Weekly Forex Currency Review 14-10-2011

Global risk appetite has stabilised with the Euro-zone attempts to boost the banking sector a very important market influence.  Leaders still have a very important task in actually delivering plans to strengthen the banking sector and managing a Greek default. It will, therefore, still be very difficult to secure a sustained improvement in risk appetite, especially as there are still serious vulnerabilities in the global economy as markets consider the risks of a prolonged downturn.

Key events for the forthcoming week

Dollar:

The latest US data has registered some degree of relief as jobless clams have remained at lower levels and there was a firmer than expected employment report. Even if recession fears ease slightly, there will still be expectations of very weak growth and there will still be pressure  on the Federal Reserve for further quantitative easing.  Trade tensions will also be dangerous for the currency. The dollar will continue to gain some protection from elevated levels of Libor rates and fears over the Euro-zone banking sector will also provide significant support, especially if there is a flow of funds out of emerging markets. Overall, the dollar should be able to resist sustained selling pressure in the short-term.

The dollar had a weaker tone during the week as defensive demand for the currency eased following a general improvement in risk appetite.  The US currency weakened to lows beyond 1.38 against the Euro and also fell sharply on a trade-weighted basis.
   
The Federal Reserve minutes from September’s meeting confirmed that there was a lively discussion surrounding the economy and appropriate policies.  There were fears over the growth outlook, but members were not expecting economic contraction. There was a minority of FOMC members pushing for further quantitative easing while the majority view was to keep policy options open. Plosser voiced his opposition to further easing, both in the minutes and in a speech on Wednesday.

The dollar was undermined by an improvement in risk appetite and trade tensions with China also had a negative impact on the currency. The US trade deficit was marginally lower than expected, unchanged at US$45.6bn for the month as exports were marginally lower. The monthly trade deficit with China increased to a record US$29bn which will tend to inflame congressional anger over the Chinese yuan and trade tensions remained an important influence. Elsewhere, jobless claims were little changed at 404,000 in the latest week and provided some underlying dollar support. 

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The Euro-zone leaders will continue their battle to find credible answers to the sovereign debt crisis and will have an extremely narrow path to follow both economically and politically as popular opposition to any further bailouts increases. Political barriers to action remain high and Greece will have to default in the medium term which will pose additional risk to the banking sector. There will also be fears that ECB independence will be compromised which will undermine the medium-term currency outlook. The Euro is unlikely to be a strong currency if it continues in its present form.

The Euro rallied strongly during the week as there was greater optimism that there could be a credible solution for the sovereign-debt crisis.

The EU Commission also announced that the Summit originally scheduled for October 17th would be delayed by six days to give leaders more time to finalise plans.  
There was further speculation that much larger private-sector Greek debt write-downs would be required, although this would also increase bad-debt positions within the Euro-zone banks. There were further concerns over the banking sector following Dexia’s collapse and a warning from Austria’s Erste Bank.

There was a slight easing of financial strains as the Euribor-OIS spread narrowed during the week. In contrast, dollar Libor rates continued to increase slowly and there was also an increase in deposits held at the ECB to a record level which suggested that there was still a lack of underlying trust in the banking sector.

ECB president Trichet stated that systemic risk to the Euro-zone had increased and was extremely cautious over the sovereign-debt situation. He also stated that collateral could not be accepted from defaulted states in a clear reference to Greece. Trichet also stated that the Euro was in no danger in an attempt to ease market tensions.

The Troika report on Greece stated that the 2011 budget targets would be missed and that there would also need to be further action to meet deficit targets from 2013 onwards.  The troika recommended that the November loan payment should be made with German officials warning that approval was not automatic.

There was increased optimism surrounding the Euro-zone as the week progressed with hopes that there would be comprehensive measures to strengthen bank capital. The EU Commission called for a co-ordinated approach, but there was little in the way of detail and short covering was still a key focus.

There was further speculation that there would be a much deeper restructuring of Greek debt with the possibility of haircuts of at least 60%. The ECB warned that any move to force private bondholders to accept bigger  losses could weaken the banking sector and cause further stresses. There was more positive news during the US session on Thursday as Slovakia finally approved changes to the EFSF.

Yen:   

The global outlook will continue to have an important short-term yen impact. An underlying lack of confidence will continue to curb potential yen selling and there is also still the threat of capital repatriation as Japanese institutions move funds out of the Euro-zone. Although yields have moved slightly higher, the dollar is not in a good position to gain strong support. There is likely to be some speculation that the Bank of Japan will mirror the Swiss move and set a minimum dollar level, although this would be extremely controversial.  

After a prolonged period of stalemate, the dollar finally managed a significant move against the yen. The US currency briefly dipped to lows below 76.50 against the Japanese currency, but then rallied sharply and pushed to highs around 77.40 as the Euro moved to one-month highs.

The dollar gained some support from a sharp decline in US Treasuries which pushed yields higher and boosted US support. The yen was also undermined by a sharp improvement in risk appetite as the Euro advanced to a one-month high.

The US Senate passed the Chinese Currency Manipulation Bill which sparked high volatility in Chinese markets as the central bank intervened to support both the yuan and the stockmarket. There was some further speculation that Japan could push for a minimum dollar rate against the yen, in a similar response to the Swiss move last month and this did have some impact in curbing yen demand at higher levels.

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There will be further concerns over the UK economy with fears over domestic vulnerability compounded by international fears. Credit concerns will certainly remain a very important short-term feature given stresses within the banking sector and the revival of quantitative easing will also continue to have a negative impact on the UK currency.  There will be some support from Sterling’s position outside the Euro-zone and there will be scope for reserve diversification into the UK currency.  Sterling is still unlikely to make much headway from current levels given the debt profile.

Sterling found support below 1.56 against the dollar and rallied hard during the European session as the dollar was subjected to wider selling pressure.  The UK currency peaked just above 1.5780 before correcting slightly weaker while the Euro peaked just above 0.8780.

The latest BRC retail sales report recorded a 0.3% like-for-like increase in sales while the RICS house-price index was unchanged at -23% which did not suggest a major trend change within the economy. The headline claimant count data was slightly better than expected with an increase of 17,500 for September following a revised 20,300 increase previously. There was, however, a further increase in youth unemployment and the unemployment rate rose to a 17-year high of 8.1% from 7.9%.

The latest UK trade data was better than expected as the goods deficit narrowed to GBP7.bn for August from a revised 8.2bn the previous month. Exports were at a record level which triggered a slightly more optimistic stance towards the economy despite fears over consumer spending. Any rebalancing in growth towards exports would be vital in improving the medium-term outlook.

There was speculation that the UK bank ratings would be downgraded by Fitch and there was also a market rumour of a sovereign downgrade.  Sterling proved resilient despite the negative speculation with some support on speculation over reserve diversification in favour of the UK currency.

Swiss franc:

The National Bank will remain determined to protect the minimum Euro level against the franc in the short-term and there will also be additional speculation that there could be a move to increase the base level even though there has been no move so far.  The weaker than expected economic data will undermine the franc and increase pressure further action to weaken the currency. There is still the potential for an underlying shift of assets into Swiss institutions if confidence in the Euro-zone banking sector continues to deteriorate, but the National Bank should be the dominant force in the short-term.

There was disappointment that the National Bank did not target a higher minimum rate for the Euro. The franc also gained some net support from an improvement in confidence towards the banking sector, although it remains the case that traditional franc relationships with risk have broken down.

The dollar was able to regain the 0.90 level against the franc on Thursday as risk conditions became less favourable, but it was unable to sustain the gains. The Euro was unable to regain the 1.24 level as underlying franc selling eased slightly. The dollar’s inability to hold above the 0.90 level lessened underlying US support.

Markets are still trying to adjust to the new currency regime as the franc no longer serves as a proxy for risk sentiment and volatility is likely to remain a key feature.

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There will be further concerns over the UK economy with fears over domestic vulnerability compounded by international fears. Credit concerns will certainly remain a very important short-term feature given stresses within the banking sector and the revival of quantitative easing will also continue to have a negative impact on the UK currency.  There will be some support from Sterling’s position outside the Euro-zone and there will be scope for reserve diversification into the UK currency.  Sterling is still unlikely to make much headway from current levels given the debt profile.

Sterling found support below 1.56 against the dollar and rallied hard during the European session as the dollar was subjected to wider selling pressure.  The UK currency peaked just above 1.5780 before correcting slightly weaker while the Euro peaked just above 0.8780.

The latest BRC retail sales report recorded a 0.3% like-for-like increase in sales while the RICS house-price index was unchanged at -23% which did not suggest a major trend change within the economy. The headline claimant count data was slightly better than expected with an increase of 17,500 for September following a revised 20,300 increase previously. There was, however, a further increase in youth unemployment and the unemployment rate rose to a 17-year high of 8.1% from 7.9%.

The latest UK trade data was better than expected as the goods deficit narrowed to GBP7.bn for August from a revised 8.2bn the previous month. Exports were at a record level which triggered a slightly more optimistic stance towards the economy despite fears over consumer spending. Any rebalancing in growth towards exports would be vital in improving the medium-term outlook.

There was speculation that the UK bank ratings would be downgraded by Fitch and there was also a market rumour of a sovereign downgrade.  Sterling proved resilient despite the negative speculation with some support on speculation over reserve diversification in favour of the UK currency.

Swiss franc:

The National Bank will remain determined to protect the minimum Euro level against the franc in the short-term and there will also be additional speculation that there could be a move to increase the base level even though there has been no move so far.  The weaker than expected economic data will undermine the franc and increase pressure further action to weaken the currency. There is still the potential for an underlying shift of assets into Swiss institutions if confidence in the Euro-zone banking sector continues to deteriorate, but the National Bank should be the dominant force in the short-term.

There was disappointment that the National Bank did not target a higher minimum rate for the Euro. The franc also gained some net support from an improvement in confidence towards the banking sector, although it remains the case that traditional franc relationships with risk have broken down.

The dollar was able to regain the 0.90 level against the franc on Thursday as risk conditions became less favourable, but it was unable to sustain the gains. The Euro was unable to regain the 1.24 level as underlying franc selling eased slightly. The dollar’s inability to hold above the 0.90 level lessened underlying US support.

Markets are still trying to adjust to the new currency regime as the franc no longer serves as a proxy for risk sentiment and volatility is likely to remain a key feature.

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The Hong Kong dollar maintained a firmer tone during the week as it tested levels towards 7.78 against the US currency. There was a general improvement in risk appetite  which helped underpin the Hang Seng index and also supported the currency as the US dollar lost recent momentum.

An increase in yuan volatility had some impact on undermining Hong Kong dollar demand, although the impact was limited.

The Hong Kong dollar should remain resilient with a high degree of uncertainty surrounding the Chinese economy and global risk appetite triggering further volatility.

Chinese yuan:

There was a sharp spike in volatility during the week as the return of the local market following a holiday was compounded by an increase in international tensions.

Following the US Senate’s decision to pass a bill allowing US companies to push for retaliatory tariffs on an under-valued yuan, the central bank responded by pushing the currency weaker in a clear political statement given that the Euro was sharply stronger

There was a decline in the latest trade surplus as export growth started to falter, increasing pressure from exporters to keep the yuan competitive.

The central bank will be less willing to tolerate yuan appreciation if exports continue to weaken and inflation pressures start to ease with increased international tensions.