Weekly Forex Currency Review 22-03-2013

The Euro-zone situation will remain a very important short-term focus. There will be Euro relief if some form of Cyprus agreement can be reached and a bailout secured, but there would also still be major concerns surrounding the economic outlook given fresh deterioration in the PMI indices. There will be continuing expectations that the US economy will be able to out-perform the key European economies over the next few months which will provide underlying dollar support.

Key events for the forthcoming week

Dollar:

The US economic data has remained broadly favourable, especially in the labour market which will maintain expectations of solid near-term growth. The Federal Reserve position remains unchanged in that it remains extremely wary of tightening policy too quickly.  It will, therefore, maintain the existing policy for now, especially given some fiscal tightening, but with hints over a possible adjustment later in 2013. There will be optimism surrounding US out-performance in growth terms and expectations of an improved current account position as the energy deficit declines.

The dollar maintained a generally firm tone during the week despite a retreat from the strongest levels with a significant retreat against the yen.
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The Federal Reserve left interest rates on hold at the latest policy meeting and there were no changes to quantitative easing with monthly bond purchases of US$85bn. There was a small downgrading of 2013-2014 forecasts for both growth and unemployment. Kansas City Fed President George again dissented from the decision, fearing that monetary policy was too accommodative and risked longer-term inflation.

Fed Chairman Bernanke was slightly more optimistic surrounding the growth outlook with comments that the labour market had shown some signs of improvement over the past six months. Bernanke also stated that the Fed could adjust the amount of bond purchases on a monthly basis depending on economic developments. He also repeated that thresholds such as the unemployment level were not automatic triggers for a change in policy while there would be some fiscal drag on the economy.

There was another solid reading for jobless claims with little change at 336,000 in the latest week from a revised 334,000 previously. The flash PMI manufacturing index was also little changed at 54.9 while existing home sales were at a three-year high. With a sharp improvement in the Philadelphia Fed index there was further underlying optimism surrounding the US growth outlook.

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The Cyprus situation will remain an important short-term focus with intense pressure for some deal to be reached. There will be an important risk over miscalculation if Germany maintains a hard line which could force Cyprus out of the Euro-zone. Even if the situation can be resolved, There will be increased unease surrounding the Euro-zone economy, especially given renewed deterioration in the PMI data. There will be pressure for additional ECB action to support economies and the Euro will remain generally vulnerable.

The Euro was fragile, but did managed to avoid further heavy losses following the weekend gap lower with support below the 1.2880 area against the dollar.
 
Over the weekend, a deal was reached on a EUR10bn aid package for Cyprus.  There was a major surprise within the deal with a levy on Cyprus bank deposits of 6.7% on deposits under EUR100,000 and 9.9% above this threshold. There was a major domestic political opposition to the levy on deposits. There were also wider fears surrounding the Euro-zone with unease over wider capital flight from weaker peripheral economies.

After a barrage of rumours the government confirmed that a vote on the banking-sector levy imposed on bank deposits would go ahead as planned. There was a proposal to exempt savings up to a level of EUR20,000 which did little to bolster support for the plan. The vote went ahead, but the government party abstained and the bill was rejected with no votes in favour.  Banking-sector closure was extended until March 26th. The government entered negotiations with the Russian government over potential loan support, but no agreement was reached.

The ECB stated that it would provide emergency ELA liquidity only until Monday unless a workable solution was found to the banking crisis. The government will consider revised plans to find the EUR6bn required to gain access to a bailout. The latest indications were that a national solidarity fund would be launched with energy assets used as collateral. The government is also looking to impose capital controls to contain any capital flight if the banks re-open next week.

The government will need to gain parliamentary approval for fresh measures and will also need to convince the troika to back the plan. Uncertainty will remain extremely high on Friday and over the weekend which will tend to curb risk appetite. Failure to reach a deal would be a heavy blow for the Euro given that Cyprus would face a Euro exit while agreement would provide initial relief.

The latest PMI releases were sharply weaker than expected as the Euro-zone PMI manufacturing index fell to 46.6 for March from 47.9. There was a sharp downturn in the German and French indices which reinforced fears surrounding the outlook overall and the extremely weak state of demand in France.
    
Yen:   

The Bank of Japan will inevitably remain an extremely important focus in the short-term.  New Governor Kuroda and his team will instigate further monetary stimulus at the next policy meeting. There will be reservations over very aggressive action within some quarters and the scale of action may therefore, fall short of the most aggressive rhetoric. There will be yen relief at times, especially with the potential for year-end capital repatriation even if net underlying yen depreciation continues.

The dollar was unable to make any impression on resistance levels above 96 against the yen. New Bank of Japan Governor Kuroda reinforced the message that the bank would do whatever it takes to beat deflation within the economy.

There were strong expectations of further monetary easing while Kuroda declined to comment on the potential for an emergency meeting. The central bank head did play down the possibility of overseas bond purchases as this would be tantamount to currency intervention.

There was some disappointment that Kuroda did not take a more aggressive tone and there was some evidence of profit taking short yen positions. In this context, the dollar dipped to lows below 95 against the yen with a test of support around 94.50 as uncertainty curbed risk appetite.

The latest trade data recorded a lower deficit of JPY778bn for February from 1.63trn previously, although experts fell 2.9% over the year and there will be further pressure to keep a competitive yen

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There was some relief in the latest retail sales data, but overall confidence in the economy is likely to remain very fragile, especially with a further squeeze on real incomes.  There will be pressure on the Bank of England to sanction further quantitative easing. Moderate Sterling depreciation is unlikely to be a major concern, but the bank has expressed some unease and will want to avoid rapid depreciation. With a slightly more flexible mandate, the central bank is likely to maintain a highly expansionary monetary policy which will undermine Sterling.

Sterling was able to recover from its worst levels during the week The UK currency edged back to the 1.52 area as Euro-zone tensions provided some protection with a move to near 0.85 against the Euro. The headline UK employment data was slightly weaker than expected with a 1,500 decline for the month while the unemployment rate held steady at 7.8%.

The data was over-shadowed by the Bank of England minutes. There was a 6-3 vote to keep the amount of quantitative easing on hold with Governor King again in the minority in calling for additional action. There was a detailed discussion of the merits of additional quantitative easing with a majority of members uneasy over the potential implications for Sterling depreciation if there was further policy action.

The budget was broadly in line with expectations as the government downgraded its growth forecasts for the next two years. The fiscal stance was broadly neutral with very little room for manoeuvre. There was a change in the Bank of England remit with a move closer towards the Federal Reserve stance with the bank having scope for greater flexibility in meeting the inflation target and also using intermediate indicators such as unemployment.

There was a stronger than expected reading for UK retail sales with a 2.1% increase for February after a revised 0.7% decline the previous month. This did represent a catch-up following two poor reports, but did help to stabilise confidence. The latest headline government borrowing data was also stronger than expected, although there were further important concerns surrounding the underlying outlook

There were further expectations that the bank would take a more aggressive policy stance once Carney took office later this year. Sterling did gain some protection from the fact that the mandate change was less radical than expected.

Swiss franc:

There will be concerns surrounding the growth outlook even though headline business confidence indicators have shown some degree of resilience. The underlying evidence still suggests that there has not been serious pressure on the minimum 1.20 Euro level. Nevertheless, the bank will remain extremely wary of the situation given underlying Euro-zone vulnerability, especially given stresses surrounding Cyprus which could trigger further additional capital outflows.   

The Euro dipped weaker against the franc, although moves were restrained as the dollar was unable to push above the 0.95 level.

The Swiss ZEW index weakened to 2.3 from 10. The previous month, although there was some relief that the indicator held above zero. The trade account remained in comfortable surplus which did not have a major impact.  The National Bank again defended its intervention and minimum 1.20 rate for the Euro with markets still fretting over the possibility of renewed defensive inflows if the Cyprus situation deteriorates.
 
There was commentary from the IMF that Switzerland should use negative interest rates as a tool to curb asset inflows and there were comments from National Bank member Moser that negative rates could be considered which weakened the franc.

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The Australian dollar found support on dips to the 1.02 area against the US dollar during the week and pushed to a peak in the 1.04 area.

There were little in the way of domestic economic releases during the week and the latest Reserve Bank minutes were in line with expectations.

Despite a shift in interest rate expectations and greater confidence in the domestic economy, the Australian dollar will find it difficult to make much headway.

Canadian dollar:

The US dollar found some support on dips to the 1.02 area against the Canadian dollar and edged higher, although ranges were relatively narrow.

There was a slightly stronger than expected retail sales report, but the manufacturing data was again disappointing and there was a decline in oil prices which curbed Canadian currency support.

Further concerns surrounding the fundamentals will tend to limit Canadian dollar support, especially with doubts over the housing sector and manufacturing outlook.

Indian rupee:

The rupee was unable to make significant headway against the dollar over the week as a whole, but here was support on any retreats towards the 55 level

There was some improvement in optimism surrounding the global risk appetite. There were, however, further underlying concerns over the Indian fundamentals, especially given the current account deficit. There was also underlying uncertainty surrounding the political outlook.

The rupee is still likely to be hampered by underlying structural budget and current account deficits with little scope for significant appreciation in the short-term.

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The Hong Kong dollar continued to drift weaker with a move beyond 7.76 against the US dollar as immediate pressure on the peg limit eased. There were still longer-term concerns surrounding an over-expansionary monetary policy until there is any underlying policy shift by the US Fed.

There were important concerns surrounding overheating risks within the housing sector with pressure for further action if the latest measures fail to have an impact.

Even with a short-term focus on attempts to cool the property sector, medium-term speculation over a peg break will continue given underlying inflation concerns.

Chinese yuan:

The Chinese yuan maintained a solid tone during the week with a move towards 6.21 against the US dollar. The PBOC remained cautious over allowing gains, especially with regional currencies generally weaker.

New US Treasury Secretary Lew visiting key Chinese officials during the week and there were no substantive comments on exchange rates. The latest PMI data was stronger than expected with gains for the flash March reading which underpinned confidence to some extent.

Monetary and economic uncertainties will continue and the yuan is unlikely to make strong headway given the underlying growth and capital account profile.

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