Weekly Forex Currency Review 09-08-2013

There is still a high degree of uncertainty surrounding Federal Reserve plans, but the most likely outcome is that there will be a small tapering of bond purchases from September or October which would provide some degree of dollar support. Euro-zone trends will be very important following the Summer holiday period ahead of the September German election with China’s economy also continuing to be a key focus.  

Key events for the forthcoming week

Market analysis

Dollar:

The US employment data was weaker than expected which served to dampen confidence in the economy and trigger further doubts surrounding a short-term tapering of bond purchases.  The overall data flow has been generally firm, especially for the PMI indices, and the most likely outcome is that the Fed will still be looking to reduce the rate of bond purchases.  There will be further structural improvements in the US fundamentals as the trade deficit narrows. In this context, the dollar should prove to be resilient at lower levels.

The dollar continued to drift weaker during the week and hit a seven-week low against major currencies as long positions were pared back.
 
The US employment data was below expectations with a non-farm payroll increase of 162,000 for July from a revised 188,000 gain the previous month and May’s estimate was also revised down. There was a decline in both weekly hours and earnings which suggested economic momentum may be slowing. In contrast, there was a decline in the unemployment rate to 7.4% from 7.6%, a four-year low for the series.

The latest ISM data was much stronger than expected with an increase in the services-sector reading to 56.0 for July from 52.2 previously, close to the highest level for 2013. There was a strong rebound in orders and an increase in the inflation component which should help ease potential concerns surrounding deflation. Strong gains in the manufacturing and services-sector indices this month should boost confidence.

There was a sharp decline in the latest US trade deficit to US$34.2bn for June from US$ 44.1bn previously, the narrowest reading since October 2009. There was a small monthly advance for exports while imports registered a sharp decline, due in part to lower oil imports. This decline may raise some doubts over spending levels, but also illustrates the structural improvement delivered by rising domestic energy production.  There were also expectations of an upward revision to second-quarter GDP.

US initial jobless claims edged higher to 333,000 in the latest reporting week from 328,000 previously, but this was still near the lowest levels for five years and mortgage delinquencies also fell to a five-year low.

The dollar was unable to gain any traction following the trade data. Regional Fed President Lockhart stated that monthly payroll growth of 180,000-200,000 would be a good place to start bond-purchases tapering and this could take place in September or October. Chicago Fed chief Evans also stated that bond tapering was possible in September which is significant given his normally dovish stance. The latest job-openings survey will bolster confidence within the Fed as it strengthened to the highest level since 2009. Regional President Pianalto’s comments were broadly in line with recent rhetoric suggesting that tapering could start soon.

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Confidence in the Euro-zone outlook is likely to remain slightly stronger in the short-term as survey evidence suggests an overall improvement in demand. There will also be reduced speculation over a near-term ECB move to cut interest rates. The underlying peripheral economies are still in serious difficulties, especially with underlying vulnerability in the banking sector.  There will also be an important increase in political tensions ahead of September’s German Federal election. In this context, the Euro will struggle to secure further significant gains.  

There were generally very quiet conditions within the Euro-zone as the holiday season had an important impact in curbing activity. The fifth successive decline in Spanish unemployment helped underpin confidence. Stresses in the Italian coalition following Berlusconi’s failure to over-turn a tax evasion conviction did not have a major market impact, although underlying concerns surrounding Italy increased.

The Euro-zone economic data continued to offer some degree of Euro support with the services-sector PMI index registering a final 49.8 from a flash 49.6 reading with a composite reading above the 50 level. There was also some relief surrounding the Spanish and Italian indices as they improved for the month and Spanish benchmark bond yields dipped to the lowest level for six weeks. There was also an improvement in the Sentix investor confidence index to -4.9 from -12.6 previously.

The Euro secured a boost from stronger than expected German industrial production data, following on from a robust industrial orders release. Fitch also affirmed the German credit rating at AAA with a stable outlook.

Yen:   

The Bank of Japan will maintain a very loose policy in the short-term in order to boost growth conditions and ease underlying deflationary pressures. There has also been a steady outflow of capital from Japan which will tend to weaken the yen while competitiveness will remain an important domestic and regional policy issue. The Japanese currency could still be broadly resilient if there is no further increase in US bond yields. The yen will also gain some defensive support if global risk appetite deteriorates.

The dollar was generally on the defensive against the yen with a further negative reaction to the previous week’s US payroll data and the failure to break 100 and retreated to lows just below the 96 level before finding support.
 
The yen continued to gain some support from fragile risk appetite and there was also further speculation over repatriation flows associated with US Treasury coupon payments ahead of the Obon holidays. Liquidity is liable to remain weak in the short-term, increasing the risk of erratic moves.  

The Bank of Japan left policy on hold at the latest policy meeting which did not have a major impact. The latest capital-account data continued to register strong flows into overseas bonds which will tend to weaken the yen. Risk appetite was also generally firmer following the better than expected Chinese trade data which lessened defensive yen demand as regional equity markets rallied.

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There will be greater economic confidence in UK growth prospects following a stream of stronger than expected survey data. The Bank of England will remain an important focus and there will be further determination to keep rates low throughout the next few months. The forward guidance was not as dovish as had been expected which triggered a short-term Sterling recovery and any rise in inflation would increase pressure for the bank to increase interest rates. There will still be underlying balance of payments vulnerability and Sterling is unlikely to make much headway

There was high Sterling volatility during the week and net gains against the major currencies with a move to above 1.55 against the dollar.
 
The PMI services-sector index rose strongly to 60.2 for July from 56.9 the previous month, easily out-stripping market expectations. This was the strongest reading for seven years and from a January low below 50, there have been six successive monthly advances for the pivotal UK index. There were also strong gains for industrial production. The manufacturing figure was particularly impressive with a 1.9% gain for June following a 0.7% drop the previous month which suggests that second-quarter GDP could be revised higher.

Bank of England Governor Carney introduced a fresh set of forward guidance for monetary policy. Under the new regime, interest-rate changes and quantitative easing will be influenced by the level of unemployment as well as inflation.  The Bank of England will pledge not to raise interest rates until unemployment falls below 7.0% and there will also not be a scaling back of quantitative easing. There are some important potential get-out clauses with action possible if inflation is projected to be above 2.5% on an 18-24-month horizon or if there is evidence of asset-price bubbles.

There was an upgrading of the GDP growth forecast to 1.4% for this year from 1.2% and next year’s forecast was revised sharply higher to 2.5% from 1.7% which is significantly above consensus forecasts for 2014.

There had been some speculation that the unemployment threshold would be lower at 6.5% and, ironically, market future signalled that the likely timing of a rate increase had been brought forward given the stronger growth forecasts. In this context, after a brief decline, Sterling rallied strongly following the report with a peak above 1.55 against the dollar while there were also strong gains to beyond 0.86 against the Euro.

Swiss franc:

A sustained improvement in risk appetite would tend to lessen demand for the Swiss currency, especially if there are expectations that global growth considerations are considered to be more favourable.  There are still 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 defend the 1.20 minimum level very strongly in the short-term.

The dollar was unable to make any impression on the franc during the week and retreated to lows around 0.9200, the weakest level since mid June. The Euro was also on the defensive as it weakened to below 1.23 against the Swiss currency before finding some degree of support.

The latest National Bank data indicated that currency reserves were broadly unchanged in July at close to CHF430bn. This suggests that there is no major appreciation pressure on the Swiss currency with flows likely to be basically stable. The franc could still gain support if wider global risk appetite deteriorates again.

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The Australian dollar remained under pressure early in the week with a decline to fresh 3-year lows below the 0.8850 level against the US dollar. The Reserve Bank cut interest rates to 2.50% from 2.75% previously which was in line with expectations. The bank, however, was more cautious in its statement with no clear indication that rates will be cut again which provided some degree of relief for the currency.

The employment data was weaker than expected at unemployment increased to 5.7% and the retail sales data was also subdued. There was, however, relief surrounding the Chinese trade data with an increase in exports and imports having an important impact in improving confidence surrounding the Chinese outlook. This helped underpin the Australian dollar and there was a corrective recovery to above 0.91.

Any boost in confidence surrounding China’s outlook would underpin the Australian dollar and there is the potential for a limited correction from over-sold conditions.
 
Canadian dollar:

The Canadian dollar remained under pressure during the first half of the week and dipped to lows beyond 1.04 before finding some degree of support and strengthening sharply to the 1.03 region.

The domestic economic data was weaker than expected with a sharp decline in building permits and a falling the PMI index to below the 50 level which will increase concerns surrounding the domestic economic outlook.
 
There are likely to be increased doubts surrounding the domestic economic fundamentals, undermining Canadian dollar support, especially if oil prices weaken.

Indian rupee:

The rupee remained under heavy selling pressure during the first half of the week with record lows beyond 61.80 against the US dollar. There were further fears surrounding the current account deficit and growth with a lack of confidence surrounding the underlying Indian fundamentals and a growing sense of unease.

There was an appointment of a new central bank governor Rajan which did serve to bolster confidence to some extent and the central bank also looked to drain cash from the banking sector to help stabilise the currency.

Despite corrections at times, the rupee is likely to remain generally vulnerable on a lack of confidence in the economic outlook and the overall current account position.

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The Hong Kong dollar secured a solid tone over the week and advanced to just beyond the 7.7550 area late in the week, but ranges were very narrow. The Fed rhetoric surrounding a possible tapering in September did not have a major impact and there was a slightly more confidence tone surrounding China’s economy.

There will still be a high degree of uncertainty surrounding mainland economic prospects and the HKMA is likely to concentrate on short-term currency stability.

Chinese yuan:

The Chinese yuan had a firmer tone during the week, underpinned in part by a softer US currency while the PBOC was also content to push the currency slightly stronger at the fixings. In this environment, there were gains to beyond 6.12 against the dollar for fresh 19-year highs.

There was relief surrounding the latest trade data with an annual increase in exports and imports boosting confidence that the sharp slowdown in growth had bottomed out, although there was still a high degree of uncertainty over the data and economy.

There were still pressures to maintain a competitive currency and underlying confidence in the BRIC economies as a whole remained generally weaker.

Any relief surrounding the economic trends are liable to prove limited and generally short-lived. Net capital-account trends are also unlikely to provide yuan support.

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