Weekly Forex Currency Review 04-10-2013

US budget deadlock will be an important short-term focus and there will be fears that there will be an escalating dispute surrounding the debt ceiling. The dollar could gain some support if there is a quick resolution and risk appetite would also improve. Central bank policies will be important with an inevitable focus on the Federal Reserve tapering prospects while the ECB will also be under pressure to respond to Euro strength.

Key events for the forthcoming week

Market analysis

Dollar:

Politics will tend to dominate in the short-term with the Federal government shutdown and fears that there will be a battle over the much more crucial raising of the debt ceiling. There will be expectations that the Federal Reserve will not taper bond purchases in October given the fiscal battles which will enhance a negative impact on dollar confidence.  If the shutdown ends quickly and there is a string of robust data releases, there would be scope for a firmer dollar tone as tapering expectations would return quickly. There will also be some important underlying dollar protection from weak fundamentals elsewhere.

The dollar was unable to make any headway during the week and continued to drift weaker with five-week lows as potential buyers unable to find any justification for long positions. Political considerations were important and failure to reach a budget deal triggered a partial shutdown of the Federal government.
 
The US economic data was mixed over the week as a whole. The Chicago PMI index rose to 55.7 for September from 53.0 previously and the Dallas Fed index also strengthened for the month. Regional Fed President Plosser was critical of the Fed decision not to taper bond purchases, maintaining the consistent tone of Fed hawks to September’s FOMC decision, but he is a non-voter this year.

The ISM manufacturing data was released as planned and was stronger than expected with a rise to 56.2 from 55.7 previously. The headline figure was the highest for 30 months with the orders component again above 60 while the employment index also strengthened.

The headline US ADP employment data was slightly weaker than expected at 166,000 for September and there was also a downward revision to August’s release to 159,000 from 176,000. A downward revision to the August payroll data was an important setback for the dollar and this latest setback curbed any dollar support.

There were on-going concerns surrounding the US government shutdown and growing fears that there would be a destabilising stand-off surrounding the debt ceiling. Markets will be increasingly uneasy if the shutdown extends beyond the end of next week and the dollar could then be vulnerable to heavy selling pressure. There were some tentative signs that a deal could be reached relatively quickly as moderate Republicans looked for a way to end the stand-off .

For the fifth successive week, the US jobless claims data was better than expected with little change from last week at 308,000 from 307,000. The dollar struggled to gain any traction as underlying confidence remained fragile.

The latest ISM non-manufacturing data was also significantly weaker than expected with a decline to 54.4 from 58.6 previously. The orders component remained strong while the employment index edged lower. Looking at the past two months together, steady growth is the key feature, but the dollar weakened following the data

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There has been an easing of immediate fears surrounding the Italian political situation. There will still be important concerns surrounding underlying political stresses, especially if there is evidence that the economy is deteriorating again. There will be wider concerns surrounding the peripheral economies and protracted negotiations surrounding the German government will have some potential negative impact on the Euro.  There will also be pressure on the ECB to relax policy further and there is the threat of warnings from the central bank over Euro strength if the current trend extends much further.
 
The Euro was able to hold a firm tone and pushed to 8-month highs above 1.36 against the dollar with a lack of attractive alternatives providing net support.
 
There was a weaker than expected flash Euro-zone inflation figure of 1.1% for September from 1.3% previously which maintained expectations that the ECB would maintain an expansionary tone. The Euro-zone services-sector final PMI index registered a marginal increase to 52.2 from a flash 52.1. The Italian index moved above the 50 level for the first time since June 2011, but there was a fresh Spanish contraction for the month.

The Italian Senate continued to debate the no-confidence motion during Wednesday and there was a high degree of uncertainty over the opposition PDL stance, especially with significant internal dissent. After several reversals of direction by Berlusconi, the PDL supported the government which won the no-confidence vote. There was a sharp drop in Italian yields following the result which helped underpin the Euro.

There were no surprises as the ECB left interest rates on hold at 0.50% following the latest council meeting.  President Draghi reiterated that the bank was willing to take fresh steps if required to curb volatility in money markets, but there were no fresh measures and no hints over a near-term LTRO.

The ECB remained concerned over the rate of credit growth which was described as weak or even very weak despite improved conditions on the funding side. Draghi also stated that the bank had considered a rate cut, but rejected it.

Markets had been expecting a generally dovish slant from the ECB and the ending of uncertainty helped underpin the Euro through short covering and as an alternative with underlying dollar sentiment still vulnerable on a lack of fresh positive factors.

Yen:   

The Bank of Japan will maintain an expansionary policy throughout the next few months. The government has announced that the sales tax will be increased in April and there will be an economic stimulus package to help offset the potential negative impact. Underlying concerns surrounding the Japanese fiscal situation will continue even if there is a stronger short-term growth trend. The yen will gain strong support if there is any serious threat that the US debt ceiling will not be raised, but will find it very difficult to sustain yen gains.

Quarter-end positioning was important early in the week as trading conditions remained choppy and the dollar was unable to move above the 98.50 level against the yen and was then vulnerable over the remainder of the week.

Following confirmation that the sales tax would be increased in April, the government announced a JPY5trn fiscal package. There was, however, uncertainty surrounding corporate taxes with some evidence of divisions between the Prime Minister and Finance Ministry. Doubts over a potential tax cut tended to strengthen the yen.

The latest data recorded another week of capital flows into overseas bonds which curbed yen support. The Bank of Japan left policy on hold following the latest policy meeting and also revised up the forecasts for capital spending which provided some degree of support for the Japanese currency. Risk conditions remained important and the dollar was unable to secure any fresh support as it held just above the 97 level.

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The UK economic releases have remained generally strong and there will be strong confidence in a third-quarter GDP reading which will help underpin confidence. There is still a risk that momentum will fade quickly given the dependence on the financial sector with underlying consumer spending liable to remain fragile and the Bank of England will maintain an extremely loose policy which will tend to push yields lower. The current account position also remains extremely vulnerable from a longer-term perspective and Sterling will also be at risk if there is a sustained deterioration in risk appetite.

Sterling pushed to eight-month highs around 1.6250 against the dollar before running into pressure for a correction and edged weaker against the Euro.
 
UK mortgage approvals increased to a five-year high. There was, however, a decline in business lending which will reinforce fears that an improved UK growth outlook is based on unsustainable consumer spending gains.

The UK CIPS manufacturing index was slightly weaker than expected at 56.7 for September from a revised 57.1 previously. This was the first below-expectation reading for six months. Similarly, the construction index dipped to 58.9 from 59.1.

The services-sector data was also marginally weaker than expected at 60.3 for September from 60.5 previously, but was still a robust report in the context of the past two years.  There was an estimate that third-quarter GDP expansion could have been as much as 1.2% which will help sustain near-term market confidence.

Bank of England MPC member Dale stated that the market was not heeding the bank’s forward guidance and members in general continued to warn that the recovery was fragile. Fisher also insisted that there would be only a very slow increase in interest rates once they do increase from the 0.50% level. Comments created fresh doubts whether policy would be tightened as quickly as expected and long-term bond yields continued to retreat from recent peaks which sapped Sterling strength.

Swiss franc:

Although the franc will continue to be vulnerable on yield grounds and seen as an attractive carry-trade currency, it could still prove to be resilient in the short-term, especially with the Federal Reserve and ECB both determined to maintain dovish policies. The franc could also gain renewed support if there is evidence that global economic conditions are deteriorating and emerging-market stresses intensify, especially if a US debt default appears to be a realistic possibility. From a longer-term perspective, fresh losses are likely.

The franc secured fresh gains for the week as a whole with the dollar dipping to test 17-month lows against the franc while the Euro also lost ground.
 
The Swiss PMI index edged higher to 55.3 for September from 54.6 the previous month which should not have a major impact on policy expectations or the Swiss currency. A general decline in Euro-zone peripheral bond yields limited near-term defensive franc demand, but the Swiss currency held firm as markets were plagued by uncertainty surrounding the US budget developments.

The dollar was subjected to renewed selling pressure following the US data and ECB press conference on Wednesday with a slide to below the 0.9000 level for the second time in a week before making a tentative recovery. The Euro was able to find some relief and pushed to a high above 1.2250 during the US session.

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The Australian dollar found support on dips to below 0.93 against the US dollar during the week while hitting resistance on any move towards 0.95. There was uncertainty surrounding risk conditions as equity markets proved to be broadly resilient despite uncertainties surrounding the US shutdown

As expected, the Reserve Bank left interest rates on hold at 2.50% following the latest policy meeting. The statement was broadly neutral which helped trigger a covering of short Australian dollar positions. The retail sales data was close to expectations while there was a drop in building approvals and a weaker than expected trade account.

The Australian dollar will gain some support from expectations that interest rates have reached their lows, but underlying growth considerations will curb any gains.

Canadian dollar:

The Canadian dollar was confined to narrow ranges during the week  with the US currency find support below 1.03, but unable to make any significant headway.

Uncertainty surrounding the US economy was compounded by the government shutdown and there was a reluctance to take on additional positions which also tended to dampen activity in the Canadian currency.  

The Canadian dollar will find it difficult to gain any sustained support given the overall valuation grounds with near-term fundamentals providing some support.

Indian rupee:

The rupee was able to hold a solid tone during the week, primarily due to external influences and was stronger than 62 against the dollar. The US currency was generally weak which helped support the Indian currency while expectations of a further delay to any Fed tapering continued to underpin the local currency. There was evidence of portfolio inflows into India which also provided support.

There were still important doubts surrounding the underlying domestic fundamentals which limited the potential for gains with markets still expecting longer-term losses.

The rupee will continue to gain some protection from a decline in US yields and reduced pressure on wider emerging-market assets, but with limited scope for gains.

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The Hong Kong dollar held steady during the week as a whole. There was longer-term speculation that the existing currency peg could come under stress in the medium term, especially if are further medium-term gains for the Chinese yuan.  

There will be a continuing debate surrounding the Hong Kong currency peg, especially if the yuan continues to strengthen, but stability will continue for now
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Chinese yuan:

The Chinese yuan consolidated around the 6.12 area against the US dollar and there was further speculation that the trading band could be widened. Markets were shut for most of the week with national holidays.

The fundamentals and underlying debt fears are unlikely to support strong yuan gains There will be further speculation that PBOC will look to widen the  trading band. 

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