset by a dip in permits for the month. There was a slight downgrading of growth prospects in the latest Fed Beige Book.

Initial jobless claims increased to 386,000 in the latest week from 352,000, although the underlying trend may well have been little changed. Existing home sales fell to 4.37mn from 4.62mn previously which dampened confidence in the housing sector.  The Philadelphia Fed manufacturing index did register a monthly improvement, but it was still weaker than expected for the fourth consecutive week and negative throughout the past quarter.

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The Euro-zone crisis will continue to dominate in the short-term.  There will be some relief if there is agreement on Spain’s support package for the banking sector.  Nevertheless, the underlying rend in bond yields will remain extremely important and the widening divergence within the markets suggests that underlying stresses are increasing as capital flows out of peripheral economies. Unless this trend can be reversed, there will be a very high risk of terminal stresses within the Euro area and growing pressure for a split. This speculation may perversely help underpin the Euro with volatility set to increase. If the Euro area does hold together, there will be pressure for a more aggressive ECB stance.

The Euro was able to resist further losses against the dollar, but it remained vulnerable on the crosses with record lows against the Australian dollar.
 
Yield trends remained very important within the Euro-zone and global markets. There was a negative yield at the latest German 2-year bond auction for the first time on record and market yields remained below zero in six countries as there was further evidence of capital flows away from  peripheral economies.  The Bank of Spain reported a further drop in bank deposits for June and the bad loan ratio within the banking sector increased to near 9.0% according to the latest data.

There were sharply higher yields in the latest Spanish bond auctions and there was also a sharp decline in the bid/cover ratios which suggested particularly weak investor demand. Benchmark Spanish bond yields moved above the 7.0% level with fears that Spain was sliding deeper towards requiring a sovereign bailout.

The Euro rallied on reports that the EFSF might be able to buy Spanish bonds if there were spare resources from the rescue package, but this was later denied by the European Commission with the Eurogroup set to meet to finalise the bailout package on Friday.  A successful outcome would provide some temporary relief.

Fed Chairman Bernanke’s warning that Europe was not close to a long-term solution which will tend to reinforce global growth fears and these concerns were echoed within the IMF’s latest report as it saw severe downside risks surrounding the Euro-zone outlook. The IMF called for a further cut in ECB interest rates and for quantitative easing which will tend to undermine the Euro.

Yen:   

There will be further concerns surrounding the Japanese economy with the fundamental outlook still extremely vulnerable. Competitiveness issues will also be important and there will be strong pressure for yen gains to be resisted especially if there is a weaker tone for the Chinese yuan. Global considerations will remain extremely important and there is still likely to be underlying yen demand, especially with major fears surrounding the Euro-zone outlook. In this environment, the yen can still resist aggressive selling pressure.     

The dollar was undermined by the weaker than expected US data with additional speculation over further Fed action to support the economy and a test of support below 78.50. There was evidence of semi-official bidding below the 78.50 level which helped trigger a small-scale recovery.

The yen also gained support on defensive grounds as funds continued to shun European peripheral bond markets. There were also further concerns surrounding the Asian outlook. There will, however, be competitiveness pressures if there is further weakness for the Chinese yuan.

The yen continued to gain underlying support from weaker than expected US economic data and by continuing safe-haven demand as Euro-zone fears intensified. Ranges were relatively narrow, especially as there were still important reservations surrounding the threat of Ministry of Finance intervention to restrain the yen.

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There will be further concerns surrounding the UK growth prospects, especially with fears over the impact of Euro-zone recession conditions. Sterling has again been broadly resilient in the face of quantitative easing and economic fears with defensive demand for UK bonds still having an important in supporting the currency. This demand may continue in the short-term, but there is still a high risk that domestic fears will overwhelm these inflows and Euro-zone fears are likely to increase volatility.

Sterling pushed to 44-month highs against the Euro with a peak beyond 0.78 while the UK currency also managed an advance against the dollar.
 
The latest consumer inflation data was weaker than expected with a decline in the annual rate to 2.4% for June from 2.8% previously, the lowest rate for two years. There was evidence that a combination of poor weather and weak demand had pushed retailers into additional discounting which helped keep the rate down.

The unemployment claimant count data was close to expectations with a 6,100 increase in the total for June following a 6,900 increase the previous month. The ILO data was more favourable as the unemployment rate dipped to 8.1% from 8.2%.

The Bank of England recorded a 9-0 vote for unchanged interest rates while there was a 7-2 vote for the additional GBP50bn quantitative easing. All members agreed that further stimulus was warranted and there was discussion of an additional GBP75bn. The new lending programme discouraged the more aggressive stance at this stage and two members voted for no change.  The retail sales data was weaker than expected with a 0.1% monthly gain for June following a revised 1.5% gain the previous month.

There was further evidence of safe-haven considerations as demand for non-peripheral European bonds remained extremely strong which continued to have a positive Sterling impact as the Euro remained weak on the crosses. There is likely to be longer-term speculation that Sterling could be subjected to renewed selling.

Swiss franc:

With confidence in the Euro-zone outlook remaining extremely weak, defensive flows into the Swiss currency are likely to continue, especially following the move to cut deposit rates to zero. The National Bank is still being forced to defend the minimum level on a daily basis and if pressure increases further there will be strong demands for the bank to consider capital controls or negative official interest rates to weaken franc demand. There is still the medium-term possibility that the minimum level will break if the Euro slides sharply against the dollar.

The Euro was trapped close to the 1.2010 level against the Euro during the week while the dollar hit resistance above the 0.9850 area.

The trade account remained in surplus and there was a gain in exports for the first time in four months which provided some support. There will still be strong pressure for franc gains to be resisted with further concerns surrounding the deflation threat.

The latest Swiss ZEW survey was little changed at -42.5 for July which will maintain a lack of confidence in the economic outlook and pressure for franc gains to be resisted. The Economics Ministry reaffirmed its commitment to the 1.20 minimum level, but there will be increasing pressure on the National Bank if conditions deteriorate further and defensive capital inflows intensify.

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The Australian dollar found solid buying support on dips and pushed to two-month highs near 1.0450 before edging slightly weaker. There were gains for global equity markets and a recovery in commodity prices which helped underpin the Australian currency. There were some further expectations of an underlying shift in reserves into the Australian dollar, especially with a lack of confidence in other major currencies and the currency moved to a four-month high above 1.04 against the US currency.

The Reserve Bank was more confident surrounding the growth outlook in the latest minutes which also provided relief for the currency with reduced expectations of further near-term interest rate cuts. There were still important uncertainties surrounding the Chinese economy which restrained buying to some extent.

The Australian dollar will find it difficult to sustain any further significant advances given unease surrounding domestic and regional growth trends.

Canadian dollar:

The Canadian dollar was able to maintain a strong tone during the week with gains to beyond the 1.01 level against the US currency.

The Bank of Canada held interest rates at 1.0% following the latest policy meeting and was still uneasy surrounding the global growth outlook.  The Canadian currency derived support from a rally in oil prices as well as a wider gain for commodity prices.  

Concerns surrounding the global economy and commodity-price trends will tend to limit scope for Canadian dollar gains even if oil prices resist further declines.

Indian rupee:

The rupee was able to maintain a solid tone during the week, although it was difficult to sustain gains with selling pressure towards the 55 level against the US dollar.

There was a continuing mood of optimism towards the government’s reform efforts which helped underpin the currency.  Regional and global equity markets were also still important in pushing the currency stronger. There were still important reservations surrounding the growth outlook and fears surrounding the Euro-zone economy also had a negative impact on the rupee.

Doubts surrounding the regional economy will still tend to limit the scope for rupee gains even if domestic confidence and reform optimism is sustained.

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Hong Kong dollar:

The Hong Kong dollar was unable to make any serious attack on the 7.75 band limit against the US currency and was trapped in narrow ranges with resistance on any move towards the 7.7550 area. Global risk appetite was slightly firmer, but the local currency was unable to translate this into gains, especially with major underlying doubts surrounding the mainland Chinese economy.

Even with speculation over a medium-term policy shift, uncertainty surrounding the Chinese outlook should prevent serious near-term pressure on the peg.  

Chinese yuan:

The yuan was unable to make any significant headway during the week and the spot rate edged slightly weaker beyond 6.37 against the dollar. The weakness persisted even with the PBOC attempting to move the official rate slightly stronger with the yuan very close to its weakest limit within the permitted daily band.

There was evidence of corporate dollar demand during the week amid further speculation over an underlying US currency shortage. There were further important reservations surrounding the Chinese economic outlook and speculation that there would be a further reduction in reserve ratio requirements.

The yuan is likely to be subjected to underlying selling pressure given a developing dollar shortage within the economy and unease over the growth outlook.

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