Weekly Forex Currency Review 18-10-2013

Underlying US budget and debt tensions will continue given the short-term debt deal, but attention for now will tend to focus back on the economy, especially with a series of delayed economic data reports due next week. There will also be a renewed focus on potential Federal Reserve actions and the possible schedule for any tapering of bond purchases. There will also be a fresh focus on European economic developments.

Key events for the forthcoming week

Market analysis

Dollar:

The deal to re-open the government and avert a potential debt default has eased immediate uncertainty, but there will be important concerns that the underlying issues have not been resolved and further deals will be needed before February.  Underlying sentiment towards US securities has been damaged. There will also be speculation that the Federal Reserve will not sanction a tapering of bond purchases this year, especially given the disruption to economic data releases.  The US economy still has important underlying advantages and there will tend to be a snap-back in demand over the next few weeks. The dollar will also gain important support with confidence in Europe liable to weaken again.

The dollar held in narrow ranges over the first half of the week as US uncertainty persisted before weakening sharply, especially against European currencies as the Euro pushed to highs near the 2013 highs of 1.3710.

A budget deal was passed in the Senate and the House and with President Obama signing the bill, the shutdown has ended and the debt ceiling lifted. The government will be funded until Januray15th and the debt ceiling lifted until February 7th

The dollar was subjected to heavy selling pressure on Thursday, especially against European currencies. The US currency continued to be undermined by the fact that congress only put together a short-term budget and debt deal which will ensure further political tensions over the next three months

Capital account trends remained an important focus with additional speculation over inflows into Europe. European stocks pushed to six-week highs and the latest survey of investor sentiment suggested that funds were not over-weight on US equities for the first time since January.

This shift in sentiment was compounded by the Chinese rating agency Dagong’s decision to downgrade the US credit rating again. Although the move may be politically motivated, it also maintained fears of an underlying asset switch away from US securities and the risk of further downgrades from other agencies. The Euro broke above the 1.3600 level and pushed to highs above 1.3650 at the US open.

The US initial jobless claims was broadly in line with expectations with a decline to 358,000 in the latest week from 373,000 the previous week. The Philadelphia Fed index was stronger than expected at 19.8 for October from 22.3 previously which should boost optimism that economic conditions are holding firm despite the government disruption.

The dollar was, however, unable to gain any traction following the data and the Euro pushed to highs  around 1.3680 before being subjected to some profit taking. There were further expectations that the Fed would delay any tapering of bond purchases, potentially well into 2014, especially as the forthcoming economic data will have important distortions. The delayed employment data now due for release on Tuesday.

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With attention fixed firmly on US political developments, the Euro-zone has still tended to be out of the headlines. Underlying growth conditions are still extremely weak and there are certainly underlying concerns within the ECB, especially with an underlying tightening of monetary conditions. With potential deflationary pressures, there will be pressure for further ECB action and a cut in interest rates. There will also be the potential for verbal intervention to restrain the Euro if the currency continues to deteriorate.

The Euro was not the main focus of attention during the week as the currency tended to gain support, partially by a lack of alternatives as it strengthened against the dollar and also secured gains against the yen.

There were further generally dovish remarks from ECB officials with Bonnici stating that the ECB was prepared to introduce negative deposit rates, but that there were some complications. The Euro-zone data releases had little impact as a consumer inflation reading of 1.0% reinforced expectations of a dovish ECB policy stance and potential for additional policy action if deflation fears increase further.

There was nervousness over the potential for verbal intervention by the ECB to curb Euro gains and some further speculation that the central bank would be forced to cut interest rates again in order to combat potentially deflationary forces within the Euro-zone. Markets have generally not been focussed on the ECB policies during the US shutdown, but this could change rapidly if  Euro-zone tensions increase.

The headline German ZEW index was stronger than expected at 52.8 for September from 49.6 previously. The overall elements were, however, mixed and failed to provide any sustained Euro support and a sharp decline in Greek bond yields also failed to provide any headline currency backing, although there was evidence of further net equity inflows into the Euro-zone.

The Euro was not the main focus of attention during the week as the currency tended to gain support, partially by a lack of alternatives as it strengthened against the dollar and also secured gains against the yen.

There were further generally dovish remarks from ECB officials with Bonnici stating that the ECB was prepared to introduce negative deposit rates, but that there were some complications. The Euro-zone data releases had little impact as a consumer inflation reading of 1.0% reinforced expectations of a dovish ECB policy stance and potential for additional policy action if deflation fears increase further.

There was nervousness over the potential for verbal intervention by the ECB to curb Euro gains and some further speculation that the central bank would be forced to cut interest rates again in order to combat potentially deflationary forces within the Euro-zone. Markets have generally not been focussed on the ECB policies during the US shutdown, but this could change rapidly if  Euro-zone tensions increase.

The headline German ZEW index was stronger than expected at 52.8 for September from 49.6 previously. The overall elements were, however, mixed and failed to provide any sustained Euro support and a sharp decline in Greek bond yields also failed to provide any headline currency backing, although there was evidence of further net equity inflows into the Euro-zone.

Yen:   

Immediate uncertainty surrounding the US budget situation has eased which will help underpin risk appetite and lessen defensive demand for the yen. Underlying yield considerations will remain negative for the Japanese currency and there will be further concerns surrounding longer-term fundamentals with particular concerns surrounding the debt burden. The dollar will still find it difficult to gain substantial support unless there is a significant shift in Fed expectations. 

The dollar was unable to make any impression on the yen during the week with the Japanese currency also unable to make any headway against other currencies with the dollar consolidating around 98 after finding support just below this level.

The dollar dipped lower again as Fitch put the US credit rating on negative watch due to the budget impasse and warned that it could downgrade the rating even with a deal.

There was an improvement in risk appetite with relief following the US deal with global equity indices at record highs and expectations that there would be a fresh flow of funds into carry trades. These expectations were important in curbing yen demand and, in this context, both the dollar and yen were generally out of favour.

The latest capital-account-data recorded a net outflow of funds from Japan in the latest week from sharp inflows the previous week which suggest that the threat of capital repatriation eased quickly which will lessen the potential for yen gains and the dollar consolidated around the 98 level on Friday with China’s GDP growth of 7.8% for the third quarter not having a major impact.

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Underlying confidence in the UK economic outlook will remain stronger in the short-term and there will be a solid third-quarter GDP release. There will still be some underlying concerns surrounding the consumer spending with the threat that economic momentum will fade quickly given weakness in disposable income. There will be some speculation that the Bank of England will be forced to raise interest rates relatively quickly despite the forward guidance. Sterling will find it difficult to sustain further gains given the balance of payments vulnerability. 

Sterling was able to hold its ground against the Euro during the week and recovered ground against the dollar despite a sharp mid-week decline with gains to near 1.62 from a low near 1.59 with high volatility.

The UK consumer inflation rate held steady at 2.7% for September, contrary to expectations of a slight decline, while there was an increase in the core rate. The headline claimant count data was stronger than expected with the second successive monthly decline of over 40,000. There had been some speculation that the unemployment rate would decline again, but this held at 7.7% for the month.

Sterling spiked higher following the data, but there was also some disappointment over the rate of earnings growth at 0.7% which implied that real incomes are still declining and will eventually curb consumer spending.

The latest UK retail sales data was broadly in line with expectations with a 0.6% monthly increase from a revised 0.8% decline previously. There were underlying concerns that spending momentum could slow, but this was overshadowed for now by speculation that interest rates could rise sooner than expected, especially if there is any significant move higher in inflation. In this context, the UK currency was able to make net gains against the Euro in choppy trading conditions.

Comments from Bank of England officials will be watched very closely over the next few weeks to assess whether there is any shift in stance towards forward guidance, especially with generally robust trends in housing prices.

Swiss franc:

Defensive considerations will be important and the franc will tend to lose ground following the US budget deal. The franc will also remain vulnerable on yield grounds and there will tend to be net capital outflows from Switzerland when overall risk appetite improves. The underlying economy is still performing relatively strongly which will provide support. Overall, despite gains at times, the most likely outcome is that there will be net selling pressure on the franc.

The dollar reversed course and weakened sharply against the franc on Thursday with lows close to the 0.9000 level.  The franc also out-paced the Euro’s gains against the US currency with the Euro dipping towards the 1.23 level before recovering ground with the franc still registering net losses against the Euro during the week.

The franc held firm despite an overall improvement in risk appetite which will cause some uncertainty over potential longer-term trends. Nevertheless, the strength in equity markets will tend to curb underlying franc demand, at least in the near term.

Domestically, the ZEW business sentiment index rose to 24.9 from 16.3 previously, maintaining a generally optimistic tone towards the outlook which helped underpin the franc to some extent.

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The Australian dollar was able to secure further gains during the week with a peak close to the 0.9650 level against the US currency for the first time since the middle of June. The currency secured support from a generally weaker US currency and an improvement in risk appetite following the US budget deal. 

Domestically, the Reserve Bank minutes were broadly neutral and there was some support for the currency on yield grounds with reduced speculation that there would be further cuts in interest rates over the next few months.

The Australian dollar will be underpinned by improved risk appetite and speculation that domestic interest rates will not be cut further, but should be near a peak. 

Canadian Dollar

The Canadian dollar was able to make some progress against the US currency during the week with a test of support beyond the 1.03 level, primarily due to a weaker US currency. There was only a limited focus on domestic fundamentals with a weaker than expected release for manufacturing sales.

The Canadian dollar will gain some support from the lack of confidence in the US currency, but appreciation potential is liable to be limited given fundamentals.

Indian rupee: 

The rupee was able to hold a solid tone during the week and pushed to two-month highs just beyond the 61 area against the US dollar. The US currency was generally weaker which helped underpin the domestic currency and there was also a net improvement in risk appetite following the deal to avert a US debt default. 

There was evidence of capital flows and dollar selling by exporters  with underlying doubts surrounding the fundamentals of secondary importance for now with investor attention focussed elsewhere. 

The rupee will gain further protection from a more fragile US currency and reduced pressure on wider emerging-market assets, but with limited scope for further gains. 

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The Hong Kong dollar held firm as it settled stronger than 7.7550, underpinned by an underlying lack of confidence in the US dollar following the budget tensions.

There was a significant focus on the currency peg which was implemented 30 years ago. The HKMA chief continued to insist that there would be no move to implement a peg with the yuan, especially with crucial structural issues such as differences in the rate of productivity growth between Hong Kong and mainland China.

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

Chinese yuan:

The Chinese yuan remained strong during the week and there wee a succession of record highs against the US currency with the currency strengthening through the 6.10 level against the US dollar. There was a sharp rise in currency reserves during the third quarter which suggested that the PBOC was still intervening to restrain the local currency and prevent more substantial gains with a premium on stability.

There was weaker trade data than expected as exports registered an annual decline and the higher than expected consumer inflation release dampened expectations that the central bank would be able to loosen policy significantly.

The dollar dynamics will tend to support the yuan in the short-term. The PBOC will still be reluctant to let the currency appreciate sharply, at least in the near term.

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