Weekly Forex Currency Review 10-12-2010

Over the next few weeks, there will be a strong focus on contrasting policy options within the US and Europe. While the US is promoting highly-expansionary policies and risking higher deficits to promote short-term growth, the Euro-zone is looking to keep debt levels under control and improve the longer-term position. The perceived successes of these contrasting policy stances will be very important for currency-market sentiment.            

Key events for the forthcoming week

Market analysis

Dollar:

The latest US economic data releases will maintain expectations of a slightly firmer economic tone and investment inflows, especially with expectations that tax-cut extensions will boost consumer spending.  There will still be a high degree of unease over the policy framework, especially as tax cuts will tend to widen the budget deficit. There will also be speculation that the Federal Reserve will seek to keep bond yields down which would also tend to curb dollar support. It remains the case that the dollar will find it difficult to make much headway without a persistent deterioration in risk appetite.

The US currency retreated sharply at the end of last week following the much weaker than expected US employment data with the non-farm payroll increase held to 39,000 for November while unemployment rose to 9.8%. The dollar secured a net advance against the Euro during the week and also spiked higher against all major currencies in mid week, but the US currency found it difficult to sustain gains.

There was optimism that President Obama’s proposals to broker a deal over an extension of tax cuts could bolster growth within the US economy and this was important in pushing US bond yields sharply higher which also supported the dollar.

There was also an increase in consumer credit for the second successive month which will create some optimism over near-term consumer spending trends and a potential easing in the credit restrictiveness seen over the past 2 years. Greater confidence in US growth prospects will increase the potential for increased investment inflows, although it will also pose very important longer-term structural risks.

The latest US jobless claims data was better than expected with a decline to 421,000 in the latest week from a revised 438,000 and overall confidence in the economy is likely to remain slightly higher which will provide some dollar support. This backing will be tempered by speculation that the Federal Reserve will look to push Treasury yields lower.

The US developments illustrated the sharp divisions between US and Euro-zone policies with many Euro members tightening fiscal policy in an attempt to narrow budget deficits. Markets wanted to give the dollar the benefit of the doubt, but there were still very important US vulnerabilities which curbed US currency support.

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The Euro-zone structural vulnerabilities will remain an extremely important focus over the next few weeks at least. It will be very difficult to secure a sustained improvement in market confidence with the risk that governments will not be able to find a formula to strengthen the medium-term outlook. The ECB will need to maintain its special liquidity measures and an increase in bond buying would compromise longer-term confidence in the central bank. Overall, it will be difficult for the Euro to secure more than temporary relief.

The Euro remained on the defensive for much of the week, but did recover from lows as markets also had important doubts surrounding other major currencies.

The Euro-zone debt-market developments remained a key focus as markets continued to fret over medium-term vulnerabilities The Irish government presented its 2011 budget and package of spending cuts and won an initial parliamentary vote on the measures. This failed to have a significant impact in boosting confidence and there were persistent fears surrounding a contagion effect.

Ratings agency Fitch downgraded Ireland’s bond rating by a further three notches as debt costs continue to spiral higher. Confidence surrounding Ireland remains extremely weak and a key problem for the Euro is that uncertainty will persist with the Irish parliament still debating the budget and a vote on whether to approve the aid package is due to be held next week.

There was continued speculation over additional measures to support weaker Euro-zone members with further debate surrounding possible Euro-bond issuance, although these plans appears to have been rejected by Germany and potential opposition to additional support continued to have a negative Euro impact.

Discussions will continue ahead of the EU summit due to be held at the end of next week and the Euro will be vulnerable to further selling pressure if there are public disagreements over plans.

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Underlying confidence in the Japanese economy will remain weak and there will be further pressure any yen gains to be resisted in order to underpin the competitive sector. The Korean situation will also continue to be monitored and the yen will be vulnerable to some selling pressure if tensions intensify again. There will be caution over aggressive capital outflows from Japan, especially given a lack of  confidence in the Euro-zone and US economies. Without substantial capital outflows, the yen will be resist to heavy selling pressure.

The dollar rose strongly in mid week with gains to a peak just above 84 against the yen from lows near 82.50 as US Treasury yields rose strongly. The dollar then drifted lower as yield stabilised at higher levels.

There was further speculation over a possible Chinese move to increase interest rates over the weekend, especially with key economic data release dates brought forward to Saturday and this provided some near-term yen support. If there is no Chinese move to raise rates then the yen would be vulnerable to renewed selling pressure.

Domestically, there was a deterioration in fourth-quarter business confidence according to the latest Bank of Japan survey while consumer confidence weakened. The other Japanese data was generally weaker than expected with a 1.4% decline in core machinery orders while there was a contraction in bank lending for the 21st consecutive month. There will be persistent unease over Japanese growth trends which will maintain pressure for yen gains to be resisted.

Sterling:

There will be expectations of a sharp economic slowdown during the first quarter of 2011 as tax increases take effect and there will be strong pressure on the Bank of England to maintain a highly-expansionary monetary policy which will curb Sterling support. In relative terms, the lack of confidence in the US and Euro-zone will continue to provide very important currency protection. Sentiment could, however, fluctuate sharply with fears that the banking sector would be damaged by any sustained downturn in the housing sector. In this context, Sterling sentiment could fluctuate sharply.   

Sterling proved resilient during the week with support near 1.5650 against the dollar and it also tested two-month highs beyond 0.8380 against the Euro. It continued to gain some degree of protection from underlying fears surrounding the Euro-zone. The situation is still complex as there remains a risk that Sterling will get dragged into a wider loss of confidence surrounding European economies and currencies.

The UK economic data had a slightly positive tone with a higher than expected increase in manufacturing output for October, although there was a decline in industrial production as a whole.  The NIESR estimated that GDP growth was 0.6% in the three months to November which was slightly higher than the previous estimate and reinforced hopes for a robust fourth-quarter performance.

The positive Sterling impact is still likely to be offset by unease over the first quarter of 2011 when there is liable to be a sharp slowdown and the housing data also remained generally weak with a further decline in the Halifax house-price index.

As expected, the Bank of England left interest rates unchanged at 0.50% following the latest MPC meeting and the quantitative easing total was also held steady at GBP200bn. There was no statement and details of the discussion including the vote split will not be known for 2 weeks. There was some further criticism of central bank Governor King for straying into the political arena.

The latest trade data was again disappointing with the goods-related deficit rising to GBP8.5bn for October from a revised GBP8.4bn previously and this dampened hopes for a sustained export-led recovery.

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International developments are liable to remain dominant in the short-term and the franc will maintain defensive support on a lack of confidence in the Euro-zone. There is also a possibility of much more substantial capital flight away from the Euro into the franc if the ECB is unable to restore confidence. The National Bank is likely to remain vigilant over the possible deflation threat and the forthcoming policy meeting will be watched very closely. Without a sustained improvement in Euro-zone sentiment, the franc should prove broadly resilient.

 The franc maintained a firm tone over the week with the Euro testing support below 1.30 while the dollar was unable to make any fresh attack on resistance levels above parity as it tested support below 0.98.

The franc continued to gain crucial support on defensive grounds from a lack of confidence in the Euro-zone outlook.

 Domestically, the seasonally-adjusted unemployment rate held steady at 3.6% for November There will be caution ahead of the National Bank’s quarterly monetary policy meeting next week as the bank could signal its opposition to further franc gains

 Australian dollar:

The Australian dollar strengthened sharply at the end of last week following the weaker than expected US employment data and held the bulk of the gains.

Domestically, there was another large increase in employment for November which boosted optimism towards the economy and currency. The PMI surveys remained generally weak which had some negative impact on sentiment.

The Australian currency drew some support from a higher than expected Chinese trade surplus and metals prices also rose, but the impact was offset by fears over a further increase in Chinese interest rates.

Australian dollar volatility is liable to remain high in the short-term with the potential for sharp fluctuations in sentiment. Resistance levels are likely to remain strong on any move to the parity area against the US currency.

Canadian dollar:

The Canadian dollar hit tough resistance close to parity against the dollar and dipped sharply weaker during the middle of the week, but it ended broadly unchanged with buying support apparent on dips.

As expected, the Bank of Canada held interest rates unchanged at 1.00% following the latest council meeting. The bank was generally cautious over the economic outlook with a warning that export growth had slowed. There were also increased concerns over the level of personal debt which undermined confidence to some extent.

It will remain difficult for the Canadian dollar to secure a strong advance from current levels, especially if there is increased market concerns over debt levels.

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The rupee maintained a generally firm tone over the week as a whole and the currency advanced to a 3-week high beyond 45.30 against the dollar before correcting slightly weaker. There were net overseas inflows into the local stock market for the week as a whole, although there was a more cautious attitude late in the week.

The latest industrial production data was stronger than expected which provided some degree of relief, but there were still reports that the Reserve Bank would intervene if the market if necessary to curb rapid rupee gains.

The rupee should prove to be broadly resilient in the near term, although it will be difficult to advance far, especially given background competitiveness concerns.  

Hong Kong dollar:

The Hong Kong dollar was unable to secure renewed support during the week and retreated to lows near 7.7750 against the US currency.

The currency was unsettled by a rise in yields and there was further unease over the possibility of fresh monetary tightening and policy restrictions by the Chinese authorities which curbed capital inflows.

The Hong Kong dollar will lose ground when risk appetite deteriorates, but heavy selling pressure from current levels should be resisted given the fundamentals.

Chinese yuan:

The yuan edged firmer over the week as a whole and consolidated close to 6.65 against the US currency on Friday with NDF markets also continuing to signal gradual appreciation for the Chinese currency.

The latest trade data was stronger than expected with annual export growth close to 35% and this increased speculation that resistance to a faster pace of yuan appreciation would diminish.

There was further over a further near-term increase in interest rates, especially with a suspicion that the latest inflation data would be stronger than expected.  

There will be continuing expectations that yuan appreciation will accelerate in the medium term, especially following strong export data.

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