Weekly Forex Currency Review 11-03-2011

Monetary policy trends will continue to be watched very closely in the short-term and attention will now tend to turn towards the Federal Reserve which meets next week. Any hint that the bank is moving towards a tighter policy would have a very important currency-market impact, although the evidence suggests that they will tend to be cautious at this stage and keep all options open, especially given high energy prices.

 Key events for the forthcoming week

Market analysis

Dollar: 

The US economic data will maintain expectations of firm growth which will help underpin the dollar. The Federal Reserve will be watched very closely in the near term with some speculation that the central bank will signal an end to quantitative easing once the current bond-buying phase expires at the end of June. The US currency will be in a stronger position to gain ground if the Fed does signal a policy shift.  Risk conditions will have a mixed impact on the currency as any further rise in oil prices could have a negative impact, but there will be support if there is a sustained decline in equity markets or an exodus of funds from emerging markets. The most likely source of dollar strength will be weakness elsewhere rather than strong dollar support.

The dollar remained under pressure early in the week with the Euro challenging resistance levels above 1.40, but the US currency gained some fresh support later in the week as Euro confidence faltered and the trade-weighted index recovered from four-month lows.

Risk appetite had a mixed market impact with the US currency gaining some support from a sharp decline in equity prices, but there was a negative impact from an increase in oil prices, especially after reports that protests within Saudi Arabia had turned violent. The US currency should gain net support from reduced institutional confidence in emerging markets.

The US economic data was weaker than expected with jobless claims rising to 397,000 in the latest week from a revised 371,000 previously, although the underlying trend remained generally favourable. The trade deficit also rose to US$46.3bn from a revised US$40.3bn the previous month. Higher oil prices will put additional upward pressure on the deficit which will maintain medium-term concerns over dollar valuation levels, but higher trade volumes will boost growth hopes.

Markets remained on high alert for comments from Federal Reserve officials ahead of the March 15^th FOMC meeting. There has been further speculation that the central bank will signal that quantitative easing will not be extended beyond June and that the Fed will want to signal this in advance. There were no comments this week from key members that a policy shift was being considered.

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There will continue to be opposing forces on the Euro in the short-term. The probability of an interest rate increase at the April meeting will reinforce the Euro’s yield advantage which will certainly support the currency at times. The currency will, however, be unsettled by structural fears and sovereign debt concerns, especially if political tensions intensify. There will also be fears that any tightening of monetary policy will exacerbate debt problems and increase the risk of medium-term instability.

The Euro maintained a strong tone initially, but was then subjected to fresh selling pressure and retreated on the crosses with lows below 1.38 against the dollar.

The Euro received an initial boost after reports that the ECB was buying European peripheral government bonds which calmed market nerves. The impact was short lived as Portuguese bond yields rose sharply in the latest auction. Benchmark Portuguese yield spreads relative to German bunds also rose to record levels which also had a negative impact on wider confidence.

A downgrading of Spain’s credit rating to AA2 from AA1 reinforced market concerns over sovereign ratings and debt-default risks, especially with a further widening of credit spreads. The widening of yield spreads will increase pressure for Euro-zone governments to secure an agreement this month on extending and improving bailout terms for EU countries which are unable to access market funds.

The Friday EU summit will, therefore, be watched closely, although the impact may be lessened by the fact that no major break-through is expected at this meeting ahead of a bigger summit starting on March 24th.

There were further robust comments on inflation and interest rates from ECB council member Weber and at this stage there is no evidence that the ECB is backing away from an April interest rate increase with.  The Euro will gain support on yield grounds if fundamental doubts can be kept at bay.

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Trends in risk appetite will remain very important and the yen will continue to gain support when global confidence deteriorates. There will also be yen backing from capital repatriation ahead of the fiscal year-end at the end of March with exporters also looking to sell any dollar rallies. The Japanese currency will remain vulnerable on yield grounds in the short-term as rising US and Euro-zone bond yields undermine capital inflows.  From a medium-term perspective, overall confidence in the Japanese fundamentals is also likely to remain fragile and sustained yen gains will be difficult.

The dollar found support weaker than 82 against the yen during the week and strengthened briefly to a high above 83.20 following news of the Japanese earthquake, but it was unable to hold above the 83 level with fragile risk appetite still providing support for the Japanese currency.

The dollar continued to gain support on yield grounds with a further increase in benchmark Treasury yields as optimism surrounding US growth prospects continued. There will continue to be capital repatriation in the near term and exporter selling will also be a feature which will make it difficult for the dollar to make strong headway.

Domestically, there was a 4.2% increase in machinery orders for February which will underpin sentiment towards the economy, but there will be unease over regional economic trends and the risk of a growth slowdown later in 2011.

A small downward revision to the fourth-quarter Japanese GDP data did not have a major impact while the reported Chinese trade deficit had a small impact in dampening risk appetite.

Sterling:

Growth and inflation trends will continue to be watched very closely in the near term given their impact on monetary policy. The inflation outlook will remain troubling in the short-term, especially with a further increase in energy prices. There has been evidence of a downturn in consumer spending and the Bank of England will find it much more difficult to justify higher interest rates if the economy is weakening which would erode Sterling support. The UK currency will tend to be more vulnerable when risk appetite deteriorates and there will be heavy selling pressure if the banking sector comes under fresh pressure.

Sterling held firm early in the week and again challenged resistance levels above 1.63 against the US dollar. Several attempts to break resistance failed and the currency retreated towards the 1.60 level. The UK currency will tend to be more vulnerable selling pressure when there is a deterioration in risk appetite and confidence was fragile during the week.

The Bank of England left interest rates on hold at 0.50% following the MPC meeting and, as usual when there is no change in rates, the bank did not issue a statement. The vote breakdown will not, therefore, be known until the minutes are released in two weeks time.

The consensus was that rates would be left on hold, but there had been some speculation that the bank could raise rates and there was a substantial Sterling decline following the decision. There will be further fears that the bank is more worried about the growth outlook which will tend to undermine confidence in the UK currency and there was a general scaling back of more aggressive interest-rate expectations.

The latest trade data was better than expected with a decline in the goods deficit to GBP7.1bn for January from a revised GBP9.7bn the previous month. The data is likely to have been affected by weather conditions with exports delayed from December helping to boost January shipments.

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The franc will continue to be strongly influenced by trends in risk appetite and there will certainly be support at times when risk conditions deteriorate, especially given the underlying Euro-zone area fears. There will also be optimism that the economy can deal with the impact of currency strength following the recent favourable growth indicators. High volatility is likely to remain an important factor on major shifts in international sentiment with the franc vulnerable on valuation grounds.

The dollar found support below 0.9250 against the Swiss franc and pushed to a high near 0.9360, but trading conditions were erratic as the Swiss currency recovered from initial selling pressure as risk appetite deteriorated again.

There was fresh demand for the Swiss franc on safe-haven grounds as risk appetite deteriorated with the Euro dipping to lows below 1.2850 as equity markets fell sharply. Strength on the crosses made it even more difficult for the dollar to advance.

The Swiss currency also gained support from renewed fears surrounding the Euro-zone debt fears and any increase in political tensions would increase the potential for capital flows into Switzerland.

Domestically, there was a 0.5% increase in consumer prices in the year to February which was broadly in line with expectations and there were no additional fears over deflation at this stage.

Australian dollar:

The Australian dollar continued to hit tough resistance close to 1.02 against the US dollar during the week and there was a generally weaker tone with a slide to lows just below parity later in the week. Risk appetite improved at times, but conditions were generally unfavourable, especially as equity markets came under pressure.

The domestic data provided no real support for the currency with a decline in home-loan approvals compounded by a reported monthly 10,100 decline in employment and a deterioration in consumer confidence.

Even though the currency will rally at times, reservations over domestic and global conditions will tend to make the Australian dollar more vulnerable.

Canadian dollar:

The Canadian dollar resisted maintained a strong tone for most of the week and pushed to 3-year highs just beyond 0.97 against the US dollar. There was support from overall confidence in the fundamentals and the high level of energy prices.

The latest trade data was weaker than expected and there were further concerns over valuation grounds which hampered the Canadian dollar late in the week.

The Canadian dollar will continue to draw support from the high level of energy prices. It will still be difficult for the currency to advance far from current levels.

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The rupee was unable to make any significant headway against the US dollar during the week, but it did prove to be broadly resilient and generally traded within a narrow band around 45.20 against the US dollar.

Risk conditions were generally unfavourable for the currency with global equity markets coming under pressure while oil prices also remained at very high levels which boosted demand for the US currency from oil importers.

The latest industrial production data was better than expected and there was optimism surrounding underlying investment inflows which helped support the rupee.

The combination of weaker international risk appetite and uncertainty over emerging-market inflows will make it difficult for the rupee to make significant headway.

Hong Kong dollar:

The Hong Kong dollar was unable to advance beyond 7.7850 against the US dollar during the week and had a generally weaker tone with a succession of weaker closes and a low near 7.7920.

The currency was undermined by generally weaker risk appetite during the week and the Chinese trade deficit also tended to undermine confidence in the local currency.

The Hong Kong dollar will continue to be more vulnerable when international risk appetite deteriorates and the currency will find it difficult to regain strong support.

Chinese yuan:

The yuan was unable to make further progress against the US dollar during the week and it consolidated weaker than the 6.57 level. The central bank resisted any significant appreciation through the setting of a weaker central rate.

The central bank also stated that it remained committed to a broadly stable and balanced exchange rate which suggested that strong appreciation would be resisted.

The latest consumer inflation data was slightly higher than expected at 4.9%, unchanged from January, which maintained speculation that the central bank would need to tighten monetary policy further in order to curb inflationary pressure.

The central bank will see a firm exchange rate as useful in helping to control inflation, but stability is likely to be a priority, especially given volatile emerging-market flows.

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