Weekly Forex Currency Review 22-07-2011

Immediate confidence in the Euro will be strengthened by the fresh support package for Greece. There are still very important political barriers that will need to be overcome and the tensions will tend to increase again if there is evidence of a further downturn in the Euro-zone economy. In this context, any market respite could still prove to be short-lived. 

Key events for the forthcoming week

Dollar:

Negotiations surrounding the US debt ceiling will continue to be watched very closely as the August 2nd deadline draws closer. The dollar is likely to be subjected to heavy selling pressure if there is no deal while there will be some relief if default is averted. Underlying confidence in the economy will remain weak following a series of lacklustre economic reports. The Federal Reserve will keep interest rats at extremely low levels and there will be some further speculation over additional quantitative easing. Immediate defensive demand for the dollar will tend to be lower, but concerns over the global economy are liable to  increase again which will provide protection. The dollar remains substantially under-valued from a longer-term perspective.

The dollar gained support early in the week as the Euro was subjected to heavy selling pressure and there was a deterioration in risk appetite, but the US currency lost ground heavily over the second half of the week with the trade-weighted index threatening lows seen in May.
 
The US housing data was weaker than expected with existing home sales falling to an annual rate of 4.77mn from a revised 4.81mn previously as cancellations also increased, dampening optimism triggered by firm housing stats data on Tuesday.
The Philadelphia Fed index rose to 3.2 for June from -7.7 previously while jobless claims rose to 418,000 from 408,000 previously.

The latest US capital account data recorded a decline in net long-term inflows to US$23.6bn for May from US$30.6bn the previous month which suggested that foreign appetite for US investments had fallen, although there was an increase in long-term US Treasuries held by China.

There were further negotiations surrounding the US debt ceiling, but rumours of a deal were denied by congressional leaders as the deadline moved closer. There were no substantive comments from Federal Reserve FOMC members during the week.

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The second rescue package put together for Greece will ease immediate market fears over disorderly contagion within the Euro area which will also reduce market fears over the currency. There will still be doubts over the effectiveness of the plan in the medium term, especially as Greece will still be trapped win recession. There will also be increased concerns over the economic outlook following a further deterioration in the latest PMI releases. The Euro will continue to benefit from yield support if market fears can be calmed, but the currency still faces strong barriers to sustained gains, especially given the risk of political opposition.  

The Euro remained firmly on the defensive in European trading on Monday as Euro-zone debt fears continued to increase. There was a sharp move higher in peripheral yields with Spanish yields above 6.3% while Italian yields again pushed above 6.0% with yield spreads over German bunds at their highest since the Euro’s inception in 1999 as the bank stress tests announced on Friday failed to bolster confidence.

The flash Euro-zone PMI manufacturing index fell to 50.4 for July from 52.0 previously which was the lowest reading for 23 months while the services-sector index also dipped sharply to 51.4 from 53.7 previously. There were increased fears surrounding the economy which would also increase pressure on weaker members.

Following an extended meeting between German Chancellor Merkel and French President Sarkozy, there was an announcement that they had reached a joint negotiating position ahead of Thursday’s meeting.

As EU leaders prepared for the emergency Summit, reports that the Greece could be put into selective default undermined confidence and pushed the Euro lower. The currency swiftly reversed losses with strong gains from the New York open as markets grew more confident over the outcome and there were suggestions that the ECB would not block any deal.

The EU leaders agreed a EUR109bn support package for Greece. The ESFS fund will be expanded and have a bigger future role as it would be able to buy secondary bonds if necessary to prevent contagion. Interest rates on ESFS bonds will also be lowered to 3.5% which ease the loan-repayment burden on weaker economies. There will be debt write-downs of around 20% on private-sector bondholders while the ECB indicated that it would continued to accept Greek bonds as collateral even if Greece is declared in temporary default. The Euro gained relief on an easing of immediate contagion fears, although the political implications will also be watched very closely given the potential for substantial opposition within Germany.   

Yen:   

There will be concerns over the Asian growth outlook which will tend to curb selling pressure on the Japanese currency and the dollar continues to be poorly placed to gain on yield grounds.  There will be some speculation over a reduction in domestic leveraged currency positions which will tend to support the Japanese currency over the next few weeks.  There will be further concerns over competitiveness and pressure for intervention will certainly persist while immediate capital repatriation flows from Europe may slow. The dollar will find it difficult to secure more than limited gains.  

The dollar was unable to regain the 80 level during the week and remained firmly on the defensive. The latest Japanese trade data was stronger than expected with a small headline surplus as exports recovered and the adjusted deficit narrowed which provided some yen support.

The yen was able to resist selling pressure despite some optimism over a deal surrounding the Greek-debt crisis. The yen also gained support from the weaker than expected Chinese PMI data as it dipped to below 50 for the first time in 12 months.

The dollar was unable to gain support on yield grounds with investors still concerned over the debt-ceiling negotiations and these uncertainties tended to have a bigger impact as Euro fears diminished.

There was some speculation that the would be an easing of speculative positions and a reduction in short yen positions as new rules on leveraged accounts come into force in early August. Finance Minister Noda continued to warn over the intervention threat, but there was no confirmed intervention.

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Confidence in the economy will remain weak with further concerns over the growth outlook, especially with fears over a weak second-quarter GDP release. Expectations of a loose monetary policy will continue to undermine Sterling yield support even if the Bank of England resists further quantitative easing. Underlying confidence in the government’s economic policies is also liable to falter which will curb currency support. Sterling is unlikely to make much headway given the yield and risk structure, although immediate fears surrounding the banks should ease.

Sterling weakened ahead of the Bank of England minutes on Wednesday with lows near 1.6070 against the US dollar. The MPC vote from July’s meeting was in line with expectations at 7-2 with Weale and Dale again voting for an increase in rates.  There was a further warning that inflation was liable to rise to above the 5.0% level and there was no suggestion of additional quantitative easing in the short-term.

Although the minutes did state that the  possibility of a near-term increase in interest rates had receded, markets were relieved over the absence of quantitative talk and Sterling rallied. The retail sales data was slightly stronger than expected with a 0.6% monthly increase for June following a revised 1.3% decline the previous month as non-food sales recovered, but there was still little increase for the second quarter.

The latest government borrowing requirement of GBP12.0bn pushed the deficit for the first quarter of the fiscal year to GBP39.2bn from GBP39.5bn last year. Uncertainty over the economic environment will continue and there will be expectations of a weak second-quarter GDP reading next week.

Swiss franc:

The franc will continue to be influenced very strongly by the Euro-zone stresses and degrees of risk appetite within global markets.  The immediate contagion fears within the Euro area have eased which will lessen defensive demand for the Swiss currency. So far, however, the Euro is still weaker than when the Greek austerity package was agreed last month. Domestic policies will be watched closely as there will be additional pressure on the National Bank to intervene or impose capital controls if there are any fresh gains for the Swiss currency.
 
The Euro rallied strongly from record lows below 1.14 early in the week and also found support on dips towards 1.1620 against the franc on Thursday. The Euro rallied strongly following leaked reports of the EU summit draft with highs near 1.18. The dollar found support below 0.8150, but was unable to make any headway despite a spike higher in early US trading.

There will be some easing of immediate defensive franc demand as the contagion threat surrounding the Euro-zone is lifted, although the Euro is still weaker than when Greece passed its austerity programme in June. Domestically, there was a sharp decline in the ZEW business confidence index to -58.9 for June from -24.3 which will increase fears over a sharp slowdown and will maintain pressure for National Bank action to curb franc gains.

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The Australian dollar came under renewed selling pressure early in the week with a test of support below 1.06 but, as has been the case throughout the past few weeks, there was firm buying support at lower levels and the currency pushed to above 1.08 which was the strongest level since early May. There were also doubts surrounding the Asian economy following the latest Chinese data releases, but the currency continued to draw firm buying support on dips as risk appetite improved.

There was a shift in the latest monetary policy minutes with the Reserve Bank edging back to a more neutral stance on interest rates with the bank taking a wait and see approach. There was an adjustment in interest rate expectations with some investment banks forecasting a rate reduction by the end of 2011.

The domestic and international risk profile suggest that risks surrounding the  Australian dollar will tend to increase over the next few weeks.

Canadian dollar:

The Canadian dollar net gains over the week as the US came under wider pressure with a move to beyond 0.95.  The Bank of Canada left interest rates on hold at 1.0%, while the underlying tone was slightly more hawkish than expected. There was also an absence of strong rhetoric against Canadian dollar strength which curbed selling pressure on the currency.

The currency also gained support from a net improvement in risk appetite even though there was caution over the latest international PMI releases.

The Canadian fundamentals should remain broadly favourable, but the Canadian dollar is unlikely to make gains given the underlying international risk profile.

Indian rupee:

The rupee dipped again proved broadly resilient during the week with no major challenge on the 45 level against the US dollar and it advanced to a peak near 44.25 with renewed gains late in the week as the Euro advanced strongly.

There were concerns over threat of a regional slowdown, but the local stock market again proved to be resilient with some potential capital flows witching into India and away from China as economic doubts increased.

The currency should be able to remain resilient given hopes for equity-related capital inflows and the possibility that it will attract inflows at the expense of China.

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The Hong Kong dollar was able to resist a serious test of support near 7.80 during the week and briefly strengthened through the 7.79 level, although ranges were generally narrow. The currency was protected by a generally weak US dollar performance and risk conditions did manage to stabilise.

There was still a high degree of caution over the mainland economic trends which dampened investor enthusiasm with fears over an increase in bad loans.

Although the Hong Kong dollar will gain support when risk appetite improves, uncertainty surrounding regional economic trends will limit any advance.

Chinese yuan:

The Chinese yuan secured significant net gains during the week with the Central bank setting a series of record-high fixings and the currency pushed through the important 6.50 level against the dollar late in the week as the Euro also gained ground strongly

The flash PMI manufacturing survey dipped to below the 50 level for the first time in a year which maintained caution over the economic outlook. There were still fears surrounding higher inflation and fears that excessive lending had created a bubble in the housing sector.

The IMF again called for a further yuan strengthening, calculating that the currency was under-valued by between 3% and 23% depending on the methodology used.

There will be a growing threat of instability and fears surrounding the Chinese economy and yuan, especially if inflation pressures cannot be contained.