Weekly Forex Currency Review 27-04-2012

The Federal Reserve has maintained its commitment to low interest rates throughout the next 2 years at least which will provide underlying support to liquidity as well as curbing yield-related demand for the US currency. There will still be underlying fears surrounding the Euro-zone outlook with fears surrounding the Spanish and Italian outlooks. With underlying banking-sector de-leveraging and unease surrounding the Chinese economy, confidence surrounding risk appetite is likely to remain fragile.

Key events for the forthcoming week

Dollar: 

 The Federal Reserve stance will continue to limit the scope for near-term dollar support with expectations that interest rates will remain at very low levels throughout the next two years. There will also be expectations that the Fed will respond to any fresh downturn with fresh quantitative easing. There should still be expectations that the US economy will out-perform in the short-term, especially with persistent Euro-zone fears. Growth expectations should also provide some net support to capital inflows. The dollar will still find it difficult to gain strong support unless there is a serious deterioration in global risk appetite.

The dollar was unable to make any significant headway against major currencies during the week as the Federal Reserve maintained a dovish tone.

The latest US consumer confidence data was slightly weaker than expected with a small decline to 69.2 from a revised 69.5 the previous month. The latest US jobless claims data was again weaker than expected with initial claims at 388,000 in the latest week from 389,000 previously, maintaining the significant deterioration seen during April. In contrast, the pending home sales data was stronger than expected.

The latest durable goods orders data was sharply weaker than expected with a headline 4.2% decline for March as aircraft orders dropped heavily and there was 1.1% underlying decline which will create fresh doubts over investment trends.

The Federal Reserve left interest rates on hold at the latest policy meeting and also maintained its commitment to maintaining very low interest rates. There was a 9-1 vote for the statement with Lacker again dissenting as he opposed the pledge to keep rates at exceptionally low levels through the end of 2014.

The Fed upgraded its growth forecasts for 2012 and was more optimistic surrounding the labour market, but there was still a very notable underlying tone of caution with comments that global financial turmoil still posed important downside risks to the economic outlook. Fed Chairman Bernanke maintained a broadly unchanged stance in his press conference with a promise that the Fed would maintain a highly accommodative policy and would be prepared to take further action if required.

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Euro-zone structural fears will remain an important short-term focus as underlying tensions persist. There will be continuing fears that restrictive fiscal policies will intensify recession conditions in peripheral economies and exacerbate bad loans within the banking sector. There will be strong pressure for further ECB support and there will also be growing political pressure for a shift in underlying policies towards a more growth-orientated strategy. This would, however, risk major tensions with the Bundesbank. The Euro will still gain important support at times, especially with potential capital repatriation.

The Euro was again able to prove resilient during the week even with continuing fears surrounding the structural outlook and there was market frustration that the Euro had not weakened further which triggered a covering of short positions.

The Euro-zone PMI data was weaker than expected with sharply weaker readings for the French PMI services and German manufacturing data. Although the services data was stronger than expected, the net outcome was a decline for both readings with the manufacturing index at the lowest level since July 2009.

The data tended to contradict more optimistic German business surveys, unsettling markets, and there was further peripheral economic unease. As well as the PMI data, the Bank of Spain confirmed that there was a further GDP contraction for the first quarter, maintaining fears over the economic outlook and the banking sector. There were rumours of ECB price checking during the week.

Politically, markets were unsettled by the French election result as the strong polling outcome for the National Front reinforced market fears that support for current economic policies was continuing to weaken. The Dutch government also tendered its resignation after failing to agree budget cuts as the Freedom party withdrew its support, maintaining fears over regional instability. More positively, there was speculation of 2013 budget agreement later in the week

A series of relatively small-scale Euro-zone bond auctions provided some net Euro support in the middle of the week. There were solid bid/cover readings for the latest Spanish bill auction while there was a decline in Dutch yields which eased fears over the impact of political stresses. From a wider perspective, there was greater evidence and speculation that pressure for a change in austerity policies was intensifying.

The Euro was subjected to renewed selling pressure late in the US session as Standard & Poor’s cut Spain’s credit rating by a further two notches to BBB+ which also triggered some fresh unease over Friday’s Italian debt auctions.

Yen:  

The Bank of Japan will inevitably remain an important focus in the short-term with pressure for additional policy responses. There will be additional pressure for a competitive currency to help protect the industrial base, especially if there is any weakness in the Chinese yuan. There will still be defensive demand for the yen at times, especially if global growth fears intensify. From a longer-term perspective, there will be a lack of confidence in the economy and currency.

The dollar found solid buying support on dips, although it was unable to make significant progress as yield support remained weaker and was unable to make any attack on the 82 region as the yen was resilient on the crosses.

There were further uncertainties surrounding the Bank of Japan policies ahead if Friday’s policy meeting. The government pushed for further monetary easing, but there were also reports from sources that the central bank would resist major new measures. Underlying risk appetite held firm as equities rallied and this dampened immediate yen demand.

The Bank of Japan announced a further expansion of JPY10trn in the asset-purchase programme to JPY40trn. There was also a JPY5trn cut in a domestic credit-purchase fund which caused some initial confusion on the headline announcement and triggered high yen volatility. The dollar pushed to highs around 81.40, but it was unable to sustain the gains and retreated back to below 81. The Japanese data was mixed with a stronger than expected increase in retail sales while the industrial production rebound was held to 1.0% for April.

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There will be further uncertainty surrounding the economy in the short-term. The business surveys have been generally optimistic, but there was a sharp contrast with the second-quarter GDP data which officially put the economy back in recession. There will be some renewed speculation that the Bank of England will sanction further quantitative easing in May There will also be serious reservations over medium-term structural vulnerability, especially if there banking-sector fears. There will still be significant defensive demand for the UK currency as Euro-zone fears continue.

Sterling maintained resilient tone during the week and pushed to seven-month highs against the dollar while the trade-weighted index was at the highest level since the third quarter of 2009 with further evidence of defensive inflows into the UK currency.

The ONS reported that the economy contracted by 0.2% in the first quarter of 2012 following a 0.3% decline the previous quarter. Officially, this put the economy in recession for the second time in three years as a small gain in the services sector was not enough to offset weak manufacturing and a sharp decline in construction output.

There was an important element of suspicion surrounding the data with expectations that it would be revised higher. Nevertheless, there was some speculation that the Bank of England would have to consider additional quantitative easing at the May meeting. The data was also politically damaging for the government.

The latest BBA mortgage approvals data recorded a decline to 10-month lows which reinforced concerns surrounding the housing sector. The latest CBI retail sales survey weakened to -6 for April from zero the previous month, but companies were notably more optimistic surrounding the May outlook which provided some relief.

MPC member Weale stated that the case for quantitative easing had been increased by the GDP data, although uncertainty remained very high.

Swiss franc:

There is still the potential for further defensive flows into the Swiss currency in the short-term, especially with increased Euro-zone structural fears. The National Bank may continue to be tested severely in the short-term as markets again attempt to take out the 1.20 minimum Euro level. The central bank is likely to hold firm in the short-term. A lack of attractive alternatives should still provide significant net support for the Swiss currency.

The dollar was unable to make significant headway against the franc and dipped sharply to a test support just below the 0.91 level before stabilisation. The Euro was again unable to make any headway and dipped back towards the 1.2010 level as Euro-zone political tensions and pressure for economic policy shifts remained a key focus.

Markets remained on edge over National Bank intervention and there was further speculation that the bank’s resolve could be tested, especially with franc liquidity low when European markets were closed. The Economics Ministry warned that the franc was likely to stay strong in the short-term.

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The Australian dollar was confined to narrower ranges during the week with solid buying support on dips. There was a weaker reading for producer prices and a much weaker than expected reading for consumer prices of 0.1% for the second quarter which reinforced expectations that the Reserve Bank would cut interest rates in May.

Global risk appetite was generally resilient during the week which helped underpin confidence in the local currency before a cautious tone on Friday following the Spanish credit-rating downgrade.

Expectations over further domestic interest rate cuts and unease over the Asian economic outlook are likely to keep the Australian dollar generally on the defensive.

Canadian dollar:

The Canadian dollar maintained a firm tone against the US currency and pushed to highs near the 0.98 level which was the highest level since September 2011.

There were further expectations that the Bank of Canada could move to a tightening of monetary policy within the next few months which provided underlying support.

There was also evidence of capital inflows as a defensive play as an alternative to the major currencies, especially with a lack of underlying Euro confidence.

Although the Canadian dollar should be broadly resilient and gain support as a defensive option, global growth doubts will tend to limit the scope for gains.

Indian rupee:

The rupee remained under pressure during the week and retreated to a three-month low towards 53 against the US currency. There was strong US demand from importers and oil refiners which contributed to the negative rupee tone.

The announcement by Standard & Poor’s that the credit rating had been put on negative watch galvanised fears surrounding the budget and trade outlooks which maintained underlying fears surrounding the outlook. Risk appetite held relatively steady which helped curb selling pressure to some extent.

With further uncertainties likely surrounding the domestic and regional economic outlook, the rupee is likely to remain generally on the defensive.

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The Hong Kong dollar maintained a firm tone during the week, although the most notable feature was a narrowing of ranges. The Hong Kong currency found support slightly weaker than the 7.76 level with a peak in the 7.7580 region.

The Federal Reserve commitment to keeping interest rates at extremely low levels helped curb any selling pressure on the Hong Kong currency.

Uncertainty surrounding the Chinese outlook will curb speculation over a long-term policy shift. Low US rates will provide underlying Hong Kong dollar support.

Chinese yuan:

The PBOC maintained its policy of setting strong yuan mid points and set a record high for the currency at on two successive days. The central rate was set just beyond 6.28 on Friday with speculation that the bank was looking for a strong rate ahead of key talks with US officials.

Significantly, there was further divergence between official rate and spot rate with the yuan still weaker than the 6.30 level.

There were further concerns surrounding the Chinese economic outlook, especially with further uncertainties surrounding the property sector. The latest data also recorded a lower current account surplus for the first quarter.

The PBOC appears committed to maintaining a series of strong fixes. A weaker capital account and economic doubts are likely to keep the yuan on the defensive.

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