Weekly Forex Currency Review 11-10-2013

US budget and debt negotiations will continue to have a crucial short-term impact. Markets are expecting some form of compromise and failure would trigger a sharp increase in volatility. The dollar will be hampered by expectations that the Fed will be reluctant to taper bond purchases this year, but the ECB will also be under increasing focus and under pressure to relax policy, especially if Euro-zone demand starts to falter again.

Key events for the forthcoming week

Market analysis

Dollar:

US congressional negotiations will dominate in the very short-term with the Federal government still closed and no deal to raise the debt ceiling. There are expectations that there will be a congressional deal within the next few days and any agreement would tend to provide limited dollar support. The focus will also be on monetary policy and there will be speculation that a tapering of bond purchases will be pushed even further back given economic doubts. There will also be expectations of a dovish Fed stance under next Chair Yellen. The overall US structural fundamentals should still provide important underlying support to the dollar, especially with European doubts likely to increase again.

The dollar was able to make some gains during the week, although underlying sentiment was still relatively fragile

The White House announced that Yellen would be nominated as Fed Chair on Wednesday. Markets expect that she will maintain a very expansionary monetary policy next year which immediately weakened the dollar, but it regained composure with relief that uncertainty over the appointment had been alleviated.

Regional Fed President Evans maintained a generally dovish tone in comments with a call for more accommodative monetary policy and the possibility of lower the unemployment rate threshold for considering an increase in interest rates. Bullard stated that a tapering of bond purchases was less likely in October due to the shutdown and the underlying dovish Fed tone continued to dampen dollar sentiment.

The Fed minutes from September’s policy meeting were broadly in line with expectations with a confirmation that the decision not to taper purchases was a very close call. Some members were concerned that recent data releases had been weaker than expected and there were concerns that market rates could increase. There were clear divisions between voters and non-voters with the latter camp much keener to start the tapering process.

The US initial jobless claims data was sharply higher than expected at 374,000 in the latest week from 308,000 previously. There were distortions from the continuing impact from California’s computer-system switch and there was also some impact from the Federal government shutdown which accounted for around 15,000 claims.

There were tentative negotiations between US Congressional parties and the potential for a deal on a short-term increase in the debt ceiling in return for wider budget negotiations. There was some further optimism that a deal could be reached by early next week, although it is possible that the debt ceiling could be increased without re-opening the Federal government. A short-term solution would also not provided sustained relief to the underlying situation.

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The Euro-zone has generally been out of the limelight over the past few weeks with attention fixed firmly on US political developments. The Euro-zone has managed to maintain some marginal growth, but there will be fears that conditions will deteriorate again quickly, especially if monetary conditions tighten further. The ECB will adopt a dovish stance and there will be strong pressure for further monetary accommodation and another LTRO to boost liquidity. There are still very important political stresses as unemployment levels remain at extreme levels. Any fresh downturn in growth could trigger major political protests and a weaker currency.

The Euro drifted weaker, although losses were limited with euro-zone developments a secondary factor while the currency gained some support as a refuge from the US stresses. The Euro retained an important element of being a defensive asset as fears surrounding peripheral economies were over-shadowed for now by US concerns

As far as the Euro-zone is concerned, the Sentix business confidence index was slightly weaker than expected with a slight decline to 6.1 for September from 6.5 previously, in contrast to expectations for a further modest improvement.

There was further speculation that a gradual tightening in market liquidity through a repayment of LTRO loans would tend to put upward pressure on the Euro. There was also speculation that the ECB would be less concerned over Euro gains given that money-market rates have not been increasing. Nevertheless, there will still be important concerns within the central bank given the threat of a renewed downturn.

ECB President Draghi also maintained a dovish tone in a speech on Thursday. He stated that the central bank had an explicit easing bias with downside risks to the economy. The markets did not take significant notice of the remarks, but there will be an eventual threat that the Euro will suddenly be subjected to selling pressure

Yen:   

Defensive considerations will remain important in the short-term and if US politicians miscalculate and fail to raise the debt ceiling the yen would be likely to gain strong support. Overall yield considerations will remain negative for the yen even if there is no increase in US yields. The Bank of Japan will also maintain a highly-expansionary monetary policy. There will be further important concerns surrounding Japanese fundamentals as the underlying debt situation remains extremely vulnerable.

The dollar was unable to make any impression on the yen early in the week and dipped to test support levels below 97.0. The yen continued to gain defensive support from fears over the US government shutdown situation. The yen gradually lost ground as sentiment towards the US gradually turned more optimistic.

There was increased optimism that Congress would be able to reach a budget agreement within the next few days which helped underpin risk appetite and also provide net support for the dollar during the New York session. Although there was no deal, there was optimism that an arrangement could be secured over the weekend. With a Japanese holiday on Monday, there was a reluctance to hold short dollar positions during Friday and the US currency rallied to the 98.50 area.

The adjusted Japanese current account surplus was substantially weaker than expected at JPY0.35trn from JPY0.32trn the previous month which will maintain concerns over longer-term Japanese fundamentals and will tend to be a negative yen factor. The latest capital account data-recorded a record selling of foreign bonds in the latest week, illustrating the threat of a yen surge if there is a US default. The latest machinery orders was stronger than expected with a 5.4% monthly increase

From a longer-term perspective, there were expectations that the Bank of Japan would maintain a highly-expansionary policy and introduce further easing next year.

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There will be expectations of a robust third-quarter GDP release. The most recent data releases will, however, tend to trigger some downward adjustment to expectations and overall enthusiasm for the economy is liable to fade. The Bank of England will also maintain an expansionary monetary policy which will curb yield support. There will also be concerns surrounding the UK fundamentals given the weak trade data and Sterling will be vulnerable to a deterioration in risk appetite.  Overall, the currency is liable to be subjected to renewed selling pressure over the next few weeks.

Sterling weakened against the dollar during the week with a combination of profit taking and some increased unease surrounding the UK outlook.

Sterling briefly dipped sharply on Tuesday as the Bank of England announced it would hold a long-term repo operation on Wednesday. Markets initially thought this was a new instrument by the central bank which would have represented a net easing of monetary policy with a determination to push shorter-term market rates down.

The UK economic data was much weaker than expected with industrial production registering a decline of 1.1% for August compared with expectations of a small monthly increase.  The trade data was also worse than expected as the monthly goods deficit only fell marginally to GBP9.6bn for August from GBP9.9bn previously as the overall export performance remained disappointing.

The data increased fears both over the pace of the UK economy and the threat that growth remains very unbalanced and dependent on consumer spending. The latest NIESR GDP estimate was 0.8% for the three months to September. This estimate is important as it should correspond to GDP growth for the third quarter and there will tend to be further scaling back of the more optimistic forecasts

There was no surprise from the Bank of England with interest rates left on hold at 0.50% and quantitative easing also left at GBP375bn.

Swiss franc:

Defensive considerations will be important and the franc will tend to lose ground if there is a US budget deal. In contrast, any failure to raise the US debt ceiling could trigger a sudden surge in franc demand. The franc will remain vulnerable on yield grounds and there will tend to be net capital outflows from Switzerland if capital markets normalise. Overall, despite gains at times, the most likely outcome is that there will be net selling pressure on the Swiss currency.

The franc was unable to sustain gains during the week as risk conditions gradually improved. The Euro pushing to highs above 1.2320, the strongest level for three weeks. In this environment, the US currency was also able to hold its position against the Swiss currency as it held close to the 0.91 level.

Defensive considerations remained important and hopes for a negotiated deal in Washington curbed immediate demand for the Swiss currency as equity markets rallied. There were also expectations that overall capital flows were less favourable.

National Bank Chairman Jordan stated that it had not needed to enforce the franc’s Euro cap for 12 months which maintained expectations that underlying pressures had eased which could eventually weaken the Swiss currency

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The Australian dollar was confined to relatively narrow ranges during the week with resistance on any move to the 0.95 area while there was support below the 0.94 level. Risk appetite was broadly resilient even with US debt fears which stifled selling pressure on the Australian currency.

There were mixed economic releases with a decline in unemployment, but a lower than expected increase in employment. There was an increase in business confidence while consumer sentiment declined. Overall, there was slightly greater confidence in the domestic economy which provided some degree of support.

The Australian dollar will gain some support if there is an improvement in global risk appetite and sign of domestic recovery, but a strong advance looks unlikely.

Canadian Dollar

The Canadian dollar edged generally weaker with lows beyond the 1.04 level against the US currency. Oil prices were generally lower which sapped support for the Canadian currency. The trade data was weaker than expected with a CAD1.3bn deficit for August while there was a sharp decline in building permits for the month.

The Canadian dollar will be hampered by lower oil prices and doubts over the domestic housing sector, but the currency should be broadly resilient.

Indian rupee:

The rupee was able to hold a solid tone during the week and strengthened to a two-month high beyond the 61.50 level against the US currency. Overall dollar demand was generally weaker which helped underpin the local currency.

There was a general reduction in dollar demand while rupee sentiment was also firmer. The government looked to issue a new bond which would attract capital flows and there were also moves to get India included in the global bond index which would potentially boost capital inflows. There was also some reduction in fears surrounding the current account deficit which is likely to be lower than expected for this year.

The rupee will continue to gain some protection from a decline in US yields and reduced pressure on wider emerging-market assets, but with limited scope for gains.

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The Hong Kong dollar held slightly firmer during the week with levels beyond 7.7550 against the US currency. Underlying dollar demand was weaker and there was a slightly firmer Chinese yuan which maintained speculation that there would be medium-term pressure to peg the currency against the Chinese currency.

There will be a continuing debate surrounding the longer-term Hong Kong currency peg, especially if the yuan continues to strengthen, but with stability for now .

Chinese yuan:

The Chinese yuan edged slightly stronger to beyond 6.12 against the dollar during the week, although ranges were relatively narrow. There was speculation that the PBOC wanted to maintain low volatility ahead of a series of crucial political and economic policy meetings during November.

There was also speculation that the bank would look to narrow the gap between the spot rate and fixing rate in advance of a widening of the yuan’s trading band. There was caution ahead of the latest trade and inflation data due in the next few days while the PBOC also announced a swap facility with the ECB.

With China holding a key economic policy forum next month the PBOC is likely to aim for stability, although there is the potential for a widening of the trading band.

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