Weekly Forex Currency Review 11-02-2011

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Inflation pressures and the central bank responses to rising food and energy prices will continue an important global focus in the short-term. The evidence suggests that G7 authorities will take further time to asses developments and there appears little momentum for a very short-term change in policies. It will be more difficult for Asian countries to resist interest rate increases, but they will also be very concerned over potential speculative capital inflows which would increase the threat of capital controls.           

 Key events for the forthcoming week

 Market analysis

 Dollar: 

Although the headline payroll data was weaker than expected, the general theme of recent releases and survey evidence has suggested that the US economy is growth more robustly with an easing of credit conditions. There will be doubts whether the improvement can be sustained, but there will be dollar support from the rise in US Treasury yields.  There will still be expectations that the Fed will maintain a highly-expansionary monetary policy which will limit currency support. The US budget position will remain an important focus and there will be further unease over the longer-term risk of a credit-rating downgrade. The dollar will remain dependent on weakness elsewhere to make strong headway.

The dollar gained support from a rise in US bond yields during the week and advanced against the yen while it recovered from intra-week lows against the Euro with a move back towards 1.3550.

US jobless claims fell to 383,000 in the latest week from a revised 419,000 previously which countered the weaker than expected payroll report at the end of last week. The employment report overall was also mixed as unemployment fell to 9.0% from 9.4%.

There was a slight fall in the latest US consumer confidence reading, but this followed a big rise the previous month. There was still a feeling of optimism surrounding the economy following recent data and benchmark 10-year Treasury yields rose to a fresh 9-month high above 3.75%.

The comments from Fed Chairman Bernanke were watched closely, especially as two Regional Fed Presidents had voiced opposition to any further quantitative easing. In congressional testimony, Bernanke stated that economic conditions were improving and that price stability was the Fed’s over-riding objective. He also stated that unemployment was unlikely to return to normal levels for several years which maintained speculation that the Fed would be very slow to tighten policy given its dual mandate of price stability and employment.

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EU political leaders will look to strengthen mechanisms for alleviating the debt crisis within weaker peripheral countries. There will be fears that underlying tensions will block progress and there will also be fears that there will be no escape route from recession for weaker economies. There will, therefore, still be a high degree of unease over the risk of debt restructuring which would tend to renew selling pressure on the Euro.  Monetary policy will also be an important focus and the Euro will gain support at times from a tough ECB line on inflation even though there will be doubts whether the bank will be in a position to raise interest rates. Overall, the Euro will find it difficult to make strong progress.

The Euro rallied over the first half of the week, but failed to sustain the gains and weakened over the second half as confidence started to deteriorate again.  

There were renewed tensions within the Euro-zone peripheral bond markets which unsettled the Euro as Portuguese benchmark bond yields rose sharply above 7.5% to the highest level since the Euro’s introduction. There will, therefore, be renewed fears that Portugal will effectively be shut out of international capital markets which would also force it to accept multilateral support and undermine Euro confidence.

There is also substantial resistance to competiveness proposals put forward by Germany and France and fears that these measures will be forced through as a condition of providing increased financial support for weaker members.

Manoeuvrings surrounding Trichet’s replacement as ECB President also remained an important market focus.  Bundesbank Weber declined the opportunity to make a formal statement on his future, but the evidence suggests strongly that he will not be a candidate for the ECB post. The appointment of German anti-inflation hawk would have been an extremely useful tool for Chancellor Merkel in defusing internal opposition to increased EU bailout funds.

If Weber is not a candidate then Merkel’s position will also be weaker and this will increase net risks to the Euro. There were also reports that The ECB was back in the market buying peripheral bonds for the first time since late January.

ECB member Mersch stated that the central bank would take action if the inflation rise was not temporary, reinforcing expectations that the bank will take a wait and see attitude in the short-term.

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There will be near-term yen support from capital repatriation and there will also be yen support when wider global risk appetite deteriorates, especially if there are fears over a sharp slowdown in Asian growth rates. Yield trends will remain important and the yen will be undermined by higher US yields.  There will also be further unease over the domestic debt situation with expectations of long-term yen depreciation. In this context, any yen gains are unlikely to be sustained.

The dollar found support below the 82 level against the yen during the week and advanced to near 2011 highs just above 83.50.

There were further reports of export selling towards the 83 level and there was also evidence of capital repatriation back to Japan which underpinned the yen and also curbed speculative dollar buying.

There were comments from a Moody’s analyst warning over the negative consequences if there is no fiscal reform by Japan, although there were also comments that the country was still a long way from a crisis situation. 

Domestically, there was also a rise in machinery orders for the first time in three months, but the 1.5% gain was lower than expected and confidence in the economy will remain fragile even with the Bank of Japan taking a slightly more optimistic tone.

Sterling:

Inflation and growth trends will continue to be watched very closely in the short-term. There will be additional pressure on the Bank of England to raise interest rates if the headline rate rise again. The central bank’s decision not to increase rates this month will, however, also be seen as a tacit admission that the underlying economy is weak.  The overall policy mix will tend to remain a tight fiscal stance and loose monetary stance which will tend to limit Sterling support. Weaknesses in other key economies will be important in stemming selling pressure on the UK currency with high volatility likely to remain the key feature.

Sterling was subjected to choppy trading during the week and there was a slight net decline against the US currency even though it held above 1.60.

The government announced a GBP0.8bn increase in the 2011 banking sector levy which had a negative Sterling impact, especially as there was a stock-market retreat.

As far as the economic data is concerned, there was a modest improvement in the RICS house-price index to -31% for January from -39% while the BRC retail sales report recorded 2.3% annual sales growth and shop-price inflation rose.  The trade data was weaker than expected with an increase in the goods deficit to a record high of GBP9.2bn. There was a suspicion that the data had been distorted by adverse weather conditions, but the underlying trend will continue to give cause for concern.

The Bank of England left interest rates on hold at 0.50% which had been the expected outcome despite speculation that there could be an increase. There was no statement with the decision and the vote breakdown was also not known. Sterling dipped briefly following the announcement, but recovered ground quickly on the assumption that the bank would increase rates within the next three months. The quarterly inflation report will be watched very closely next week for further growth and inflation evidence.

Given the deteriorating inflation outlook, there will be market fears that the Bank of England is expecting the economy to weaken further in the near term and this is likely to cap any Sterling gains. There was also a weak NIESR monthly GDP estimate which will have some negative impact on sentiment. 

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Defensive demand for the Swiss currency will diminish when confidence in the global economy improves and risk appetite is robust. A sustained improvement in the Euro-zone outlook would also tend to weaken the Swiss currency, a trend which would certainly be welcomed by the National Bank. Substantial franc losses look unlikely, especially as there would be pressure on the central bank to raise interest rates in the event of a weaker currency trend. Euro-zone fears are also liable to return given underlying stresses.

The franc was generally weaker against the Euro as defensive demand for the currency waned.  The dollar was able to take advantage of the trend and pushed to a four-week high just above 0.97. The franc’s inability to gain much support from Euro tensions suggests that underlying demand for the currency is weaker.

The latest Swiss consumer inflation data was weaker than expected with a 0.4% monthly decline in prices which will tend to increase fears over deflation pressures from a strong currency and will also tend to increase pressure on the National Bank to resist renewed franc appreciation.

Australian dollar:

The Australian dollar pushed to a high near 1.02 against the US dollar, but was unable to break higher and weakened steadily over the second half of the week as it dipped below parity for the first time since early February.

The headline employment report was stronger than expected with a 24,000 increase in jobs, but there was a decline in full-time employment and confidence in the economy remained slightly weaker. Reserve Bank Governor Stevens stated that an interest rate increase was unlikely in the near term.

Overall risk appetite was slightly more fragile and the further increase in Chinese interest rates had a negative impact on the Australian dollar as commodity prices fell.

There are likely to be further  reservations over the domestic and international outlook which will toughen resistance levels for the  Australian dollar.

Canadian dollar:

The Canadian dollar was unable to break through the 0.9850 level against the US currency following stronger than expected employment data at the end of last week and the currency gradually weakened, although there was support close to parity.

The Canadian dollar drew support from the high level of oil prices during the week, especially after rumours that Saudi Arabia’s King had died.

The domestic influences were limited over the week as a whole and there was still an important suspicion that the Bank of Canada was opposed to a stronger currency.

The Canadian dollar will find it difficult to advance given the commodity-price strength already priced in and the Bank of Canada will be uneasy over currency gains.

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The rupee again found support on retreats towards 46 against the US dollar during the week, but it was unable to make any significant progress.

The local share market remained under pressure as it declined to a seven-month low with further evidence of overseas capital outflows. There was also further dollar buying by oil importers which had a negative impact on the local currency. There were expectations that interest rates would increase further which also dampened sentiment towards the local share market.

The rupee should be able to resist substantial losses, but a significant recovery is unlikely given high energy costs together with the domestic and global risk profile.  

Hong Kong dollar:

The Hong Kong dollar generally remained under downward pressure against the US currency even though markets were closed for much of the time for the Lunar New Year. There was a negative impact on the currency from higher US yields.

There was downward pressure on the local stock market which pushed the Hong Kong currency to lows just beyond 7.7920 against the US dollar.

The Hong Kong dollar will lose ground when international risk appetite deteriorates, but sustained pressure on the currency looks unlikely in the short-term.

Chinese yuan:

The Chinese markets were shut during the first half of the week, but there was a spike in activity as the Central bank increase interest rates on the last day of the holiday. The US Treasury declined to name China as a currency manipulator, but there was further pressure for a stronger yuan.

The lending rate was increased by a further 0.25% to 6.06%. There were also expectations that the central bank would use the strong yuan as a useful tool against inflation. Nevertheless, the central bank showed its resistance to rapid currency gains as it fixed the currency sharply weaker beyond 6.595 on Friday.

Uncertainty over the economy and policy response is likely to increase in the short -term. The central bank is likely to tolerate overall gradual yuan appreciation, but there is liable to be increased volatility.

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