Weekly Forex Currency Review 15-06-2012

08.30 AM GMT Overall strategy:  The Euro-zone stresses and structural vulnerabilities will continue to be an extremely important focus, especially with the Greek election being held this Sunday amid fears of an exit from the Euro-zone. Wider stresses will also be very important following the Spanish banking-sector bailout with fears that Spain and Italy will get dragged closer to a sovereign bailout. Underlying risk appetite is likely to remain generally fragile on fears over an underlying global deterioration with high volatility.

Key events for the forthcoming week

Dollar: 

The US economic releases have remained generally slightly weaker than expected with a subdued reading for retail sales. The Federal Reserve will remain an important short-term focus and the central bank is likely to maintain the possibility of further action to support the economy even if near-term measures are resisted. Longer-term fiscal concerns are also likely to unsettle the currency. Safe-haven considerations will remain extremely important as markets continue to focus on the Euro-zone crisis and global vulnerabilities. In this context, there is still scope for defensive US currency demand.

The dollar drifted lower for the week as a whole not helped by relatively weak data releases with losses curbed by an underlying lack of Euro-zone confidence. Risk conditions gradually stabilised which lessened defensive demand for the US currency.

The US retail sales data was weaker than expected with a 0.2% headline decline for May, matching April’s revised fall. There was also a weaker 0.4% decline in core sales after a 0.3% fall previously. The headline producer prices data was also weaker than expected with a 1.0% monthly decline as core prices were in line with expectations with a 0.2% rise.

US jobless claims were slightly higher than expected at 386,000 in the latest week from a revised 380,000 previously which suggested little underlying improvement in the labour market. There was also a 0.3% decline in headline consumer prices for May, although there was a core 0.2% increase in prices. There will be further uncertainty over Federal Reserve policies ahead of next week’s FOMC policy meeting with soft data maintaining speculation over further Fed measures.

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There will be major uncertainties surrounding the Euro-zone outlook with an increasing focus on Spain and Italy as well as the Greek election. There will be fears surrounding Greece’s outlook even if the pro-austerity parties secure a victory in the election. There will also be speculation that Spain and Italy will move closer to requiring sovereign bailout funds. There will be strong pressure for a shift in German policies and there will also be strong pressure for a more aggressive ECB stance on monetary policy as policies remain unsustainable. In this environment, the Euro will find it difficult to gain more than limited relief.

Although Spanish fears increased again, the Euro was able to recover from lows near 1.24 against the dollar during the week with pressure for a covering of short positions compounded by some hopes that the Greek crisis could ease following the election.

The Spanish banking-sector bailout inevitably remained a very important focus following the weekend agreement. There was a sharp initial decline in Spanish 10-year yields to below 6.0% for the first time in three weeks before a sharp reversal.

There were uncertainties whether the bailout funds would be made available through the EFSF or the ESM and there were important reservations surrounding the ESM. Assuming the fund is ratified by all national governments and brought into operation as planned at the beginning of July, there will also be further fears that any use of ESM funding would subordinate existing private bond holders. This would lessen the attractiveness of Spanish sovereign debt.

There was significant friction between Italy and Austria following Austrian Finance Minister Fekter’s remarks that Italy could require assistance. Although Fekter looked to tone down the rhetoric after the Italian government criticised the comments underlying tensions remained high.

Spanish Prime Minister Rajoy also called for a battle to be waged to solve liquidity and funding pressures with the government sounding increasingly desperate. The latest Euro-zone industrial production data was close to expectations with a 0.8% April decline. There will be further pressure for more aggressive monetary policies with Nowotny suggesting that further ECB interest rate cut could be considered.

Moody’s cut Spain’s sovereign rating by three notches to BAA3 and warned over further potential action. Following the Moody’s downgrade there was another rise in Spanish bond yields as benchmark 10-year yields briefly rose to the 7.0% level. This is an important level for sentiment with fears that a rise above this level will push Spain towards a wider sovereign bailout. There were reports that the government held emergency talks about the economic situation. Italian yields also rose during the day with three-year yields rising to 5.30% at the latest auction from 3.90% previously. 

The Greek elections also remained an important focus and there was some speculation that private opinion polls were suggesting a victory for the New Democracy party. This eased fears over a victory for Syriza with some optimism that the government would maintain a commitment to austerity policies which would lessen the immediate threat of a Euro-zone exit. There was also expectations that the Euro-zone could revise the terms of its austerity package. Although confidence remained very fragile, there was a further incentive to pare speculative short Euro positions.

Yen:  

Defensive considerations will remain very important and there will be further safe-haven yen demand when risk appetite deteriorates, especially with markets very uneasy over the fundamental outlook in other major economies. There will also be pressure to maintain regional competitiveness which will reinforce pressure for yen gains to be resisted, especially if there is a weaker tone for the Chinese yuan. There will be an important lack of confidence in longer-term Japanese fundamentals which will should limit the potential for yen gains and there will also be further speculation over intervention to curb any gains.

There was underlying yen demand emanating from underlying Euro-zone fears which prevented a dollar move to above the 80 level. There was caution over pushing the yen aggressively stronger, especially with unease over the threat of official intervention and the possibility that the Bank of Japan would announce further quantitative easing at this week’s policy meeting.

The IMF also stated that the yen was still moderately over-valued and that the Bank of Japan should consider additional stimulus.

The central bank held interest rates steady at the latest policy meeting and also left the amount of quantitative easing unchanged. Although the decision had been expected, there was a further yen advance to the 78.80 region following the decision and the Japanese currency was able to regain some ground against the Euro.  

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There will be further concerns surrounding the economic outlook with spending and investment likely to remain very fragile in the short term. There will be further speculation over additional Bank of England quantitative easing, although the central bank may concentrate on alternative policy measures. Safe-haven considerations will remain important and there will be scope for additional inflows if Euro-zone fears intensify. It will, however, be difficult to secure strong support, especially with unease surrounding the UK financial sector and Sterling volatility is likely to increase.

Sterling found support below 1.55 against the dollar with nervous range trading as the UK currency lost ground against the Euro with a move to the 0.8150 area. Defensive considerations will remain extremely important in the short term with volatility likely to be a key feature.

The UK economic data remained uninspiring at best with a 0.7% decline in manufacturing production for April as industrial output was unchanged. The NIESR estimated that GDP expanded 0.1% in the three months to May from a revised 0.1% decline for April which did little to inspire confidence surrounding the outlook.

Attention focussed on the Mansion House speech. Bank of England Governor King stated that the case for further quantitative easing was continuing to strengthen and also warned over the threat posed by the Euro-zone crisis. The government and central bank also announced additional measures to provide cheap funds to commercial banks on the basis that this must be channelled into business lending. The bank will also implement its new liquidity programme with details set to be announced later and the total funds available will be around GBP80bn.

Swiss franc:

With confidence in the Euro-zone outlook continuing to deteriorate, defensive flows into the Swiss currency could escalate. The 1.20 minimum Euro level could under severe pressure, especially if fears surrounding the Euro-zone financial sector intensify and Greece is forced to exit the Euro. The central bank will continue to intervene aggressively to curb franc gains in the short term and will consider additional policy measures such as capital controls.

The National Bank left interest rates unchanged following the latest policy meeting and also maintained the minimum 1.20 Euro level.

The central bank rhetoric was broadly in line with recent comments with a pledge of unlimited intervention to maintain the minimum level. There was also a warning that the bank would consider all policy options in order to prevent franc gains with some hints that capital controls could be considered, although the bank was deliberately vague in its intentions. There was also some warning over the capital level of key commercial Swiss banks which may dampen sentiment.

The Euro was unable to sustain small gains seen ahead of the meeting, trading back to near 1.20 as intervention continued and the dollar also edged back towards 0.95.

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The Australian dollar was subjected to choppy trading conditions during the week, although ranges overall were relatively subdued as the currency found support near the 0.98 level against the US dollar with a test of resistance above parity.

There were hopes of additional policy measures to support global demand and underpin financial-sector liquidity which had an important impact in underpinning the currency. There were few domestic influences during the week as business confidence fell according to the latest NAB survey.

The Australian dollar will continue to rally at times on global policy hopes, but it will be difficult to sustain gains given unease surrounding the growth outlook.

Canadian dollar:

The Canadian dollar was unable to make much impression on the US currency, but it able to resist significant selling pressure and found support on retreats beyond 1.03.

Speculation over further central bank action to support global demand was significant in underpinning the Canadian dollar, especially as there was also some positive impact on commodity prices.

Although the Canadian dollar will gain support if commodity prices gather, concerns surrounding the global economy will tend to limit scope for currency gains.

Indian rupee:

The rupee was unable to sustain gains during the week and retreated to lows near 56 against the US currency as underlying risk appetite was still generally fragile.

Underlying confidence in the fundamentals remained relatively weak with a higher than expected 7.5% inflation reading dampening expectations of a more aggressive Reserve Bank of India stance in cutting interest rates.

There were also reports that the latest trade data was weaker than expected with an annual 4% decline in exports in the year to May. Standard & Poor’s also warned that India could lose its investment grade rating.

Given increased doubts surrounding the domestic economy, the rupee will find it difficult to secure more than limited gains even if risk conditions improve.  

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The Hong Kong dollar maintained a relatively steady tone during the week, although gains were limited with no move towards the 7.75 range barrier.

Longer-term policy considerations increased in importance during the week as former HKMA chief Yam suggested that the Hong Kong currency peg could be abandoned, potentially with a peg against the yuan. Chief Executive Tsang rejected the possibility of such a move, but longer-term uncertainty will persist.

Even with speculation over a medium-term policy shift, uncertainty surrounding the Chinese outlook will tend to limit scope for Hong Kong dollar gains.

Chinese yuan:

The yuan was unable to make any significant headway during the week with the official fixings generally in the 6.32 region against the US dollar. There was further divergence with the spot rate which moved towards 6.37.

Although there was relief surrounding the latest trade data as exports and imports both strengthened for the month, there were further underlying concerns over the outlook.

There were also some research reports suggesting that Chinese GDP growth could be as low as 7% for the second quarter with expectations of further policy stimulus by the government and PBOC.

The yuan is unlikely to make much headway with continuing unease surrounding the growth outlook and pressure for a further relaxation of monetary policy.  

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