Weekly Forex Currency Review 03-01-2014

Global monetary policies will continue to be watched very closely during the course of 2014. Markets are expecting a gradual tapering of bond purchases by the Federal Reserve and there will be very high volatility if these expectations are not met. There will be strong pressure for further ECB action if the Euro-zone economy deteriorates again.

Market analysis

Dollar:

US economic developments will be watched very closely early in 2014 with a particular focus on employment trends. The Federal Reserve will look to taper bond purchases further during the first half of the year, but there will still be important reservations over the economy and any sign of disappointment could certainly trigger a pause in the tapering process which would tend to undermine the dollar’s yield support. The US currency should also gain important support on competitive grounds as energy production increases and costs decline.

The dollar was able to maintain a solid tone during the holiday period, although the main feature was a spike in volatility. The US currency was able to regain ground against the European currencies after the New-Year holidays and gained ground against emerging currencies.
 
As far as the US economic data releases were concerned, there was a stronger than expected consumer confidence reading of 78.1 for November from a revised 72.0 previously and this was the highest reading for three month, while there was a 13.6% annual increase in the Case-Shiller house-price index. There was a slightly disappointing Chicago PMI reading at 59.1 from 63.0, although this was still a solid reading and the net impact was a slightly firmer dollar on expectations that the US economy is making headway

The jobless claims data was slightly better than expected with a decline to 339,000 in the latest reporting week from a revised 341,000 previously. There was also a slightly better than expected reading for the ISM manufacturing index at 57.0 from 57.3 previously.  There was a very strong reading for orders and the employment component also firmed over the month which helped maintain a more positive tone towards the US economic outlook. There were also expectations of further Fed tapering of bond purchases during the first half of 2014.

The dollar was unable to gain further traction despite the solid data as US Treasury bond yields backed away from their highest levels in response to weaker equity markets with 10-year yields struggling to hold above 3.0%

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There have been mixed signs for the Euro-zone economy with Germany still securing solid growth and some positive signs in peripheral economies while conditions within Franc have continued to deteriorate. With competitiveness issues, there will be pressure for the ECB to relax monetary policy further while there will also be demands for the Euro’s value to be curbed.  There are likely to be reduced capital inflows in the short-term as capital repatriation flows fade and there will also be the potential for reduced capital inflows. The Euro could still prove broadly resilient initially, but will struggle to make any sustained headway from current levels.

The Euro strengthened over the last few sessions of 2013 with a brief peak near 1.39 against the dollar and a test of 145 against the yen in volatile conditions.
 
There was also uncertainty surrounding year-end market flows and the potential impact at the start of 2014. There were further expectations that Euro-zone commercial banks were repatriating funds ahead of the year-end in order to bolster capital positions ahead of next year’s ECB audit. If there are substantial flows, then there would also tend to be a sharp dip in Euro demand at the beginning of next year.

As far as economic data is concerned, there was a weak reading for the PMI retail sales series with another reading below 50 as a recovery in Italy was offset by a deterioration in France. There were also concerns over the impact of declining money supply, but with no evidence of additional ECB measures at this time

The Euro-zone final PMI manufacturing data as a whole was unchanged from the flash reading at 52.7. Within the headline data, there was further disappointment for France at 47.0 which was an eight-month low. In contrast, there were stronger than expected readings for Italy and Spain which helped boost confidence and triggered a sharp fall in peripheral bond yields with a compression of yield spreads over German bonds.

There had been evidence of banking-sector capital repatriation flows into the Euro ahead of the year-end and there were also some expectations that there would be recued Euro demand at the start of 2014 which tended to undermine currency demand. The Euro was also unsettled by US 10-year bond yields above the 3.0% level and retreated back below the 1.37 level.

Yen:   

The yen will continue to be undermined by yield considerations in the short-term, especially if US yields sustain a move above the 3% level. There will also be expectations that the Bank of Japan will sanction further monetary easing within the next few months, especially with an increase in the sales tax at the beginning of the second quarter. The underlying Japanese fundamentals will remain very weak and there will be some defensive yen demand when global risk appetite deteriorates and equity markets decline.

The yen remained under heavy selling pressure late in 2013 with 5-year lows against the US currency and yen with the dollar peaking near 105.50 and the Euro above 145.

There was a further increase in speculative yen shorts in the latest data to the highest level since July 2007 which will maintain the potential for a sharp correction There were underlying expectations that the Bank of Japan would maintain a very loose monetary policy during 2014, especially given the risk that an increase in sales tax will hurt demand during the second quarter.

The yen gained defensive support from a decline in equity markets as risk aversion tended to increase during Thursday. There were also sharp yen gains on the crosses which was a negative factor for the US currency.

As US bond yields also declined from peak levels, there was a generally stronger yen. This pattern continued in Asian trading on Friday with the yen gaining further ground on the crosses with additional pressure for consolidation after recent yen losses as equity markets also remained generally on the defensive with a weaker Chinese services PMI index contributing to the cautious mood. The dollar retreated to lows just above the 104 level while the Euro retreated to lows near 142.

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Confidence in the economy will remain firm in the short-term and there will be expectations that the Bank of England will be forced to tighten monetary policy during 2014. There is still a significant risk that the economy will start to slow over the next few months and the central bank will also look to resist any tightening even if there is a further decline in unemployment. Sterling will also be vulnerable on balance of payments grounds and any sustained weakness in capital inflows would be liable to put the UK currency under sustained selling pressure with high volatility likely.
 
Sterling moved sharply higher late in 2013 with evidence of demand into the fixes and underlying optimism surrounding the economy overcoming any month-end related selling pressures. The Euro retreated through support levels and moved below the 0.83 level while there was a move to near 1.66 against the dollar.

There is further near-term optimism that the UK economy will out-perform during the course of 2014 which would maintain pressure for the Bank of England to tighten monetary policy

The UK PMI manufacturing data was slightly weaker than expected with a decline to 57.3 for December from a revised 58.1 previously which raised some concerns that momentum within the economy could slow. A weaker reading for export orders will also raise some concerns over the level of Sterling, increasing pressure for verbal intervention to limit further gains.

Technical and positioning factors were more important for now with the UK currency initially retreating following an inability to break resistance in the 1.6600 area against the dollar.  There had also been an important element of window-dressing and year-end position adjustment which tended to unwind and caused additional selling pressure during the day.

The Euro found support in the 0.8270 area and rallied back above 0.8300 in choppy trading conditions while Sterling retreated to lows near 1.64 against the dollar

Swiss franc:

Evidence of firm domestic growth will continue to provide underlying franc support in the short-term. There will be some further speculation that the National Bank will consider removing the Euro minimum level during this year, especially if there are further concerns surrounding the inflation outlook. For now, the bank is likely to hold the line and the franc will tend to lose ground if there is greater optimism surrounding the global economy.

The dollar found support near 0.88 against the Swiss franc and rallied back above the 0.90 as the Euro also recovered ground after finding support below 1.22.

There are some expectations that demand for defensive assets will be generally weaker during 2014, especially following the decline in gold prices, and this will tend to limit demand for the Swiss currency. There will still be reservations over franc selling given the possibility of a National Bank policy shift on the peg.  

The franc was unable to derive any significant support from a deterioration in risk conditions as equity markets were subjected to downward pressure, but the Swiss currency did come off its worst levels later in the New York session with the Euro unable to hold above 1.23. 

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The Australian dollar was again subjected to volatile trading, especially with liquidity at seasonally-reduced levels. There was a slide to re-test 2013 lows below 0.8850 before the currency found some degree of relief.

There was a rebound in gold prices which helped stabilise the currency and there was also some pressure for a covering of over-extended shorts, but the overall tone was generally defensive with continuing unease surrounding growth prospects.

There will be scope for Australian dollar corrections from over-sold conditions, but difficult to secure a sustained recovery given the RBA push for a weaker currency.
 
Canadian dollar:

The Canadian dollar was subjected to volatile trading during the holiday period. The dollar found resistance beyond 1.07 and briefly retreated to lows below 1.06 before finding a fresh surge of buying support.

Overall expectations of weaker commodity prices over the next few months and a phasing out of the Fed’s quantitative easing programme continued to have a negative impact on the currency with a weaker domestic PMI index adding to concerns.  

The Canadian dollar will continue to be unsettled by slower demand for commodities and expectations of a less accommodative Fed policy, but with measured losses.

Indian rupee:

The rupee initially held a firm tone, but dipped to two-week lows beyond 62.25 against the dollar early in the new year. There was some disappointment surrounding the latest PMI release with a decline to 50.7 for December from 51.3 previously which maintained concerns surrounding the growth outlook.

There was also weakness in the local equity market which unsettled the rupee as markets waited for fresh evidence surrounding monetary policy.

Although the rupee has been generally resilient, doubts surrounding the domestic fundamentals and weaker capital inflows from bond tapering will unsettle the rupee.

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The Hong Kong dollar found support on dips to just beyond 7.7550 against the US currency with the currency trapped in relatively narrow ranges. The Federal Reserve policies will be watched very closely during the first half of 2014 amid expectations that bond purchases will be tapered further.

China’s exchange rate policies will be watched closely and a move to widen the currency band would increase uncertainty surrounding the Hong Kong peg.
 
Chinese yuan:

The yuan maintained a very firm tone during the holiday period as the PBOC set a string of higher fixes for the currency and the spot rate edged to fresh record highs around 6.05 against the dollar early in 2014.

Money-market rates remained high despite action from the PBOC to inject liquidity into the market. The economic data was uninspiring with a retreat in the PMI index maintaining concerns over the rate of growth and over-dependence on credit.

Competitiveness concerns are likely to be significant, especially with the yen remaining under pressure and regional economies performing more strongly in terms of exports. There will be demands for further yuan gains to be resisted.

The PBOC has indicated that it will tolerate a stronger currency for now, but net economic pressures are liable to be significantly less favourable later in 2014.

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