Weekly Forex Currency Review 24-05-2013

The Federal Reserve stance will continue to be extremely important. The market is still expecting that there will be a scaling back of bond purchases within the next few months. These expectations could be prone to a significant reversal if there is evidence of deterioration within the US economy. There will be further important stresses within the Euro-zone while there will also be concerns surrounding the global economy and the threat of capital outflows from emerging markets with underlying dollar resilience.

Key events for the forthcoming week

Dollar:

Markets will continue to watch Federal Reserve policy very closely in the short-term. Comments from Chairman Bernanke suggest that the policy of bond purchases will be maintained in the short-term with the FOMC still reluctant to withdraw stimulus given economic uncertainties. Fiscal tightening will also increase the threat of weaker growth which would prevent monetary tightening and also limit dollar support. The US currency should still gain support on expectations of relative out-performance and any deterioration in global economic conditions would also provide defensive US currency support.

The dollar strengthened sharply at times during the week, but failed to hold its best levels as the trade-weighted index edged back from 3-year highs.
 
Principal attention focussed on congressional testimony from Fed Chairman Bernanke. In prepared remarks to the Joint Economic Committee, Bernanke stated that the amount of bond purchases could be increased or reduced depending on economic circumstances.  He expressed further concerns surrounding the labour market even though there had been some improvement over the past few months. He also commented that there would be clear dangers in tightening policy too quickly given the risks that the economy could weaken again.

The generally dovish statement triggered losses for the dollar as the Euro probed the 1.30 level. The Euro was unable to hold the gains with the dovish tone already priced in. Bernanke tried not to be drawn on the timing of bond purchase tapering, but he was forced to admit that it could happen within the next few FOMC meetings. Markets also took advantage of the slide to buy the dollar at lower levels and the Euro retreated sharply with a focus on the possibility of a shift within the next few months.

The dollar gained further traction later as the latest Fed minutes confirmed that some members wanted an early reduction in the quantitative easing programme, although the majority wanted more evidence and the key factor is that policy moves will be dependent on economic developments.

The latest US economic data releases were slightly stronger than expected with jobless clams falling to 340,000 in the latest week from a revised 363,000 while there were further monthly gains in house prices.  Confidence was also underpinned by a steady reading for the latest PMI index with an increase to 51.9 for May.

The data had a significant impact in calming market nerves as equity markets recovered  strongly from their worst levels. There were further comments from Regional Fed President Williams who stated that the Fed could even expand quantitative easing even after tapering bond purchases. The overall tone of rhetoric was less hawkish which had an impact in curbing dollar demand.

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The latest economic data has suggested some degree of stabilisation in conditions, but the economy as a whole is still contracting and stresses within peripheral economies remain intense. There will be pressure for additional ECB support, butt he bank will be very reluctant to adopt controversial measures such as negative interest rates while other policies could be blocked by not being within their mandate. Political tensions will also increase, especially if friction between France and Germany escalates. Overall, there is the risk that international confidence will deteriorate sharply again.

The Euro was less of a focus during the week despite underlying stresses and the currency found support in the 1.28 region.
 
There were further reports that the ECB was considering the possibility of using negative interest rates as a tool to support the economy. There were some reports that the Bundesbank had asked commercial banks over the viability of negative rates within the banking system.

There were underlying concerns surrounding Franco-German tensions with expectations that new growth-orientated proposals from French president Hollande would receive a frosty reception with severe underlying stresses.

There was some relief surrounding the latest Euro-zone data, although the underlying picture remained extremely fragile. There was a recovery in the latest flash PMI manufacturing index to 47.8 from 46.7 and there was also a small improvement in the services sector. Although the data continued to signal GDP contraction, there was some relief that a further deterioration was avoided.

In this context, there was some scaling back of expectations surrounding further ECB monetary action. The underlying situation remains extremely fragile, however, and ECB member Nowotny was notably downbeat in remarks on Thursday.

Yen:   

The Bank of Japan will continue to sanction an extremely aggressive monetary policy in the short-term. There is likely to be a more cautious mood in the short-term, especially in view of instability within the domestic bond market.  Regional trade tensions are also liable to increase given the impact of much stronger Japanese competitiveness. The yen will continue to gain some respite if there is a deterioration in international risk appetite. The main feature is liable to be a sustained increase in yen and wider currency-market volatility.  

The dollar strengthened to highs above 103 against the yen during the week before weakening sharply as Japanese bond-market volatility increased.
 
Japanese Economy Minister Amari commented on Monday that the yen correction was largely done and that further yen weakness could be damaging. The latest trade data was weaker than expected with a deficit of JPY880bn for April from JPY364bn previously as imports rose sharply and export growth was disappointing.   

Underlying yen sentiment remained weak on expectations of further capital outflows. The latest Japanese data, however, recorded  a substantial net inflows of funds into Japan which caused a significant jolt to market expectations.  There was also a deterioration in risk appetite following the sub-50 Chinese flash HSBC PMI reading. In this environment, there was a powerful reversal with the dollar weakening to lows near 102 as the Nikkei index fell sharply.

Risk aversion eased as equity markets regained ground and this was important in curbing defensive yen demand and there was solid US currency demand on dips with expectations of longer-term yen selling. Bank of Japan Governor Kuroda stated that sufficient easing had already been announced which triggered some fresh yen buying, especially as the Nikkei index dipped sharply after an initial recovery.

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There will be expectations of growth within the economy, but overall sentiment will still be extremely fragile and it will be difficult to secure expansion at the pace needed to secure a meaningful decline in the budget deficit. In this context, there will still be pressure for a more aggressive Bank of England policy, especially if there is a further short-term decline in inflation. Uncertainty will be a key feature with Carney taking over as Bank Governor in July. The UK will also continue to have underlying balance of payments vulnerability which will limit the scope for any Sterling gains.

Sterling found support close to 1.50 against the dollar and also found support close to 0.86 against the Euro as the UK currency found support on dips.
 
The latest UK inflation data was weaker than expected with a decline in the headline rate to 2.4% from 2.8% and compared with expectations of 2.6% as fuel prices declined. The decline increased speculation that there could be additional scope for further Bank of England quantitative easing.  This is important given speculation that incoming Governor Carney will look to take a more aggressive stance.

The retail sales data was sharply weaker than expected with a 1.3% headline decline for April from a revised 0.6% fall previously. There was a recovery in the CBI industrial orders index to -20 from -25 previously. The IMF, in its annual review of the UK economy, stated that monetary policy should remain accommodative and that the economy was still a long way from securing a strong and sustainable recovery.

The revised UK first-quarter GDP release was in line with the preliminary estimate at 0.3%, but there was some disappointment over the data breakdown as the advance was driven to a large extent by rising inventories. There was a decline in investment and exports which will maintain underlying concerns surrounding the outlook with no re-balancing of the economy away from consumption.

Swiss franc:

There will be further uncertainties surrounding capital inflows into the Swiss franc.  There will be further expectations over a decline in inflows on defensive grounds. There will also be speculation that the national Bank will take advantage of any vulnerability to raise the minimum Euro level. If global risk appetite deteriorates, there could still be a rapid flow of funds back into the Swiss currency, especially as domestic investors would again be reluctant to push funds overseas and volatility is likely to remain higher.
 
The franc was subjected to fresh selling pressure on Wednesday with 2-year lows beyond 1.26 against the Euro before a recovery. Similarly, there was a slide to fresh 2013 lows above 0.98 against the US currency before a partial recovery.

The IMF called for the National Bank to take advantage and reverse some of the huge intervention amounts and buy the franc back if there was any sustained weakness in the Swiss currency.

National Bank Chairman Jordan stated that the bank could consider a raising of the Euro minimum level and also re-iterated that it would not exclude the use of negative interest rates if necessary. For now, there has been an underlying decline in defensive franc demand which is undermining the currency.

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The Australian dollar was subjected to heavy selling pressure during the week and briefly retreated to 11-month lows below 0.96 against the US currency before regaining some ground. The currency lost ground when risk appetite deteriorated before regaining slightly later in the week.

There was a decline in consumer confidence according to the latest data, maintaining unease surrounding internal demand and the economy as a whole. Confidence was also undermined by the weaker than expected Chinese PMI data which reinforced fears over an Asian and Australian economic deterioration.

The Australian dollar will remain vulnerable on domestic and international growth concerns, but with some scope for a short-term recovery from over-sold conditions.

Canadian dollar:

The Canadian dollar initially held firm before weakening sharply in the middle of the week with lows near 1.04 against the US currency. International trends tended to dominate with the Canadian currency undermined by lower commodity prices and a generally strong US currency. There was a slightly weaker than expected reading for retail sales which reinforced market unease over growth prospects.

Falling commodity prices and domestic doubts will remain important negative factors for the Canadian dollar. Positioning should limit the risk of further near-term losses.

Indian rupee:

The rupee remained under pressure for most of the week and lost ground for six consecutive sessions and dipped to lows around 56 against the dollar before finding some relief. There was a general downturn in confidence surrounding emerging markets with fears that a weaker global economy and any US tightening could lead to weaker growth and a sharp decline in capital inflows.

There were further concerns surrounding underlying balance of payments vulnerability with the current account deficit estimated at just over 5% of GDP.

There are likely to be more important reservations surrounding emerging-market assets as a whole and this will prevent any significant recovery for the rupee.

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The Hong Kong dollar was unable to strengthen through the 7.76 area against the US dollar and retreated towards 7.7630, although volatility and movement was relatively constrained given the sharp moves in emerging-market assets.

There were concerns surrounding a slowdown in regional economies which had an important impact in stifling immediate Hong Kong dollar demand despite the underlying concerns.

Concerns surrounding the threat of imported inflation and an over-heated property sector could ease slightly for now, but medium-term peg stresses will continue.

Chinese yuan:

The Chinese yuan strengthened to fresh 19-year highs close to 6.13 against the dollar in the middle of the week before edging weaker as the US currency strengthened.

In relative terms, the currency held broadly firm with the PBOC still encouraging a generally strong currency. There were further concerns surrounding the economic outlook as the flash HSBC PMI index weakened to below the 50 level for the first time since October. There were also further doubts surrounding the accuracy of trade data with concerns that exports would be damaged by weaker competitiveness

The PBOC will be reluctant to let the yuan strengthen strongly given competitiveness issues and economic doubts are also liable to curb capital inflows, unsettling the yuan.

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