Weekly Forex Currency Review 21-06-2013

08.30 AM GMT Overall strategy:  The ramifications of a potential shift in Federal Reserve policies will continue to dominate market sentiment in the short-term. The Chinese outlook will also be an important focus given fears over a sustained credit crunch which would also tend to damage global growth prospects. There will be a further unwinding of carry trades which would also tend to support the US currency, although there will be corrective pressures at times with volatility set to remain higher.

Key events for the forthcoming week

Market analysis

Dollar:

Federal Reserve policy will remain the key short-term focus following the latest FOMC meeting with expectations that the Fed will start to taper bond purchases before the end of 2013.  Anticipation of a reduction in quantitative easing will underpin yields and also provide underlying dollar support. The US currency will also gain backing from vulnerability in key emerging markets and unease surrounding the global growth outlook. Support for the US currency would falter, at least temporarily, if there is evidence of deterioration in economic growth as US releases remain under close scrutiny.

After a weak tone early in the week, the US currency gained strong support following the Federal Reserve meting. The NAHB housing index was much stronger than expected with an increase to 52 from 44 previously. Significantly, this was the first reading above the 50 benchmark level for the first time since March 2006.

There were no policy changes at the latest Federal Reserve meeting with interest rates and the amount of quantitative easing both left on hold. There was a 10-2 vote for the decision with Bullard and George dissenting and wanting a more restrictive policy at this stage. The Fed downgraded its economic projections slightly, but in the statement it was more confident in the outlook with reduced downside risks to the economy.

Principal attention focussed on the outlook for bond purchases and the potential for a scaling-back of bond purchases. In his press conference, Chairman Bernanke stated that if the economy progressed as the Fed expected and the unemployment rate fell further, there would be scope for the bond-purchase programme to finish during 2014. It would also be appropriate for the rate of bond purchases to be reduced later this year. These comments were more hawkish than had been expected which triggered a rise in bond yields and also put upward pressure on the dollar.

There were still significant caveats from Bernanke with comments that any adjustment to the unemployment rate threshold for action would be lowered rather than increased and that inflation was slightly below the target range.  The key will, therefore, be whether the economy does perform in line with expectations or whether there is a fresh deterioration. Any slowdown would force a reassessment.

There was further selling pressure on US bonds on Thursday as markets continued to price-in a less accommodative stance. The yield on the benchmark 10-year bond increased sharply to a high above 2.45%, the highest since October 2011.

Emerging-market currency stresses were also important with BRIC economies under sustained pressure. There were further concerns surrounding the Chinese banking-sector situation as money-market rates continued to rise sharply. There were major concerns surrounding the banking sector and risk of a sharp deterioration in growth conditions which triggered a further immediate flow of funds into the dollar.

The US PMI manufacturing index was marginally lower at 52.2 for June from 52.3 previously while jobless claims rose to 354,000 from a revised 336,000. The data initially relieved some of the pressure on bond prices as yields dipped lower.  A rise in existing home sales, however, to the highest level since November 2009 and a sharp rise in the Philadelphia Fed index sparked fresh dollar demand.

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There have been some further tentative signs of improvement in economic conditions with gains in the PMI readings. The indices are, however, still in contraction territory and the peripheral outlook remains bleak. There will be further pressure for a more aggressive ECB monetary policy to help improve conditions, especially given the rising threat of political stresses. Any upsurge in tensions surrounding Italy could plunge the Euro-zone back into crisis and it will be very difficult to sustain any significant Euro gains.

The Euro dipped weaker against the dollar from four-week highs around 1.34 against the dollar, although it proved to be broadly resilient as selling pressure eased.
 
The German ZEW business confidence index was marginally stronger than expected with an increase to 38.5 for June from 36.4 previously although there was a disappointing reading for current conditions. Markets looked for the data to trigger a break above important resistance in the 1.34 area with a failure to crack resistance triggering a correction.

ECB President Draghi took a generally dovish tone with comments that the bank was ready to act if needed and again stated that the bank was technically ready to introduce negative interest rates. The comments only triggered a short-term relapse with reports of institutional Euro demand. Given the damage to competitiveness, there will be additional pressure on the ECB to talk the Euro down and adopt a more aggressive stance to counter currency appreciation.

Euro-zone data releases were slightly stronger than expected with the manufacturing PMI index rising to 48.7 from 48.3 previously while the services component also registered a significant improvement. The data boosted confidence that the Euro-zone economy was at least starting to stabilise with consumer confidence also improving.

Yen:

There will be further concerns within the bank over the impact of bond-market instability, especially as this would increase the risk of a major debt-financing crisis. There is, therefore, likely to be a slightly more cautious tone surrounding monetary policy which will curb yen selling. The yen will also gain important support if there is no reversal in the current trend of net capital repatriation and a sustained deterioration in risk conditions. The principal feature is likely to be a sustained increase in yen volatility over the next few weeks.  

The dollar tended to drift very slightly weaker ahead of the Federal Reserve meeting, but there was no test of support in the 94.50 region. A more optimistic assessment by the Fed pushed US Treasury yields sharply higher to the highest level of 2013 and this was important in driving the dollar sharply higher with a peak above the 98 level before a partial correction.

The yen gained some degree of protection from weakness in emerging-market currencies, but there were still significant net yen losses. There was a similar pattern on Thursday as a weaker than expected Chinese HSBC release, together with a further rise in money-market rates undermined Asian currencies.

There were also still some reservations over aggressive yen selling given that the latest capital account data again recorded net inflows to Japan. There will also be clear reservations over aggressive yen selling if global risk appetite continues to deteriorate.

Japan continued to record a trade deficit for May, but there was export growth of 10% which will provide some underlying support for the yen on reduced pressure for a more competitive currency.

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Confidence in the economic outlook is likely to remain slightly stronger in the short-term, especially after a stronger than expected retail sales report. There will still be concerns over the longer-term spending outlook given a persistent squeeze on real incomes. The Bank of England was also surprisingly downbeat over the outlook which suggests an underlying lack of confidence and the possibility of a more aggressive policy under new Governor Carney. Concerns over the banking sector and a generally risk averse environment will also tend to undermine the UK currency with limited scope for gains.

Sterling failed to break above key technical resistance in the 1.5750 area and weakened sharply, but did resist further losses against the Euro.
 
The latest Bank of England minutes for the June meeting again recorded a 6-3 vote to leave the amount of quantitative easing unchanged at £375bn. This was the fourth consecutive month that out-going Governor King was in the minority camp and voted for additional quantitative easing.

There was a generally bearish assessment of the outlook with the dissenters more vocal in their support for additional quantitative easing. Given the recent tone of commentary from officials and improvement in key business surveys, there was some surprise at the overall tone within the minutes and Sterling retreated. In his Mansion House speech, King remained generally pessimistic surrounding the banking sector and repeated that there was a compelling case for more stimulus.

The latest UK retail sales data was much stronger than expected with a headline increase of 2.1% for May following a revised 1.1% decline. The data helped ease immediate concerns surrounding the spending outlook, although there were still underlying concerns surrounding the outlook given a squeeze on disposable income.

Swiss franc:

There will be scope for defensive franc support when global risk appetite deteriorates, especially given an increase in fears surrounding emerging markets. There will also be renewed franc demand if there is any increase in Euro-zone political stresses. The National Bank has held monetary policy steady and will continue to defend the 1.20 Euro minimum level forcefully in the short-term.
 
As expected, the National Bank left interest rates on hold at a 0.00-0.25% range at the latest policy meeting. The Euro minimum level of 1.20 was also left unchanged at the latest review. Bank officials continued to insist that the Euro minimum level would be defended will all necessary steps and refused to rule out negative interest rates if required in the context of a more aggressive ECB stance.

The dollar was unable to sustain a move above 0.9350 and dipped to lows below 0.9280 as underlying buying faded. The franc will also gain some degree of support from a deterioration in risk appetite and held stronger than 1.23 against the Euro.

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The Australian dollar attempted to rally at times and moved back above the 0.96 level against the dollar before being subjected to very heavy selling following the Federal Reserve meeting. There was a rapid slide to 3-year lows below 0.92 against the US currency before a limited correction.

There was a further loss of yield support relative to the US currency which undermined currency demand. International growth fears were an important influence with selling compounded by a decline in commodity prices and increased fears surrounding the Chinese growth outlook as credit conditions deteriorated.

High volatility will continue in the short-term. There is scope for a short-term correction from over-sold conditions within a likely longer-term downtrend.

Canadian dollar:

The Canadian dollar was unable to sustain a move through the 1.0150 area against the US dollar during the week and retreated to lows near 1.04 before finding support.
The currency was undermined by a deterioration in risk appetite and a retreat in oil prices on growth concerns. There were no substantive comments from new Bank of Canada Governor Poloz.

With global growth and commodity price vulnerability and some overall fundamental doubts,  the Canadian dollar is likely to weaken, but with only measured losses.

Indian rupee:

The rupee attempted to stabilise over the first half of the week before being subjected to renewed selling over the second half as it dipped fresh record lows near 60 against the US dollar. There was a marked deterioration in wider emerging-market sentiment following the Federal Reserve meeting which had a serious rupee impact

There were net stock-market investment outflows of close to US$3.8bn so far in June and the potential rupee impact was magnified by concerns surrounding the current account deficit.  The Reserve Bank intervened to help stem further losses.

The rupee will remain vulnerable due to continuing unease surrounding emerging-market assets as a whole and local fundamentals, but with scope for a correction.

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The Hong Kong dollar found support weaker than 7.765 against the US currency and advanced to highs near 7.753 following the Federal Reserve meeting.

The more hawkish than expected Federal Reserve stance helped underpin the Hong Kong currency through expectations of rising local interest rates and there may also have been capital inflows from China due to the Chinese credit crunch.

Although pressure for a longer-term Hong Kong dollar link to the yuan will remain, immediate trends will tend to be dominated by China’s credit crunch.

Chinese yuan:

The Chinese yuan initially held steady before weakening through 6.13 against the dollar as the PBOC guiding the fixing lower and dollar demand surged. Although movements in the currency were still very limited There was some speculation that the central bank would widen the currency band.

The economic data was weaker than expected with a flash HSBC PMI reading at a nine-month low of 48.3. Credit conditions remained extremely important during the week as the PBOC refused to alleviate pressures through an injection of funds.  There were increased concerns that any form of prolonged credit crunch would have a serious negative impact on growth with rumours surrounding bank failures.

A weaker capital account position will undermine the yuan and the currency will also be vulnerable if there is a sustained credit crunch, especially as growth will weaken.

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