Weekly Forex Currency Review 14-02-2014

Global monetary policies will continue to be an important underlying influence in the short-term. Further tapering by the Federal Reserve, a refusal by the ECB to sanction additional more aggressive policy action and tightening in China would tend to increase global deflation fears and trigger fresh currency instability over the next few weeks.
 
Key events for the forthcoming week

Market analysis

Dollar:

At this stage, despite another disappointing US employment release, markets are expecting that the Fed will continue to taper bond purchases at the next policy meetings. Comments from Fed Chair Yellen also continued to suggest that the Fed will look to resist any change in tapering plans. There will, however, be speculation over a policy shift if economic data releases remain disappointing which would also undermine the dollar’s yield support. The currency will also tend to lose ground if there is a closing of long positions. There should still be important protection from underlying fundamentals and the dollar will also gain significant support if emerging-market stresses intensify again.

The headline US employment data was weaker than expected with an increase in non-farm payrolls of 113,000 for January following a revised 75,000 gain the previous month.  Details within the report were mixed as the unemployment rate fell to fresh five-year low of 6.6% while government jobs declined sharply. The dollar was unable to gain any traction from the data and maintained a more subdued tone throughout much of the week with 3-week lows on a trade-weighted basis.

In an initial response, the dollar weakened sharply with a Euro peak around 1.3640. The dollar did regain some composure after initial selling pressure was absorbed. Dallas Fed President Fisher stated that the Fed would not be swayed by a single data point which helped provide some US currency relief.

Yellen’s prepared text in congressional testimony was in line with expectations with comments that the labour market is still fragile and that recovery if far from complete. There were also comments that monetary policy will remain highly accommodative even after quantitative easing ends. Yellen did indicate that the pace of tapering would continue if the economy performed as expected. The comments overall continued to suggest that there will be a high barrier to halting the tapering process.

The latest US retail sales data was weaker than expected with a headline decline of 0.4% for January, the second successive monthly fall, while core sales were unchanged over the month. The jobless claims was also slightly weaker than expected at 339,000 from 331,000 previously. Although this was still a solid release in underlying terms and there was only a limited decline in US bond yields, underlying US sentiment remained slightly weaker.

The Euro was unable to make a move much above 1.3680, although there were only limited retreats as the dollar remained on the defensive

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Monetary policy will continue to be watched very closely in the short-term. The ECB is uneasy surrounding the growth potential and threat of deflationary pressures.  It is, however, also extremely wary over the potential for further cuts in interest rates and it will be very difficult to secure support for any form of quantitative easing.  The existing monetary policy will provide net Euro support, but market sentiment could turn rapidly if the economy starts to deteriorate again. There will also be underlying concerns surrounding the political situation, especially in Italy. Although the Euro can hold firm for now, the currency is likely to be increasingly brittle.

The Euro remained resilient and tested important resistance levels around 1.37 against the dollar despite some vulnerability on the crosses.

There were further uncertainties surrounding last week’s Constitutional Court ruling surrounding proposed bond-buying plans buy the ECB. Markets had initially assumed the plans would not be derailed, but there have been a generally more sceptical degree of analysis this week which has maintained underlying concerns, especially if peripheral yield spreads start to widen again.

Executive-board member Coeure commented that the ECB was taking the possibility of negative interest rates very seriously even if the impact would probably be limited. In response, the Euro dipped to lows below 1.3570.

The latest ECB economist projections showed lower consumer inflation forecasts for 2014, but they also expect inflation to rise back towards the 2.0% target in 2016, a period which has been marked-out by ECB President Draghi as crucial when considering interest rates. The forecasts provided a measured Euro move higher on reduced speculation of action to relax policy at March’s council meeting.

The Euro was able to resist any significant selling pressure despite continued tensions within the Italian government. Prime Minister Letta announced that he would tender his resignation to the President on Friday and market concerns will increase if the chances of fresh elections appear to increase while a new, more stable, administration without elections would provide some support.

Yen:   

There has continued to be a net deterioration in the balance of payments position with the current account close to moving into deficit. This will continue to weaken the yen’s underlying support base. The currency will also be vulnerable if there is evidence that the Bank of Japan will push for additional quantitative easing as growth stumbles. The yen will still gain some interim support when risk appetite deteriorates, especially if there is serious selling pressure on emerging-market currencies.

The dollar was unable to gain any significant support against the yen with resistance above 102.50 while the yen was resilient against the crosses and the US currency tested support near the 101.50 area as the Nikkei weakened on Friday.

Fed Chair Yellen’s second congressional testimony was cancelled due to adverse weather conditions and weather was also a contributory factor to the disappointing sales data which helped cushion the dollar from more aggressive selling.

The latest current account-data displayed a deficit for December, maintaining longer-term expectations of yen weakness. From a shorter-term perspective, the latest Japanese capital-account data documented substantial selling of foreign bonds by domestic institutions in the latest week which will underpin the balance of payments and tend to provide underlying yen support.

There was slightly reduced speculation that the Bank of Japan would sanction further quantitative easing over the next few months which dampened yen selling pressure. In contrast, a stronger than expected set of Chinese data helped underpin risk appetite which curbed yen demand and the dollar consolidated just below the 102.50 level.

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Sterling will continue to gain short-term support on growth and yield expectations. Although the Bank of England is looking to resist any interest-rate increase for the next 12 months at least, there will be expectations that the UK will be the first major economy to raise interest rates. There will be a significant shift in expectations if growth starts to deteriorate again and concerns surrounding the fundamentals are also liable to increase. Given these vulnerabilities, Sterling sentiment could reverse very quickly, especially as it is significantly over-valued against the dollar.

Sterling gained strong support during the week, pushing to 30-month highs above 1.6650 against the dollar and also testing 14-month highs against the Euro.

There was a stronger than expected reading for the BRC retail sales index with a 3.9% annual increase in like-for-like sales which provided some relief over spending trends.

There was a high degree of speculation and anticipation surrounding the latest Bank of England inflation report and there was no disappointment in terms of market volatility.  The central bank sharply upgraded its GDP growth forecasts for the economy with 2014 GDP growth now estimated at 3.4% while maintaining expectations that inflation would stay in check over the next two years.

The 7% guidance threshold for unemployment was maintained, but the bank also insisted that additional factors such as wages would be taken into account and suggested that the unemployment rate was over-stating strength within the labour market. Overall, the bank continued to estimate that there would be sufficient spare capacity in the economy to avoid having to tighten monetary policy this year. Bank Governor Carney did not express any major concerns surrounding Sterling’s level.

Swiss franc:

With the Swiss economy continuing to perform strongly in the short-term, markets will continue to look at indicators of asset prices and inflation. The National Bank will remain concerned surrounding over-heating in the property sector, but the measures of wholesale and consumer inflation have certainly remained extremely benign which will lessen the potential for tolerance of any franc gains. The minimum Euro level will be maintained for now with the franc gaining support when risk appetite deteriorates.

There have been no major shifts in emerging-market currencies which has eased potential defensive demand for the Swiss currency, although there will still be an underlying mood of caution, especially with concerns surrounding the Chinese outlook. The dollar hit selling above 0.90 with the franc resilient on the crosses.

Domestically, there was a 0.3% monthly decline in consumer prices which was in line with expectations while there was a 0.1% annual increase. The data will maintain some underlying caution surrounding potential deflation risks and will maintain National Bank unease over letting the franc appreciate. Producer prices were unchanged in January for the second successive month.

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There was another week of high volatility for the Australian dollar, buffeted by domestic and international factors. There were further concerns surrounding the Chinese economy, offset to some extent by a slightly more stable tone in major emerging markets. The currency peaked near the 0.91 level against the dollar before retreating back below the 0.90 level.

There was a mixed set of data as a further improvement in business confidence was offset by a further decline in home loans and a weaker than expected employment report for the second successive month which triggered some renewed speculation that the Reserve Bank could sanction a further interest rate cut.  

The Australian dollar will continue to be subjected to high volatility and will be subjected to renewed selling if fears surrounding the Chinese outlook intensify.
 
Canadian dollar:

The Canadian dollar was able to resist a fresh move beyond 1.11 against the US dollar during the week while hitting resistance on approach to 1.0950. There was a firmer tone to oil and gold prices which helped underpin the Canadian currency, especially with some further underlying pressure for a reduction in short positions.

The central bank will be comfortable with further Canadian dollar depreciation to help underpin the trade account and doubts surrounding the housing sector will increase.

Indian rupee:

The rupee was unable to strengthen through the 62 level during the week and dipped lower in the middle of the week even with a generally fragile US currency.

There was evidence of oil importers buying any dip in the dollar and there was underlying vulnerability in equity markets as wider emerging-market sentiment remained generally fragile.

There was a mixed set of data releases as consumer inflation fell to a two-year low and the trade data was better than expected while there was a weaker than expected industrial production release which maintained underlying growth doubts.

Confidence in the domestic economy will remain slightly stronger in the short-term. Concerns surrounding emerging markets as a whole will limit potential support.

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The Hong Kong dollar was confined to narrower ranges during the week as it resisted any further depreciation through the 7.76 level against the US currency and pushed to highs near 7.7550 level.

There was a generally weaker dollar tone which offered some degree of protection and there was some easing of immediate tensions surrounding key emerging markets.

The Hong Kong dollar will gain relief if emerging markets can maintain a more stable tone, but underlying tensions are liable to maintain high, limiting potential support.
 
Chinese yuan:

The yuan was unable to make any headway during the week and edged lower to lows near 6.0650 against the US currency as the PBOC looked to resist any currency gains.

Although there was a higher than expected trade surplus in the latest data, underlying doubts surrounding the economic outlook persisted with a continuing focus on credit markets as the PBOC and government look to deflate excessive lending at a measured pace. The consumer inflation data was broadly in line with expectations at 2.5%.

Credit developments will be watched very closely with concerns that attempts to manage a controlled de-leveraging will trigger a severe downturn in the economy.

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