Weekly Forex Currency Review 29-06-2012

The Euro-zone stresses and structural vulnerabilities will continue to be an extremely important focus.  As has been the pattern over the past two years, there will be important near-term relief surrounding a the Summit Deal. It will still be extremely difficult to resolve the underlying growth and structural contradictions and alleviate recession conditions within countries such as Spain and Italy. In this environment, fear could return to dominance relatively quickly, especially with increasing concerns surrounding the global economy.

Key events for the forthcoming week

Dollar:

The US economic releases have had a mixed tone over the past week with a weaker than expected reading for consumer confidence offset by more robust readings for the housing sector.  There will still be expectations that the US economy will out-perform in the short-term, especially with increased doubts surrounding the global outlook.  The Federal Reserve will remain on alert against the threat of a further deterioration in the economy and could still be poised to expand quantitative easing again.  Defensive considerations will remain important with the potential for renewed support and there is also potential US currency demand on reserve diversification grounds.

The dollar pushed higher in the middle of the week as fears surrounding the Euro increased again before retreating again following a EU Summit deal with the Euro rallying back to the 1.26 region against the US currency.
 
The latest US consumer confidence index was weaker than expected with a decline to 7-month lows of 62.0 from 64.4 previously and the latest Richmond Fed index was also lower than expected, but the housing data remained more positive with the Case-Shiller index continuing to register monthly improvements which maintained optimism surrounding US out-performance, at least on a near-term view.

The headline durable goods increase was marginally firmer than expected at 1.1% while there was a core increase of 0.4%. There will be some relief following a series of weaker than expected reports, but little optimism surrounding strong gains in investment. The pending home sales data was stronger than expected with a 5.9% monthly increase, maintaining a greater degree of optimism surrounding the housing sector.  Initial jobless claims falling to 386,000 in the latest week from a revised 392,000 the previous week. There were no major comments surrounding monetary policy from key Federal Reserve officials.

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The EU Summit deal will help stabilise immediate sentiment surrounding the Euro-zone and lessen the sense of panic. There will be relief surrounding the Spanish and Italian capital markets, but there will still be important vulnerabilities surrounding the underlying economic outlook, especially as economic policies overall are still unsustainable. There will also still be an increasing potential for a more aggressive ECB stance on monetary policy as the Euro-zone has little chance of medium-term escape unless growth conditions improve. In this environment, the Euro is likely to remain generally vulnerable despite sharp rallies at times.  

The Euro remained under pressure ahead of the EU Summit amid expectations that leaders would be unable to secure a longer-term deal.

Spain formally applied for a banking-sector bailout up to EUR100bn and Cyprus also submitted an application for support funds to underpin the banking sector as its credit rating was downgraded. There was a sharp rise in interest rates at the latest Spanish bill auction while bid/cover ratios were also lower which increased concerns that Spain will find it increasingly difficult to secure market funding. Underlying sentiment remained extremely weak amid fears that sovereign and banking-sector debt were becoming increasingly dependent and vulnerable on each other.

There was a weaker than expected German employment report which had some negative impact on confidence while the latest business confidence index also weakened further.  There was further speculation that the ECB would cut interest rates at July’s meeting given the severe economic outlook.

The Euro was subjected to sharp selling pressure in European trading on Thursday as German Chancellor Merkel continued to indicate that there would be a hard-line and no concessions on Eurobonds at the EU Summit. Ahead of the New York open, the Euro rallied briefly on media reports that the German Finance Ministry was prepared to negotiate on Eurobonds and there was also speculation that EFSF funds could be used to buy peripheral bonds before slipping again after Ministry denials.

Summit tensions remained extremely high with Spain and Italy effectively blocking agreement on a EUR120bn growth package unless there was a deal to bring down their borrowing costs. After intense negotiation, leaders agreed that ESM funds would be able to be used to help stabilise bond markets. There would be no increase in the sovereign debt levels and the ESM funds would not have seniority over sovereign bonds while there would be no need for troika supervision. There would be new ECB powers to oversee the banking sector, due to be in place by the end of 2012.

There was immediate relief that some form of deal had been agreed and the Euro spiked higher to a peak above the 1.26 level. The peripheral bond markets will be watched very closely on Friday and the German reaction will also be watched very closely with the ESM due to be agreed in parliament. There will also be frustration within other peripheral countries such as Ireland.  
 
Yen: 

There will be further pressure to maintain regional competitiveness which will reinforce pressure for yen gains to be resisted, especially if there are significant Chinese yuan losses.  There will continue to be an important lack of confidence in longer-term Japanese fundamentals which should limit the potential yen buying. There will also be further speculation over intervention to curb any gains.  Defensive considerations will remain very important and there will be still be safe-haven yen demand when global risk appetite deteriorates despite the serious Japanese fundamental concerns.   

After rally attempts, there were expectations of substantial dollar sell orders on any approach to the 80 level and the US currency drifted weaker as it was unable to make a serious test of resistance.  The latest economic data was mixed with a sharper than expected decline of 3.1% for industrial production while the PMI index dipped to below the 50 level. The labour-market and household spending data, however, was stronger than expected.

The government secured passage for the bill to double the sales tax rate to 10% over the next three years, but there were further concerns that internal dissent would force the calling of an early general election.

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There will be further concerns surrounding the UK growth prospects, especially with weakness in the global economy limiting the potential for export growth.  There will be further expectation over additional Bank of England quantitative easing, especially after officials remained generally downbeat in parliamentary testimony. Safe-haven considerations will remain important and there will be scope for renewed inflows into Sterling if Euro-zone fears intensify again . It will, however, be difficult to secure strong support, especially with concerns surrounding the UK banking sector.

Sterling dipped to lows below 1.55 against the US dollar before finding renewed buying support as wider Euro-zone developments tended to dominate markets with the Euro regaining ground.  

Bank of England members were generally pessimistic on the economic outlook in parliamentary testimony on the latest inflation report.  Governor King stated that he was now much more concerned over the situation with unease surrounding the US economy and increased fears surrounding the Euro-zone situation which will inevitably damage the UK outlook. The MPC members doubted whether a cut in interest rates would be effective, although the measure had not been ruled out.

The government borrowing requirement increased to GBP15.6bn for May from a surplus the previous month and the more telling comparison was a wider deficit compared with last year.  The latest BBA data recorded a weaker than expected increase in mortgage approvals and there was a decline in net lending for the first time since 1997. In contrast, there was a much stronger than expected reading for the latest CBI retail sales survey with a reading of 42 for June from 21 in May.  

The first-quarter GDP estimate remained at -0.3% according to the final estimate, but there were downward revisions to the previous data which undermined confidence in the underlying outlook. The latest Bank of England consumer credit survey suggested both a tightening in conditions for the second quarter and a likely further tightening in the current period, maintaining concerns surrounding consumer spending.

Swiss franc:

With confidence in the Euro-zone outlook remaining extremely weak, defensive flows into the Swiss currency could still intensify despite immediate Summit relief. The 1.20 minimum Euro level is liable to come under severe pressure, especially if there are increased fears surrounding Spain and Italy. The central bank will continue to intervene aggressively to curb franc gains in the short-term and will have to consider additional policy measures such as capital controls or negative interest rates if stresses intensify.

The dollar maintained a firm tone in Europe on Thursday and pushed above the 0.9650 resistance area as European currencies were subjected to wider selling pressure. The franc rallied sharply to a high near 0.95 following the EU Summit deal while the Euro made a marginal net advance.

The National Bank will hope that the EU deal will help stem capital flows into the franc which would also ease pressure on the minimum level.  Investor sentiment remains generally risk averse within Switzerland and this will continue to dampen any capital outflows from the Swiss currency.

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The Australian dollar found support on dips to below parity against the US currency during the week. Initial rallies were limited and stalled just above the 1.01 area before a stronger advance in Asia on Friday.

Underlying risk appetite was fragile which had a dampening impact on the Australian currency, especially as commodity prices were also weak. The impact was offset to some extent by speculation that there would be underlying reserve diversification in to the Australian dollar given its AAA rating.  There were no major domestic economic releases with markets waiting for the July Reserve Bank meeting.  

The Australian dollar will continue to rally at times, but it will remain difficult to sustain an advance given unease surrounding the growth outlook.

Canadian dollar:

The Canadian dollar initially found support in the 1.03 area against the US dollar, but rallies were limited and the currency dipped sharply to lows beyond 1.03 later in the week before recovering ground increasingly rapidly following the EU deal.

The currency was undermined by global growth concerns which triggered downward pressure on commodity prices and crude oil future also re-tested 2012 lows.  There were no major domestic economic developments during the week.

Concerns surrounding the global economy and commodity-price trends will tend to limit scope for Canadian dollar gains even if there is a further near-term relief rally.

Indian rupee:

The rupee found support at record lows beyond 57 against the dollar and recovered firmly at times, even though underlying sentiment was still fragile. There was initial disappointment over the government’s reform efforts as measures were limited to a raising of the overseas bond buying limit. There was a renewed tone of optimism later in the week with greater reform commitments from new Finance Minister Singh.

The rupee was still stifled by underlying fears surrounding the economic outlook, especially with persistent doubts surrounding the growth performance.  

Doubts surrounding the domestic and regional economy will continue to unsettle the currency and limit the scope for rupee gains even if the near-term tone is stronger.

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The Hong Kong dollar maintained a generally firm tone, although the main feature was very narrow trading ranges as it traded stronger than 7.76 against the US dollar.  Underlying risk appetite was fragile, but there was further longer-term speculation that there could be a break of the currency peg which provided underlying support

Even with speculation over a medium-term policy shift, uncertainty surrounding the Chinese outlook will tend to limit scope for Hong Kong dollar gains.  

Chinese yuan:

The yuan was unable to make much headway during the weak with the spot rate consolidating around 6.36 against the US currency as the PBOC kept a tight rein on the fix, just weaker than the 6.32 level. There was evidence of increased corporate yuan demand ahead of the half-year closing, but there was also underlying evidence of a weaker balance of payments position which undermined confidence.

There was speculation over additional cuts in reserve requirements over the next few weeks. Structurally, the government announced that yuan convertibility would be trialled in Shenzhen as part of a long-term strategy to open-up the capital account.  

The yuan is likely to be subjected to underlying selling pressure given the deteriorating economic fundamentals, although near-term losses should be limited.

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