Weekly Forex Currency Review 27-01-2012

The Federal Reserve commitment to maintaining ultra-low interest rates will help underpin risk appetite in the short- term and will also curb any dollar demand. There are still substantial risks associated with the European banking sector as sovereign-debt fears persist and fear will intensify again if Greece formally defaults and, especially if fears intensify surrounding Portugal. The Chinese economic outlook will also be an important focus at the start of the new year.

Key events for the forthcoming week

Dollar:

There will be expectations of solid US growth which will provide some support to capital inflows. The Federal Reserve policies will also be a very important influence and the expected commitment to lower interest rates for an even longer period, coupled with the possibility of further quantitative easing, will undermine yield support and lessen dollar support. International considerations will still play an extremely important role and the US currency will lose defensive support when markets take a more optimistic stance.  The overall pressure for financial de-leveraging will, however, continue in Europe and this will both undermine global growth and trigger underlying dollar demand.

The dollar dipped sharply following the Federal Reserve meeting with five-week lows on a trade-weighted basis, but did find some support at lower levels.

There were no Federal Reserve policy decision surprises with interest rates left on hold.  The statement was, however, significantly more dovish than expected as the majority of participants were expecting Fed Funds to remain at the current extremely low levels until late in 2014 compared with previous expectations of 2013 previously. In his press conference, Fed Chairman Bernanke was also dovish in his outlook despite being slightly more optimistic surrounding near-term economic prospects.  Bernanke stated that further quantitative easing could be considered and, although the Fed adopted an inflation target of 2.0% for the first time, he stated that further easing could be considered even if inflation was above 2.0%.

The dovish statement was important in underpinning risk appetite and was also important in undermining the dollar as it dipped sharply to lows beyond 1.31 against the Euro.  There will be the risk of fresh trade tensions and friction with Europe given the perception that the US will resist forcefully any strengthening of the US currency.

The US jobless claims data recorded an increase to 377,000 in the latest week from 356,000 previously while durable goods orders rose 3.0% in the latest month. The data impact was inevitably limited at this stage as markets continued to consider the Federal Reserve statement and prospect for a continuation of near-zero interest rates. The US currency was still unsettled by the possibility of further quantitative easing as defensive dollar demand remained lower.

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There will be further relief that the aggressive ECB liquidity operations have managed to stabilise conditions to some extent and ease the immediate threat of a destabilising credit crunch.  The underlying situation is still precarious given exposure to sovereign debt.  There will be further fears surrounding the threat of a Greek default and the rise in Portuguese yields will spark additional fears that Portugal will also move closer to default which would destabilise the Euro area. Whatever the outcome, the ECB will also have to maintain a very aggressive monetary policy to help support the economy and offset the deflation threat which will make it very difficult for the Euro to gain ground.

The Euro continued to recover ground, advancing to 2012 highs against the dollar, but was unable to hold its best levels, especially against the yen.
 
The Euro secured initial support from the latest flash PMI data which recorded an increase in the manufacturing component to 48.7 from 46.9 previously while the services-sector index moved above the 50 level for the first time since the August 2011 release. The data maintained the run of more favourable data seen over the past few weeks and helped ease immediate fears surrounding the Euro-zone outlook, although the Euro area was still dependent on the core economies.

There was further debate surrounding the Greek private-sector debt deal with a suggestion that a new arrangement could be in place by the middle of February. Nevertheless, there was further unease surrounding the situation as default fears intensified with Standard & Poor’s indicating that any agreement was likely to be considered a default.

In the event, there was still a high degree of uncertainty surrounding Greece and no deal was forthcoming with discussions set to continue on Friday.  There were also further concerns surrounding the Portuguese situation as benchmark yields continued to rise to record levels with 10-year yields close to the 15% level.  There were further rumours of pressure on the ECB to take losses on its substantial holdings of Greek bonds which unsettled sentiment in an environment of uncertainty.

There was also further pressure for the ECB to take a more aggressive stance towards interest rates which curbed Euro support.

Yen:

There will be further concerns surrounding the industrial and trade outlook, especially with Japan registering an annual trade deficit for the first time in 16 years.  There will be pressure for the Bank of Japan to boost competitiveness through a weaker currency and there will also be fears surrounding the huge debt burden.  Global risk appetite will be important and the yen will still gain defensive support when fears over the outlook increase. The currency will also gain support from capital repatriation flows out of European bonds.

The dollar initially moved above resistance in the 77 area against the yen on Tuesday and there was a fresh surge in dollar buying which pushed the dollar to near the 78 level for the first time in a month. The dollar was unable to sustain the gains and weakened back to test support below 77.

There no significant policy changes by the Bank of Japan at its latest monetary meeting with interest rates held in a 0.00-0.10% range and no changes to quantitative easing while the growth forecasts for the year ahead were downgraded.

There was speculation that Japan would run a trade deficit for 2011 and this was confirmed in the latest data release on Wednesday with the first annual deficit for 16 years as exports declined by 8% over the year. This undermined yen sentiment on fears over a structural deterioration.

The US data releases later in the week failed to provide any sustained support for the US currency as the potentially positive impact of a firm durable goods release was offset by the pledge of ultra-low Federal Reserve interest rates.

There was a stronger than expected Japanese retail sales release with a 2.5% annual increase in the year to December while the inflation data was broadly in line with expectations with a 0.1% annual decline and no significant policy implications.

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Confidence in the UK economy will remain weak following the reported GDP contraction for the fourth quarter. There will be further fears surrounding the outlook for retail sales and the economy will also come under further pressure if the Euro-zone outlook continues to deteriorate. The Bank of England is slightly less pessimistic over the economic outlook, but there is still the potential for additional quantitative easing. The outlook for capital flows will remain mixed as there will be the potential for defensive capital inflows, but these flows could reverse rapidly at current yields. Sterling volatility is liable to increase again.

Sterling generally pushed higher against the dollar with a peak near 1.57 even though gains were generally slow while the UK currency dipped weaker against the Euro as international moves dominated for much of the time.

The headline public-sector borrowing requirement was better than expected with a figure of GBP10.8bn for December from a revised GBP15.1bn previously.  The market focus tended to be on the level of debt which rose above the GBP1trn level for the first time, but the negative Sterling impact was limited.

Bank of England Governor King remained cautious over the economic outlook with a warning that bank lending would remain weak. He also stated that lower inflation would give the bank scope to provide additional quantitative easing if necessary. King, however, was notably less fearful in his general comments on the economy compared with his tone late in 2011 which helped support Sterling.

The headline figure was slightly weaker than expected with a 0.2% fourth-quarter contraction and there will be concerns over the lack of growth in the private sector.  The data will reinforce near-term fears surrounding the economy and the underlying debt trajectory. The Bank of England MPC minutes from January’s meeting recorded a 9-0 vote for keeping interest rates and quantitative easing on hold.  

The minutes did, however, reveal greater divergence in opinion surrounding the outlook for growth and inflation. There was still a lack of confidence in the economic outlook, but several members were more doubtful whether there would be a sustained decline in inflation. In this environment, it will be more difficult to secure unanimous support for any further boost to quantitative easing at February’s meeting.

The latest CBI retail sales survey was substantially weaker than expected with a decline to a three-year low of -22  from +9 the previous month and the data reinforced a lack of confidence in the spending outlook.
 
Swiss franc:

National Bank policies will remain extremely important in the short-term given the on-going debate surrounding the minimum Euro level. There is still the risk that markets will attack the Euro, although there will also inevitably be reluctance to challenge the central bank given the potential for aggressive and unlimited bank intervention. On domestic grounds, there will also still be domestic pressure for the bank to raise the minimum level. There will also be the potential for increased capital flows out of Switzerland on valuation grounds which will tend to undermine the franc.

The dollar remained under pressure against the franc during the week and was subjected to further losses on technical ground once support in the 0.93 area was broken and the currency dipped to 2012 lows near 0.9150 before a corrective recovery. The Euro was unable to gain any sustained traction above the 1.21 area.
This Euro under-performance against the Swiss currency will be a cause of concern for the National Bank and there will be the potential for further verbal intervention.  

In comments on Tuesday, National Bank member Danthine reiterated that the bank would defend the minimum Euro level with the utmost determination and would block franc gains with unlimited buying of overseas currencies if required.

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The Australian dollar maintained a strong tone during the first half of the week and advanced to 2012 highs against the US currency with a peak in the 1.07 area. There was a general improvement in risk appetite which helped underpin the currency and the Australian currency gained support on yield grounds, especially after the more dovish Federal Reserve stance.

Fears over the Asian economy eased which helped underpin the Australian currency, although there were still doubts surrounding the Chinese outlook which will be tested once China returns from the week-long holiday break.

The Australian dollar will continue to be subjected to high volatility and it will be difficult to advance much further even with solid yield support.

Canadian dollar:

The Canadian dollar gained support from international considerations during the week and pushed to a peak just beyond parity against the US currency before correcting slightly. Risk appetite was generally firmer and commodity prices were generally resilient. The domestic influences were limited with the retail sales data broadly in line with expectations.  

The Canadian currency should prove to be broadly resilient, although it will be difficult to extend gains much beyond parity as longer-term selling will increase.

Indian rupee:

The rupee maintained a solid tone during the week and again challenged resistance levels just beyond the 50 level against the US dollar before correcting slightly weaker. There was firm dollar demand by oil importers which stemmed rupee gains.

Risk appetite was generally firmer which helped underpin confidence and there was also suspected intervention by the Reserve Bank which helped underpin the currency. Interest rates were left on hold, but there was a cut in reserve ratios.

Although resilient, it will be difficult for the rupee to extend gains given the underlying risk profile and uncertainties surrounding the Indian economy.

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The Hong Kong dollar maintained a firm tone during the week and advanced to a high just beyond the 7.76 level against the US currency as risk appetite maintained a firmer tone.  Local markets were closed for the first three days of the week which dampened activity and there were no influences from Chinese markets which were closed.  

Risk conditions will remain very important and any fresh doubts surrounding the Chinese outlook would limit the scope for Hong Kong dollar gains.

Chinese yuan:

Chinese markets were closed for the Lunar New-Year holiday

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