Weekly Forex Currency Review 14-12-2012

Monetary policy will remain a very important focus following the Federal Reserve decision to sanction additional quantitative easing during 2013.  There will be further resistance to currency gains by Japanese and also potentially the Euro-zone and this will increase the risk for further more aggressive monetary policy action by the Bank of Japan and ECB. Overall, the dollar will find it difficult to make much headway unless there is a serious deterioration in international risk appetite.

Key events for the forthcoming week

Dollar:

The Federal Reserve policies will remain an extremely important focus in the short-term. The decision to expand quantitative easing will tend to have a negative impact on the dollar.  The Fed is also committed to maintaining a highly expansionary monetary policy until there is a further marked improvement in the unemployment rate with a decline to at least 6.5%.  In this context, the dollar will find it difficult to gain any strong traction, but there will be some reward in terms of pro-growth policies and likely US growth out-performance. This will be a particularly significant factor if Euro-zone conditions deteriorate further.

The dollar weakened against European currencies during the week on additional Fed action, but did show some degree of resilience.
 
The headline US employment data was stronger than expected with an increase of 146,000 for November from a revised 138,000 gain the previous month while the unemployment rate dipped to 7.7% from 7.9% the previous month. There was a downward revision to October’s payroll gain while the participation rate fell. The US trade deficit widened to US$42.2bn for October from US$40.3bn the previous month as exports were slightly weaker, although there may have been data distortions.

The Federal Reserve left interest rates on hold at below 0.25%  following the latest policy meeting. The Fed announced that it would buy an additional US$45bn in Treasuries per month to replace Operation Twist which was in line with market expectations. As has been the case throughout the year, regional Fed President Lacker dissented and voted against further quantitative easing. The Fed downgraded its 2013 growth forecasts slightly.

There was an important shift in forward policy guidance as the FOMC dropped the reference to a specific timeframe for keeping interest rates at extremely low levels until 2015. Instead, the Fed announced that it would introduce economic targets for keeping policy extremely expansionary. In particular, the threshold for a policy change would be an unemployment rate of 6.5% and policy would remain extremely expansionary provided the inflation rate did not rise to above  2.5%.

There were no significant progress in the US budget talks and concerns surrounding the risk that no agreement would be reached before the year-end deadline.

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There will be further relief surrounding the ability to defuse the acute Euro-zone crisis phase with agreement secured on the next Greek loan tranche while peripheral bond yields have fallen. There will still be a high degree of unease surrounding the underlying economic outlook, especially with recession conditions persisting.  Political tensions will also be very important with unease surrounding Italian elections early in 2013.  The underlying peripheral situation also remains extremely fragile and longer-term fears will continue.  There will also be speculation over a cut in ECB interest rates which will sap Euro support.   

The Euro recovered some ground although this primarily reflected general dollar weakness rather than any great enthusiasm for the currency.

Interest rate remained an important focus following Thursday’s ECB press conference where Draghi indicated that a rate cut had been discussed. There were unofficial briefings from ECB officials during the day, an unusual event in itself. There were suggestions that a majority of Council members had either proposed a rate cut or not been opposed and that a decision to cut rates had been blocked by Draghi and the German representatives. The overall impression was that rates could well be cut during the first quarter of 2013 which also had a negative Euro impact.

Italian political tensions remained an important focus following Prime Minster Monti’s announcement that he would resign once the 2013 budget has been approved. The most likely outcome is that elections will be held in February which fuelled the mood of uncertainty. There were concerns that reforms could be in doubt with former Prime Minister Berlusconi’s intention to stand contributing to the mood of uncertainty. Stock markets fell sharply and there was a surge in bond yields with Spanish yields also rising sharply. Tensions did subside later in the day as Monti looked to offer reassurance over reforms.

The German ZEW index was stronger than expected with a rise to 6.9 for November from -15.7 previously which was the strongest reading for seven months. The ZEW also stated that it considered the recent Bundesbank and ECB forecasts to be on the pessimistic end of the spectrum.

There was some positive sentiment surrounding the Greek debt buyback, although the Greek government did have to pay more than expected which means that the decline in debt/GDP ratio will be slightly below target. There was a slightly more cautious outlook on the potential for a cut in ECB interest rates and there was some speculation that former Prime Minister Berlusconi would not stand in forthcoming elections.  The Euro-zone agreed on a framework for the new banking supervisor.

Yen:

The LDP, continues to hold a comfortable opinion-poll lead ahead of the December 16th General Election, maintaining expectations that there will be a much more aggressive monetary policy and potential changes to the Bank of Japan mandate next year. These expectations will undermine the yen, but there will still be the possibility of political deadlock which could delay additional policy measures. The yen will also gain defensive support at times when risk appetite deteriorates, but the underlying fundamentals will remain weak.

The yen was firmly on the defensive during the week and weakened to fresh nine-month lows near 84 against the US currency while the Japanese currency also weakened sharply against the Euro. There were media reports that the Bank of Japan would sanction a further JPY5-10trn in quantitative easing at next week’s policy meeting which contributed to a negative yen tone

There were further expectations that the LDP would win the forthcoming election and would also put additional pressure on the central bank to take more aggressive action. A slightly weaker than expected monthly increase of 2.6% for core machinery orders did not have a major market impact while the Tankan index was weaker than expected. A North Korean missile launch had some negative impact on the yen.

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There will be further doubts surrounding the UK economic outlook, especially with evidence that industrial output weakened sharply at the beginning of the fourth quarter.  The weak outlook will increase concerns surrounding the underlying fiscal outlook and also maintain pressure for the Bank of England to boost quantitative easing further.  Sterling will gain some degree of support on relative grounds given the aggressive Federal Reserve policy and the prospect of further ECB action. Nevertheless, Sterling is likely to be generally vulnerable given the UK fundamentals and credit-rating downgrade fears.

Sterling was resilient against the US currency during the week, but struggled to break above the 1.6150 area and edged weaker against the Euro.

The latest industrial data was sharply weaker than expected with a 0.8% decline in industrial production for October compared with expectations of a monthly rebound following the 2.1% drop seen in September. The data increased unease surrounding the fourth-quarter outlook and reinforced fears surrounding the economy as a whole. The NIESR estimated a growth rate of 0.1% in the three months to November with the October reading revised down sharply to 0.1% from 0.5%.

The latest labour-market report was stronger than expected as the jobless claimant count fell by 3,000 compared with a revised gain of 6,000 the previous month.  The unemployment rate also held steady at 7.8% for October, in contrast to expectations of a small increase. Earnings growth was capped below 2.0% which maintained concerns surrounding the outlook for consumer spending.

The prospect of further quantitative easing by the Federal Reserve, allied with speculation that the ECB would relax monetary policy further, had an impact in underpinning Sterling despite unease surrounding the growth outlook. There will be additional pressure on the Bank of England to take additional action.

There was a warning from Standard & Poor’s that it was revising the AAA credit rating to negative from stable, reinforcing fears that one or more of the main rating agencies would downgrade the UK sometime during 2013.

Swiss franc:

The National Bank will remain strongly committed to maintaining the 1.20 minimum Euro level in the short-term. There will be further concerns surrounding the build-up of reserves, but there will also be a very strong determination to resist franc appreciation, especially with competitiveness still a key issue. Aggressive policy relaxation elsewhere will maintain the risk that upward pressure on the franc will intensify again.

The dollar was on the defensive against the franc and retreated to lows below 0.9250. There were no surprises from the Swiss National Bank policy meeting with interest rates left on hold below 0.25% while the minimum 1.20 Euro level was also maintained. The central bank continued to insist that franc gains would be resisted with all necessary force.

The latest producer prices data recorded no change in prices with a 1.2% annual increase which may ease deflationary pressure slightly.  The Euro retreated to lows in the 1.2080 area with disappointment that there was no suggestions of additional measures to weaken the franc and the dollar dipped to lows below 0.9250. There was a small recovery in the Swiss ZEW index to -15.5 the previous month

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The Australian dollar pushed higher with a move above the 1.05 level against the US currency. There were expectations that the Australian currency would gain support from international reserves diversification although there was also pressure for the central bank to act to restrain the currency as it remains substantially overvalued.

The domestic data releases did not provide any support for the currency with a sharp decline in business confidence and consumer sentiment according to the latest surveys. A decline in gold prices was also a negative factor for the currency.

The Australian dollar will gain support from reserve diversification, but there will still be resistance to gains with the Reserve Bank under pressure to intervene.

Canadian dollar:

The Canadian dollar was able to resist any significant weakness and strengthened to highs near the 0.9820 region against the US currency. The trade account was slightly stronger than expected, although the overall impact was very limited and there was some decline in gold prices which took the edge of the currency performance.

Even with near-term resilience and optimism surrounding the fundamentals, the Canadian dollar will find it difficult to advance from current levels.

Indian rupee:

The Indian rupee was unable to make any further impression against the dollar and retreated to lows in the 54.50 region against the US currency.

There was a general downward move in the local equity market with five successive daily losses and there was further uncertainty surrounding the monetary-policy outlook.  There was still a general mood of optimism surrounding the reform programme and there was also a stronger reading for industrial production.

Despite some improved sentiment surrounding the domestic economy, there is likely to be scope for only limited rupee gains given wider risk conditions.

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The Hong Kong dollar maintained a very tone during the week and continued to test the 7.75 band limit. The HKMA was again forced to intervene to protect the peg limit with several bouts of intervention to protect the band.

There was further speculation over the potential for medium-term capital inflows and an increase in domestic inflation fears which would also increase underlying stresses on the currency peg.
 
Medium-term speculation surrounding the Hong Kong peg and a potentially radical change in policies will continue, especially if domestic inflation rises further.

Chinese yuan:

The yuan maintained a robust tone during the week and was generally stronger than the 6.23 level against the US currency, but it was unable to make sustained gains.

The PBOC continued to resist any further strengthening through the setting of relatively weak daily fixings and the Chinese currency. There was mixed economic data during the week, but the underlying mood was slightly more optimistic which helped underpin the yuan. There was a strong rebound in the Shanghai equity market late in the week which also boosted sentiment

Despite  improved confidence towards the domestic economic outlook, the yuan will find it difficult to make much headway from current levels.

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