Weekly Forex Currency Review 10-06-2011

Conditions within the US and global economy will continue to be watched very closely in the short-term. There will be strong expectations that the Federal Reserve will maintain a highly expansionary monetary policy, but there will also be continuing fears surrounding the Euro-zone and doubts surrounding the global economy are also liable to persist. Overall, the dollar should prove to be resilient against European currencies.  

Key events for the forthcoming week 

Market analysis

Dollar: 

The recent economic data releases have done nothing to improve confidence surrounding the immediate growth outlook and confidence will remain weaker for now with strong expectations that the Federal Reserve will need to maintain an extremely loose monetary policy after the end of quantitative easing. There will also be medium-term fears over the US credit rating and a deal on raising the debt limit would be likely to provide only temporary relief given underlying debt issues. Although yield support will remain weak, the dollar should still gain important protection from a lack of confidence in the other key currencies and a more defensive attitude toward risk as global growth doubts increase.

The dollar found it difficult to make much of an impression over the week as a whole, but did stage a recovery from its weakest levels against the Euro as all major currencies struggled for support due to weak fundamentals.

There was a warning from a Chinese economic institute that China needed to be wary over holding too many dollar-denominated assets which triggered initial selling pressure on the dollar. The comments were later removed from the website, but underlying confidence remained fragile.

Fed Chairman Bernanke stated that the economy remains in need of a boost given that growth remains below potential, but he also commented that there was no need for further stimulus. The remarks continued to suggest that the Fed will resist any further quantitative easing, but will also keep interest rates at very low levels over the next few months which continued to dampen the dollar on yield grounds.

The Federal Reserve’s Beige Book reported that the expansion continued, although there was some deceleration reported by a few districts. There will be further market fears over an underlying slowdown in the economy. There was further unease over the US debt-ceiling negotiations as failure to raise the debt ceiling would trigger a high risk of technical default which would compromise the US credit rating.

The US jobless claims data was slightly worse than expected with a marginal increase to 427,000 in the latest week from 426,000 previously while the trade data was better than expected with a decline in the surplus to US$43.6bn for May from US$46.8bn previously as exports rose strongly.

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The Euro-zone structural difficulties will remain an extremely important short-term focus as leaders continue to battle with the intractable Greek difficulties. The German government will effectively demand that private bond-holders accept part of the cost of any new bailout while the ECB will remain strongly opposed to debt restructuring and it will be extremely difficult to find an acceptable solution.  There will also be the persistent risk of contagion over the next few weeks. The ECB will look to raise interest rates in July, but there will still be caution over the economic outlook and the Euro will be vulnerable, especially as it is over-valued from a medium-term perspective.

The Euro was unable to sustain its strongest levels during the week as structural fears and policy doubts unsettled confidence and it retreated sharply from a high near 1.47 against the dollar.

There was negative rhetoric surrounding the Euro from key officials during the week . Euro-group head Juncker stated that the Euro was overvalued against all major currencies which had some negative impact on the currency, especially as it was in contrast with previous comments which suggests that unease has increased.

After interest rates were left on hold, the Euro spiked higher at the start of the press conference before retreating sharply. Bank President Trichet stated that strong vigilance was required on inflation and this suggested that the bank would increase interest rates in July. He was careful not to pre-commit on rate decisions and was also cautious over the outlook which suggested that the ECB could decide not to tighten beyond July.  The bank maintained extraordinary liquidity measures which maintained underlying structural fears over the Euro-zone economy.

The Greek situation was monitored closely and there was further unease over the situation, especially with growing conflict between the central bank and German government. A sharp downward revision to the Greek GDP data also undermined confidence in the Euro as it illustrated the depths of the structural problems.

The German government wants private bondholders to share the burden of debt restructuring while the ECB remains strongly opposed to any form of restructuring, especially as it would undermine the bank’s balance sheet. There was aggressive Euro profit taking, especially as uncertainty remained extremely high.

There were media reports that the IMF report on Greece would indicate that the next Greek tranche payment could not take place without corrective action on failure to meet existing revenue targets.

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Overall confidence in the economy and fundamentals will remain extremely fragile, especially as the dip in economic activity has increased underlying stresses and caused a further deterioration in the long-term debt profile. The yen will gain defensive support when risk appetite deteriorates and there will also be the potential for long-term capital repatriation which would underpin the yen. Nevertheless, the Japanese currency will find it difficult to appreciate far, especially given the possibility of fresh G7 action to curb any yen gains.  

The dollar was again hampered by a lack of yield support following the recent weak data releases. There was no evidence of direct G7 intervention on dips to below 80, but markets were still on high alert over the intervention risk.

l risk appetite remained weaker on increased fears over the growth outlook and this also triggered some defensive demand for the Japanese currency.

Domestically, a small improvement in consumer confidence did not have a significant impact on market sentiment with the dollar hampered by a lack of yield support.

The dollar was unable to break above 80.50 during Thursday and dipped again in Asian trading on Friday. A slightly narrower than expected Chinese trade surplus supported the yen, although the general mood of caution surrounding the global economy and low US yields were the primary market drivers.

Sterling:

Confidence in the UK economy will remain weak in the short-term with expectations of a further deterioration as consumer spending remains weak. Fiscal policy overall will remain extremely tight which will maintain the need for a policy of very low interest rates which will also limit scope for Sterling support. The banking sector will also be an important focus and there will be fears over fresh vulnerability, especially if there is any Euro-zone debt restructuring. Sterling will still gain important near-term protection from a lack of confidence in the Euro and dollar, but the net trend is liable to be for depreciation.

Sterling was subjected to sharp selling pressure in the European session on Wednesday following a report from ratings agency Moody’s that the UK AAA credit rating could come under threat due to fiscal slippage. The report reinforced a lack of confidence in the economy, especially as there has already been criticism that the government is tightening policy too fast.

There were no surprises from the Bank of England interest rate decision as interest rates were left on hold at 0.50% while there was no change to the GBP200bn quantitative easing amount. There was no statement following the decision and the vote split will not be known until the minutes are released later in the month.

There was further uncertainty surrounding the UK growth outlook and the general tone was pessimistic. Although there was a lower than expected trade deficit of GBP7.4bn for April, there was still little in the way of expectations that the economy can secure strong growth through rising exports. Sterling retreated back to below 1.63 against the dollar, although there was support near 0.8950 against the Euro.

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The Swiss currency will remain the ultimate safe-haven currency, especially with all major alternatives suffering from a serious lack of confidence with the dollar, Euro and yen all suffering from major vulnerabilities. Any debt restructuring and further deterioration in the Euro-zone banking sector would risk a further flow of capital into Switzerland.  There will pressure for National Bank action to curb gains and the bank may also delay an interest rate increase. The franc is substantially over-valued on a medium-term view, but the currency is still likely to maintain a strong tone in the short-term.

After a slide to record lows, the dollar continued to find support below 0.8350 against the franc, but the US currency was capped below 0.84 as the Euro was unable to sustain a recovery above 1.23 against the Swiss currency.

The combination of fears over the global growth outlook, allied with renewed fears over the Greek outlook, triggered fresh safe-haven demand and the franc will tend to maintain a robust tone as it retains its premier safe-haven status.

There were reduced speculation that the National Bank would increase interest rates which may dampen currency demand to some extent.

Australian dollar:

There was further choppy trading conditions in the Australian dollar during the week as the currency was buffeted by domestic and international factors. There was support on dips towards the 1.05 area against the US dollar, but tough resistance on approaches to the 1.0750 area.

Domestically, the latest labour-market data was weaker than expected with an employment gain of below 8,000 and there was a further decline in full-time jobs which dampened expectations of further Reserve Bank interest rate increases.

Risk conditions remained important and there were further doubts surrounding the global growth outlook with expectations of weaker demand in Asia and a lack of leadership from the US.

Short-term yield factors will support the Australian dollar, but it will be extremely difficult for the currency to hold its position given the underlying risk profile.

Canadian dollar:

The Canadian dollar was trapped within relatively narrow ranges as a downturn in domestic expectations was offset by a general lack of confidence in the US dollar with consolidation near 0.9750.

The domestic data was mixed as a sharp gain in the PMI index was offset by a sharp fall in building permits. International conditions tended to dominate and doubts over the global growth outlook were negative for the Canadian dollar even though the currency proved broadly resilient.

The Canadian dollar is liable to drift weaker given unease over the global growth and risk environment, especially as commodity prices will be vulnerable.

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The rupee secured net gains for the week as a whole and approached a one-month high near 44.70 against the US dollar with the currency broadly resilient on Friday despite a weaker Euro.

There was firm demand for the dollar from oil importers, but there was also evidence of increased corporate dollar selling which protected the rupee. There was still unease over the potential for capital outflows if there was a deterioration in regional growth.

The rupee should be able to remain resilient in the short-term even though it will be difficult for the currency to make strong gains given doubts over capital flows.

Hong Kong dollar:

The Hong Kong dollar maintained a generally weaker tone during the week, trading beyond 7.78 against the US dollar as underlying sentiment remained weaker.

The local stock market continued to have a more defensive tone which dampened support for the Hong Kong currency as interest rates moved higher. There was also increased unease over the medium-term risks of instability as Hong Kong is caught between conflicting Chinese and US interest rate policies.

The Hong Kong dollar should be able to resist strong selling pressure, but there will be increased speculation over the peg’s outlook with potentially higher volatility.

Chinese yuan:

The yuan maintained a strong tone during the week and pushed to fresh post-float highs near 6.4750 against the US dollar during the week.

There was further international pressure for China to strengthen the yuan and help improve global trade imbalances. From China’s perspective, the central bank still appeared willing to tolerate gradual appreciation to curb inflation pressures.

There was increased speculation over a slowdown in the property market which curbed speculative demand for the Chinese currency to some extent.

There is still the potential for gradual short-term yuan appreciation, although there will be a growing threat of medium-term instability as capital flows intensify.