Weekly Forex Currency Review 02-08-2013

The Federal Reserve meeting increased doubts whether there would be bond tapering in September. The impact has, however, been offset by stronger than expected data releases and a robust employment report would boost the dollar on yield grounds. Underlying Euro-zone vulnerability and Asian growth concerns would also provide important background US currency support.

Key events for the forthcoming week

Market analysis

Dollar:

The latest Federal Reserve meeting made no references to a reduction in bond purchases which will create additional uncertainty and doubts whether there will be a September tapering. The overall data releases have been generally firm and a strong payroll report would be important in boosting expectations of both reduced quantitative easing and a firmer dollar in the medium term. The underlying US fundamentals should also remain dollar supportive, especially given important reservations surrounding emerging markets. Overall, there should be a robust dollar tone over the next few weeks.

The dollar weakened following the Federal Reserve meeting, but did find support at lower levels and regained ground on a series of firm data releases as the dollar index rebounded firmly from five-week lows with sharp gains against the yen.
 
The latest US consumer confidence data was slightly weaker than expected with a decline to 80.3 for July from 82.1 previously, although it was still close to a six-year high and there was an increase in the current conditions. The latest case-Shiller house-price index also recorded a 12.2% annual increase. There was a 200,000 increase in ADP employment for July and the June figure was also revised up to show a gain of 198,000. There was also a stronger than expected second-quarter GDP reading of 1.7% compared with an expected 1.1%. There was a downward revision to the first quarter, but 2012 estimates were revised higher.

In its latest statement, the Federal Reserve was slightly more optimistic surrounding economic prospects, expecting that conditions would improve over the next few months. Labour-market conditions had shown further improvement in recent months, although the unemployment rate remained elevated. There was a reference to the dangers of inflation being too low. Kansas City President George again dissented due to longer-term inflation risks while Bullard voted with the majority this time.

Surprisingly, there were no specific references to plans for bond tapering and no mention of any timetable for an ending of bond purchases. This absence and a slightly dovish tone increased market doubts that the Fed would move to cut the rate of purchases at the September meeting which undermined the dollar and the Euro pushed to highs above 1.3340

The jobless claims data was better than expected with a decline to 329,000 in the latest week from a revised 345,000 previously and this was the lowest reading for over five years. The ISM non-manufacturing release was also robust with a rise to 55.4 for July which was the highest reading since March 2011. There was a strong increase in orders and the employment component was also firm which increased optimism surrounding Friday’s crucial payroll report.

From a longer-term perspective, there was further debate surrounding potential successors to Fed Chairman Bernanke who is not expected to seek a third term. Former White House economic advisor. There have been further reports suggesting that the Administration is looking to block current Vice-Chairman Yellen and further alternative candidates are likely to be floated.    

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There will further short term confidence surrounding the Euro-zone growth prospects following firmer PMI releases. The underlying situation is extremely fragile and there will be particular concerns surrounding the peripheral economies with a notable focus on Italy, especially given the continued contraction in domestic demand. The ECB will also have to maintain an extremely loose monetary policy with strong pressure for additional measures if there is evidence of a renewed downturn.  Overall, the Euro should be close to a medium-term peak on fundamental grounds.  
The Euro was unable to hold its best levels against the dollar, retreating from five-week highs above 1.33, but secure gains on the main crosses during the week.
 
Spanish second-quarter GDP was in line with market expectations at -0.1% and the impact was limited as the Bank of Spain had already released its GDP estimate. Similarly, a more optimistic tone from Prime Minister Rajoy was treated with caution. There was an increase in German consumer confidence to a six-year high and inflation was higher than expected with a 1.9% annual increase in prices.

As expected, the ECB made no changes to interest rates at the latest council meeting with the repo rate left at 0.50%, maintaining the focus on President Draghi’s press conference. The comments were broadly in line with last month’s meeting with confidence showing some recovery from very low levels. Economic risks, however, were still described as biased to the downside.

The bank remained committed to forward guidance without adopting any specific numerical thresholds. Draghi did comment that the rise in money-market rates was not justified and that monetary policy would remain very accommodative. The Euro briefly dipped to below the 1.32 level before regaining some support.

Yen:   

The Bank of Japan will maintain a very loose policy in the short term which will continue to limit any underlying yen support. Increased confidence in the Euro-zone outlook would increase the potential for capital outflows from Japan which would also be an important negative yen influence. The yen could still gain support if there is a sustained deterioration in global risk conditions. There will, however, also be pressure to maintain a competitive yen, especially if Asian growth profiles continue to weaken.

The dollar found support below 98 against the yen and pushed higher to the 99.50 area later in the week. The latest Japanese PMI index was weaker than expected with a retreat to 50.7 for July from 52.3. Although the unemployment data was stronger than expected with a drop to 3.9% from 4.1%, other data was less favourable with a 3.3% decline in industrial production and a weaker than expected household spending reading which will increase doubts over Bank of Japan policy effectiveness and maintain pressure for aggressive easing.

Risk appetite was solid which had a significant impact in curbing any defensive yen demand. There were still underlying concerns surrounding the Asian economic outlook which  will also maintain pressure for the yen to remain competitive.

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There will be greater economic confidence in UK growth prospects, especially if significant improvement in the manufacturing sector is matched by strength in the services sector.  Significantly, however, Sterling has failed to benefit from evidence of stronger growth over the past few weeks. There are expectations that the Bank of England will maintain a very expansionary monetary policy and will resist any increase in long-term yields. This will tend to undermine Sterling, especially if there is any Fed tapering of bond purchases and fundamental doubts will continue. Sterling overall is likely to be generally on the defensive.

Sterling remained firmly on the defensive against the Euro on Wednesday and weakened  to lows beyond 0.8750, the weakest level since the middle of February. There was further evidence of month-end Sterling selling which had a negative impact and evidence of fundamental vulnerability.

The latest UK data was again significantly stronger than expected with the PMI manufacturing index rising to a 28-month high of 54.6 from 52.9 previously. The construction and services-sector PMI readings will be watched very closely on Friday and Monday with any gains maintaining optimism surrounding the growth outlook.

The Bank of England left interest rates were left on hold at 0.50% and the amount of quantitative easing was also left on hold at £375bn. The MPC confirmed that it would publish guidelines on forward guidance alongside the latest inflation report due next Wednesday. The absence of any fresh measures initially helped underpin Sterling.

There were still expectations that the Bank of England would maintain a very expansionary monetary policy and the rise in US bond yields were important in stifling any underlying Sterling support. The currency also failed to gain any support from a NIESR upgrade to UK growth prospects and Sterling dipped to test support near 1.51 against the dollar while reversing gains against the Euro.

Swiss franc:

Defensive trends will remain important over the next few weeks. Any sustained improvement in risk appetite would tend to lessen demand for the Swiss currency.  There are, however, few attractive alternatives as a potential safe haven and global financial stresses would be likely to trigger renewed franc buying. The National Bank will continue to counter any significant pressure on the 1.20 minimum level. Overall, the franc is unlikely to make significant headway in the short term.

The dollar recovered from lows below 0.9250 and recovered with highs above 0.9350 on Thursday. There was a significant impact from a weaker Swiss currency as the Euro rose to a peak above 1.2380.

The latest Swiss KOF business confidence index registered a small improvement to 1.23 in the latest month from 1.15 previously which is not likely to have any significant implications for monetary policy.

There was a sense of relief surrounding potential growth trends given that major central banks remain committed to expansionary monetary policies. This, coupled with expectations that the US economy can post solid growth, did have some impact in curbing franc support on defensive grounds.

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The Australian dollar was subjected to substantial selling pressure during the week and retreated to 3-year lows below 0.89 against the US dollar.

The economic data was weaker than expected with a second successive sharp decline in building approvals. The manufacturing PMI index also dipped sharply for the month. Reserve Bank Governor Stevens stated that the inflation decline gives the central bank further scope to cut interest rates if necessary. He also commented that it would not be surprising if the Australian dollar fell further.

There was some temporary relief after the Chinese PMI data and when risk appetite recovered, but there was fresh selling later in the week, especially with concerns surrounding the Asian economic outlook and commodity prices.

Despite corrections, expectations of domestic vulnerability, an interest rate cut and Chinese weakness will maintain underlying Australian dollar vulnerability.

Canadian dollar:

The Canadian dollar was subjected to less volatility than most major currencies during the week. There was US currency support on dips to the 1.0250 area and it moved to around 1.0350. There were concerns surrounding commodity prices which tended to have a negative impact on the Canadian currency, although the overall impact was measured while there were no major domestic influences.

The US dollar should be able to find underlying support on US yield grounds and concerns surrounding oil prices will also tend to unsettle the Canadian dollar.

Indian rupee:

The rupee was subjected to renewed selling pressure during the week as it retreated back beyond 60 against the dollar with lows near 61. There were further concerns surrounding the growth environment while dollar demand was solid from importers.

The Reserve Bank indicated that rupee support measures introduced the previous week were only temporary and this raised major doubts over the bank’s resolve to defend the currency. The bank also appeared opposed to a sovereign bond issue to help finance the current account deficit which further undermined confidence in government and central bank policies.

The rupee is likely to remain generally vulnerable on unease over emerging markets and domestic economic prospects with the RBI unable to defend it aggressively

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The Hong Kong dollar secured a slightly firmer tone over the week, but did hit resistance beyond 7.7550 with no pressure on the band limit. The slightly more dovish Federal Reserve tone helped keep local money-market rates down.

Given continuing fears surrounding China’s economic and financial concerns, the HKMA is likely to concentrate on maintaining short term currency stability.

Chinese yuan:

The Chinese yuan was slightly stronger during the week, although the ranges were relatively narrow with resistance close to 6.13 against the dollar. The PBOC maintained liquidity operations to help prevent a repeat of June’s credit crunch and was content to leave spot rates little chnaged.

The official PMI index edged slightly high to 50.3 from 50.1, in contrast to the deterioration seen in the HSBC index and there was some degree of caution over the data  With concerns surrounding the regional economy, there was overall pressure for the yuan to be competitive. The central bank eased money-market stresses with an aggressive addition of liquidity during the week.

There will be further concerns surrounding an underlying deterioration in economic conditions. The capital-account trends are unlikely to provide yuan support.

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