Weekly Forex Currency Review 06-09-2013

Overall strategy:  The US payroll data will be important but, unless the data is extremely weak, the Federal Reserve will look to push ahead with the tapering of bond purchases. This should provide underlying dollar support and will also maintain stresses within emerging markets, although the impact should at least be partially priced in. The main feature is likely to be a sustained increase in market volatility.  

Key events for the forthcoming week

Market analysis

Dollar: 

There is still the hurdle of the monthly payroll data, but underlying confidence in the economy has remained firm and there will be widespread expectations that the Federal Reserve will sanction a tapering of bond purchases at this month’s meeting.  The dollar will continue to gain support on yield grounds, but the dollar has priced in a move by the Fed which will leave it very vulnerable if there is no tapering. The currency should still gain underlying support from stresses in emerging markets with buying by reserve managers to rebalance holdings after intervention. Overall, the dollar should be able to maintain a firm tone.

The dollar held a firm tone during the week and pushed to the strongest level sine July near 1.31 against the Euro with net gains on a trade-weighted index.

The US data was stronger than expected with the ISM manufacturing index rising to 55.7 for August from 55.4 previously and contrary to expectations of a modest retreat.  This was the strongest reading since May 2011 and the second successive outcome above expectations. The components were also broadly favourable with a strong rise in new orders and a solid employment reading.

The Fed’s Beige Book continued to report modest to moderate growth in the economy and would be no impediment to tapering of Fed bond purchases. Regional President Williams stated that he had an open mind going into the September FOMC meeting and the outcome would be data dependent.

The US ADP report was slightly weaker than expected with new private-sector jobs growth estimated at 176,000 from a revised 198,000, although this still indicated solid underlying growth. The latest jobless claims data was stronger than expected with a decline to 323,000 from 332,000 previously, maintaining underlying claims at five year lows with a very consistent tone over the past few weeks. 

The ISM non-manufacturing index was much stronger than expected at 58.8 from 56.0 previously, the highest figure since March 2011. The orders index rose strongly and there was a big rise in the employment component. Overall, there were expectations of a robust payroll figure on Friday and a Fed September tapering.

There was a further increased in US benchmark 10-year yields to near 3.0% for the first time since Spring 2011 which pushed the Euro to six-week lows below 1.3120 as the US currency secured wider support.

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There will be relief that the Euro-zone economy has shown some signs of growth. The underlying situation is still extremely fragile and peripheral economies remain very vulnerable with rising debt burdens.  The ECB remains concerned over the situation and will continue to resist further increases in money-market rates which will be important in limiting Euro support. The current account surplus will provide significant support at times, but net economic conditions are unlikely to provide backing with stresses liable to increase again.

The Euro dipped weaker later in the week with expectations of reduced yield support.
 There was a small downward revision to the final Euro-zone PMI services-sector index with progress hampered by a decline in the Italian reading and there was a weaker reading for retail sales. There were also important political stresses within Italy as the government remained close to collapse and this did have an impact in curbing underlying Euro sentiment.

A comfortable Spanish bond auction providing some degree of support and offsetting important concerns surrounding underlying Spanish budget trends.

As expected, the ECB left interest rates on hold at 0.50% following the latest policy meeting, ensuring that the main focus would be on President Draghi’s press conference.  He remained generally cautious surrounding the economic outlook as he reinforced the message that recovery would come only very slowly while inflation would remain low.

There were significant comments that the ECB was watching liquidity closely and would consider a cut in interest rates and liquidity injections if there was an unjustified increase in market rates.  There were also indications of significant splits within the council over rate levels.  Draghi’s comments pushed the Euro lower again despite a further increase in German bond yields.

Yen:

The Bank of Japan has held monetary policy steady for now, but is prepared to expand policy further if required and there are signs of faltering demand.  In this context, developments surrounding the sales tax will be watched closely as any increase would increase speculation that the bank would need to take additional action.  There will also be further important reservations surrounding the underlying fiscal situation and unsustainable debt burden. The yen will remain vulnerable on yield grounds and is vulnerable to further net losses.

The yen had a weaker tone primarily on yield considerations as the dollar probed the 100 resistance area without being able to close above this level.

Domestically, there were continuing expectations that the government would push ahead with a sales tax increase. This also fuelled expectations that the Bank of Japan would be forced to maintain a highly-expansionary monetary policy to counter any downturn in demand which would tend to undermine the yen. There were further underlying concerns surrounding the Japanese fiscal outlook and the potential longer-term negative implications for the yen.

The yen spiked briefly during the European session on Tuesday after a Russian news agency report triggered speculation that the US had launched a missile attack on Syria which undermined risk appetite.

There was no change from the Bank of Japan at the latest policy meeting with an upgrading of its economic assessment. The yen continued to be undermined by a lack of interest rate support with US yields pushing to the highest level since 2011 while Japanese yields remained constrained at lower levels.

Underlying economic risk conditions remained slightly more constructive which curbed yen demand and there was further uncertainty surrounding the Syrian situation with political clashes during the G20 summit. The dollar was unable to hold above the 100 level in Asia on Friday with caution ahead of the pivotal US data.

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Underlying confidence in the economy will remain stronger in the short-term following the persistent run of strong economic data. Sterling will gain initial support on yield grounds, but the Bank of England will still be looking to push against rising yields, especially as there will be concerns that rising yields will damage the economic recovery.  There will also be underlying current account deficit vulnerability which will limit the scope for UK currency support.

Sterling maintained a firm tone with further optimism surrounding the economic outlook with strong releases as markets continued to speculate over an increase in interest rates earlier than planned by the Bank of England. There were gains to near 0.84 against the Euro and it probed resistance above 1.56 against the dollar.

The manufacturing PMI index rising to 57.2 for August from a revised 54.8 previously.  This was the highest headline reading since March 2011 as orders rose at the fastest rate since 1994. There was an increase in the construction PMI index to 59.1 for August from 57.0 previously with notable strength in the residential sector
 
The services-sector PMI index rising slightly to 60.5 for August from 60.2 previously which was particularly impressive given the sharp increase last month. The headline index was at the highest level since the beginning of 2007 and there was strength in most components which bolstered optimism over the economy.

As expected, the Bank of England held interest rates at 0.50% following the latest policy meeting and the amount of quantitative easing was also unchanged at £375bn.

There had been some speculation that the MPC would issue a statement following the meeting to reinforce its commitment to forward guidance and look to exert downward pressure on bond yields. In the event, there was no commentary from the bank which triggered fresh buying support. The raft of favourable UK data was also important in pushing market rates higher as benchmark gilt yields moved above the 3.0% level.

Swiss franc:

The franc will be vulnerable on yield grounds, especially with the increase in bond yields throughout the G7 area.  The National Bank will also continue to resist any significant franc gains. There will be defensive support for the franc at times, but the underlying trend is likely to be for a weaker Swiss currency, especially with the currency still overvalued on a medium-term perspective.

The Swiss PMI index weakened to 54.6 for August from 57.4 previously which will trigger some doubts surrounding the economy, especially with equivalent euro-zone indices improving

The solid US economic data releases were important in curbing demand for defensive currencies as bond yields increased and this was significant in curbing franc demand. The franc came off its best levels following the dovish ECB stance.

The latest World Economic Forum again indicated that Switzerland was the most competitive economy for the fifth successive year which should provide some underlying franc support. The franc moved weaker against the Euro to around 1.24 and there was a dollar move to above the 0.94 resistance level.

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The Australian dollar was able to secure a firmer tone during the week and pushed to a high just below the 0.92 level against the US dollar.

As expected, the Reserve Bank left interest rates on hold at 2.50% following the latest policy meeting. The bank did, however, drop its previous reference to the potential for further easing which had a significant in boosting the currency.

The economic data had a very mixed tone with a sharp increase in building approvals for the latest month. In contrast, the retail sales figure was slightly disappointing and the trade data was substantially worse than expected. The currency was saved from further selling pressure by an improvement in risk appetite on hopes that the global economy would be able to secure stronger growth.

The Australian dollar has managed to stabilise on hopes for an improvement in the global economy, but the overall fundamentals are likely to block significant gains.
 
Canadian dollar:

The Canadian dollar pushed through the 1.05 level against the US dollar, but was unable to make strong headway as the US currency was generally resilient.

The Bank of Canada left interest rates on hold at 1.0% following the latest policy meeting with the bank maintaining broadly neutral stance. The trade data was weaker than expected which caused some concerns surrounding competitiveness.
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Overall confidence in the Canadian fundamentals is likely to remain weaker, especially if the Federal Reserve pushes ahead with the bond tapering.

Indian rupee:

The rupee was subjected to renewed selling pressure during the first half of the week as it dipped to record lows beyond 68.50 against the US currency. There was relief as the new Reserve Bank Governor took office and there was surprise that he immediately introduced fresh measures to help defend the currency. New swap facilities will be introduced which will increase dollar supply in the market.

The government also moved closer to pension reform measures which should boost capital inflows and there was a decline in bond yields. There were still important reservations surrounding the growth outlook and underlying fundamentals.

The rupee will strengthen at times on RBI direct measures, but structural vulnerabilities will maintain a weak overall tone with high volatility a key feature.

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The Hong Kong dollar was trapped in narrow ranges during the week. The latest currency trading flows recorded a decline in Hong Kong dollar trading volumes which cold eventually trigger more substantial volatility. For now, the HKMA will focus on stability with some potential support from rising US bond yields.  

Expectations of Fed tightening and higher bond yields will provide underlying currency support. The HKMA will concentrate on short-term currency stability.
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Chinese yuan:

The Chinese yuan was trapped within narrow ranges during the week with the spot rate confined to narrow ranges just beyond the 6.12 area as the PBOC maintained tight control of the market. The latest data indicated that the yuan had moved into the top ten global traded currencies.

There was some relief surrounding the economic data with the official PMI index holding above the 50.0 level, although there were still important reservations surrounding the economic outlook and vulnerability to rising bad debts.

The PBOC will be un easy surrounding the domestic credit conditions and the wider vulnerabilities in emerging markets and will want to keep the currency stable.

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