Weekly Forex Currency Review 25-11-2011

The Euro-zone debt crisis will continue to dominate in the short-term, especially as it is having an increasingly negative impact on the global banking sector and the international growth outlook. There will be further intense pressure for the German government to back down and accept either Eurobonds or a change in the ECB mandate while there will also be increased speculation over a Euro break-up with high volatility a key feature.

Key events for the forthcoming week

Dollar:

The latest US economic data has maintained a slightly stronger tone which has continued to ease recession fears, but doubts surrounding the sustainability of demand will continue. There will be further concerns surrounding the long-term fundamentals, especially after a failure of the congressional budget super-committee.  International considerations will remain extremely important in the short-term and there will be further defensive dollar demand as global risk appetite deteriorates. There will also be the potential for capital flows out of emerging markets as dollar funding conditions tighten and these flows will continue to provide important underlying US currency support.

The dollar moves were dominated by trends in international risk appetite during the week and there was firm underlying support for the US currency as risk appetite continued to deteriorate with the dollar at a 7-week peak against major currencies.

There was a further increase in dollar Libor rates with the benchmark 3-month rising for over 100 consecutive days to just above the 0.51% level.  There was evidence of further important stresses within the banking sector as liquidity continued to deteriorate with banks forced to respond to a withdrawal of funds by raising capital.  

Congressional sources confirmed the high probability that the Super Committee looking at long-term budget options would fail to reach agreement this week.  This initially undermined risk appetite, but there was some relief following an announcement from the major rating agencies that there would be no immediate impact on US credit ratings.

The US third-quarter GDP revision was weaker than expected with a decline to 2.0% from the 2.5% original estimate and this had a further negative impact on risk appetite as confidence in the global economy deteriorated again.  The US jobless claims data was close to expectations with a figure of 393,000 in the latest week from 388,000.

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The Euro-zone situation will remain extremely serious with a flow of funds out of peripheral economies and there will also be a growing risk of net capital flows out of the area. Even if the ECB maintains its opposition to increased peripheral bond buying and quantitative easing, there will be strong pressure for a further cut in interest rates.  There will be near-term capital repatriation by the banking sector to strengthen balance sheets which will provide some degree of Euro support, although this could prove to be increasingly fragile. There will be further speculation over a Euro break-up if Germany maintains a hard-line stance which could ironically underpin the Euro on hopes of a hard currency.

The Euro was able to resist heavy selling pressure, but there were net losses for the week and a sense that the Euro-zone crisis had reached an even more dangerous stage which increasingly undermined confidence in Euro assets.
 
There were media reports that a plan to increase ECB lending to the IMF which would then allow the IMF to buy peripheral bonds was gaining traction.  This speculation, in turn, increased optimism that there would be relief for peripheral but the mood of hope faded very quickly as fears over a Euro-area breakup continued to increase.

There was a much weaker than expected German bond auction with the Bundesbank forced to bid for its own paper as investor demand was extremely weak. The failed auction increased market fears that the contagion effect was spreading to Germany as underlying confidence continued to deteriorate.  There was a strong market reaction to the auction as investors feared a wider exit from Euro-zone bonds.

There was also a warning from the Greek central bank that Greece was facing its last chance for staying in the Euro-zone and that there was a growing threat that social cohesion would breakdown.  There was a report from ratings Agency Fitch that France’s credit rating could be under threat if there were further shocks to the economy. There was a sharp decline in Euro-zone industrial orders and the PMI flash manufacturing index weakened to a two-year low.

Equity markets were unable to gain support as underlying confidence continued to deteriorate with peripheral bond yields rising again and there was also a further sharp rise in Belgian yields as Dexia was forced to tap emergency funding. There was a further increase in fear surrounding the banking sector as a whole amid speculation over a further tightening in liquidity as banks remained shut-out of wholesale markets.

Portugal’s credit rating was cut again by Fitch while the Troika would return to Greece on December 12th for negotiations surrounding the next loan tranche and second rescue package. Peripheral bond yields continued to rise during the week.

The main focus was on the issue of Eurobonds at a meeting between German Chancellor Merkel, French President Sarkozy and Italian Prime Minister Monti. Merkel again voiced strong opposition stating that they would give the wrong signal to the markets.  The hard-line rhetoric increased fears surrounding the Euro-zone which intensified the deterioration in international risk appetite.

Yen:

Safe-haven considerations will remain extremely important in the short-term and there will be underlying defensive support for the Japanese currency, especially with a lack of viable alternatives as a safe-haven currency given the Swiss determination to block currency gains. There will be increased pressure for action to weaken the yen, especially if there is a downturn in the regional economy which would undermine exports. There will be the threat of further intervention, although it will be difficult for the Bank of Japan to reverse trends while risk aversion and growth fears remain elevated.

The dollar found support below the 77 level against the yen on Thursday and pushed to highs in the 77.50 area where the currency again hit tough resistance. The Euro found some support below 103, but still recorded significant losses for the week as a whole. The yen gained important support from a deterioration in risk appetite.

Japanese Finance Minister Azumi warned that there would be a decisive response to speculative currency moves which had some impact in curbing yen support.

There was also still evidence of capital inflows into the Japanese currency with a net buying of Japanese bonds rising to US$220bn this year. There will be the risk of further capital repatriation flows from the Euro-zone which will also support the yen.

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Confidence in the UK economic outlook is liable to deteriorate further in the short-term with fears over the impact of a downturn in the Euro-zone and the threat of a renewed contraction in bank lending. There will be expectations of further Bank of England quantitative easing, although the bank has suggested that it will wait until the current programme is completed before any further action. There will be defensive capital inflows, although it may become increasingly difficult to sustain inflows at current yields. The UK currency will also tend to weaken when risk appetite deteriorates.

Sterling weakened against the dollar and also found it difficult to make any headway against the Euro during the week even though there were defensive capital inflows as a refuge from the Euro-zone. Sterling was also unsettled by a further deterioration in risk appetite and dipped to lows near 1.5450 against the dollar.
 
The Bank of England minutes from November recorded 9-0 votes for both the interest rate decision and the amount of bond purchases. There was certainly a downbeat assessment of UK growth prospects with weak lending causing concerns.  The minutes also stated that there was little merit in fine tuning the amount of quantitative easing, especially as it would take three months to complete the existing purchases.

The comments suggested that there would be no further action until at least February which provided some degree of relief to the UK currency.  There were also reports that Japanese funds were switching into UK gilts from Euro-zone bonds which underpinned the currency as a European safe-haven.

The revised third-quarter GDP growth estimate was steady at 0.5%, but the figure relied more on a build-up of inventories which increased fears that there would be weaker data for the fourth quarter. The latest CBI industrial survey was also weak with a figure of -19 from -18 previously as export orders declined sharply.

Swiss franc:

The National Bank will remain determined to protect the minimum Euro level against the franc with further strong verbal intervention and the potential for franc selling in the forward market. There will be the risk of a renewed surge of capital into Swiss institutions if Euro-zone fears intensify which could trigger fresh instability surrounding the franc over the next few weeks even though the National Bank will be determined to prevent renewed appreciation. High volatility is likely to remain a key feature.

There was further choppy franc trading, amplified later in the week by a lack of liquidity. There was strong support on dips to the 0.9150 area and the US currency pushed to highs near 0.9230. The Euro was unable to gain any traction against the Euro and again dipped to lows near 1.2250 despite the intervention threat.

There was some initial speculation that the National Bank was checking rates which pushed the franc weaker, but there was a quick reversal as underlying risk appetite deteriorated and there were further fears over bond outflows from the Euro-zone.

There were increased fears surrounding the Euro-zone banking sector which could lead to inflows into the Swiss banking sector, although there will also be unease surrounding the domestic banks and the potential for high franc volatility.

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The Australian dollar remained under pressure for the week as a whole and retreated to 7-week lows below 0.97 against the US dollar. Global risk conditions continued to dominate and the currency was extremely vulnerable when confidence deteriorated.

In particular, there were fears surrounding the global banking sector which also undermined confidence in regional growth prospects. Domestic influences were again limited with a stronger than expected reading for construction output.

There will  the threat of further net losses for the Australian dollar if there is no improvement in risk appetite, especially if regional banking-sector fears increase.

Canadian dollar:

The Canadian dollar was unable to gain any significant traction during the week and was subjected to significant selling pressure at times with a slide to test support in the 1.05 area. The domestic data was solid with a stronger than expected retail sales report, but global issues dominated

The currency was undermined by a fresh deterioration in risk appetite and fears surrounding the global banking sector which damaged equity markets and also increased unease surrounding the global economic outlook which put downward pressure on commodity prices, although oil prices were broadly resilient.

The Canadian dollar will be vulnerable to further selling pressure given the global risk conditions, especially as industrial commodity prices will be at risk of further losses.

Indian rupee:

The rupee remained under pressure and dipped to record lows near 52.50 against the US currency before finding some respite.  Global risk conditions remained negative for the currency and this was a major factor in pushing the currency weaker, especially with a lack of inflows into the local stock market.

The Reserve Bank still appeared to be very cautious over intervening to support the rupee, but it did announce a series of measures designed to improve dollar liquidity which had some positive impact and stock-market confidence was lifted slightly by a lower reading for wholesale inflation.

The rupee trends will continue to be influenced strongly by trends in risk appetite and there is unlikely to be a significant recovery without an improvement in conditions.

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The Hong Kong dollar maintained a weaker tone and retreated to lows beyond the 7.795 level against the US currency. Risk appetite deteriorated again which undermined the currency with concerns surrounding the regional economy having a particularly negative impact on sentiment. There was also increased evidence of capital repatriation flows away from Hong Kong which undermined sentiment.

The impact was still offset to some extent by tightness in the local money market, but international risk conditions were dominant over the week as a whole.

Risk conditions will continue to sap Hong Kong dollar support in the short-term, especially if there is evidence of a more severe downturn in China’s economy.

Chinese yuan:

The yuan was unable to make much headway, although the central bank did keep the reference rate close to the 6.35 level against the US currency.  There were increased concerns surrounding the Chinese economy following a decline in the HSBC PMI index to the 48 level. Although the PBOC relaxed reserve requirements for some regional banks, it resisted wider moves to ease credit conditions.

There was also increased international speculation that upward pressure on the yuan was easing, especially as there were reported net monthly capital outflows from the banking sector for the first time since 2007.

Speculation surrounding a weaker economy and the possibility of further capital repatriation out of China will limit the scope for any yuan appreciation.