Weekly Forex Currency Review 19-07-2013

Evidence still suggests that the Federal Reserve will look to reduce the rate of quantitative easing bond purchases later this year. If economic trends suggest a significant slowdown, however, then the tapering could be very limited which would sap immediate dollar support. The overall global growth dynamics and improving fundamentals should still provide important underlying US currency support.

Key events for the forthcoming week:

Market analysis

Dollar:

Developments within the US economy and monetary policy will remain extremely important in the short-term. The underlying message from the Fed is still that they would prefer to reduce the rate of bond purchases and will do so provided the economy does not deteriorate. The dollar will, therefore, be vulnerable to fresh selling pressure if there is evidence of deterioration. The US fundamentals should still improve and US growth will out-strip Europe while Asian concerns are liable to increase. In this environment, there will be scope for underlying dollar gains despite the risks of intermittent setbacks.

The dollar was unable to make much headway during the week with Euro support below 1.31, but did prove to be broadly resilient at lower levels given underlying optimism surrounding fundamentals.

The retail sales data was significantly worse than expected as headline sales increased by 0.4% for June compared with expectations of a 0.7% gain while core sales were unchanged compared with an expected 0.5% gain. There was a higher than expected consumer prices increase on 0.5% countered by an in-line core reading of 0.2%.

The latest US housing data was weaker than expected with a decline in starts to an annualised rate of 0.84mn for June from 0.93mn previously while permits declined. The data may have some impact in cooling optimism towards the construction sector, although there will need to be a sustained slowdown before there is any significant sentiment shift. The NAHB housing index which pushed to seven-year highs at 57.

Fed Chairman Bernanke’s testimony was watched very closely. In prepared remarks, he maintained a broadly consistent tone with comments that the programme of asset purchases will start to be wound down later this year and completed during 2014 if the economy performs as expected. There were again important caveats that quantitative easing could be maintained or even extended if the economic conditions deteriorate and that any tapering was dependent on economic developments.

The latest US jobless claims data was better than expected with a decline to 334,000 in the latest week from a revised 358,000 previously which maintained underlying confidence in steady employment growth. There was an overall reluctance to sell the US currency aggressively with most players looking to buy on dips given a bullish longer-term outlook on US fundamentals.

Similarly, the latest Philadelphia Fed index much stronger than expected with an increase to 19.8 for July from 12.5 previously which was the highest reading for two years and the New York PMI index also increased.

The Euro found support above 1.3050 as markets were again unable to break narrow ranges with technical support levels holding. The Euro pushed back towards 1.3150 with a Moody’s move to putting the US AAA rating back to a stable outlook from negative not having a significant impact

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Conditions within the Euro-zone have calmed considerably over the past few weeks with some signs of stabilisation in PMI indices helped to underpin sentiment. The underlying situation is still extremely fragile and peripheral economies remain vulnerable a renewed loss of confidence, especially if there is no actual return to growth. In this environment, political stresses would be liable to intensify rapidly. The ECB will also remain under strong pressure to provide further monetary support. The Euro can still prove to be resilient, but is eventually likely to come under renewed selling pressure.

There were quieter conditions with the Euro-zone during the week as attention was focussed mainly on the US. Simmering economic and political tensions did not have a major impact despite important underlying concerns.

There were also some vague rumours surrounding another French credit-rating downgrade. Any rise in bond yields would have an important toxic impact on the peripheral economies, especially as banking-sector losses would increase again. There are all still very important concerns surrounding the political environment and pressure for a relaxation of austerity.

The German ZEW business confidence was weaker than expected with a decline to 36.3 for July from 38.5. ZEW economists tended to play down the report’s importance, but there will be unease over export prospects, especially with a slowdown in China. The Euro dipped only briefly following the data and then rose steadily into the US session.

Yen:   

The immediate focus will be on politics and this weekend’s Upper-House election. Opinion polls suggest that the LDP will gain a strong majority which will eliminate the threat of legislation being blocked and put the government in a much stronger position to pursued aggressive reflationary policies. This will tend to weaken the yen, especially with the Bank of Japan maintaining a highly aggressive monetary policy. The yen could still gain some respite if there is a further deterioration in Asian growth prospects and deteriorating risk appetite.

The dollar pushed to highs near 101 against the yen during the week, but was unable to sustain the gains. The latest Bank of Japan minutes did not have a major impact with a technical discussion surrounding the possibility of extending longer-term funding operations to help restrain interest-rate fluctuations. There were also some concerns over the aggressive policy, although it will maintain the aggressive quantitative easing in an attempt to combat deflation.

There were expectations that the G20 meeting would endorse Japan’s monetary policy or at least no voice any significant opposition and this had a significant impact in weakening the yen. The US currency pushed higher gain following the stronger than expected US data releases as underlying yield support held firm.

There were further expectations that the LDP would win a substantial majority in the Upper-House elections which would maintain expectations of sustained monetary expansion, boost the Nikkei index and tend to weaken the yen.

The latest capital account data recorded net flows into overseas bonds of over JPY1.11trn, the highest figure for 10 months which initially undermined the yen. Later on Friday, there was a sharp reversal as the Nikkei index fell rapidly on hedge-fund selling and the dollar dipped back to test support below 100.

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Survey evidence has continued to suggest an underlying improvement in UK economic conditions. The Bank of England policies will continue to have an extremely important impact. The latest minutes will increase expectations that there will be no further quantitative easing. The MPC, however, will still want to pursue and aggressive policy and will be looking to keep long-term interest rates down which will be important in curbing any Sterling support. There will also be further balance of payments vulnerability which will have a negative impact.

Sterling maintained a firmer tone during the week with the Bank of England again surprising markets in the minutes and there was a peak around 1.5250 against the dollar as Sterling also recovered to near 0.86 against the Euro.

The latest UK labour-market data was generally better than expected with a 21,200 decline in the latest unemployment claimant count which was the sharpest rate of decline for three years. There was a recovery in annual earnings growth to 1.7% from 1.3% which will help ease the squeeze on real incomes.

In the Bank of England minutes, there was a 9-0 vote for unchanged interest rates. There was a surprise with the quantitative easing vote  at 9-0 for unchanged bond purchases for the first time since October 2012. Miles and Fisher, the two remaining members who voted for further quantitative easing last time, switched to vote for an unchanged policy. Although the economic data had improved, the policy shift also reflected the fact that the bank will look at alternative measures to underpin the economy and keep bond rates down.  In this context, the initial generally hawkish interpretation may be revised over the next few weeks.

The UK headline retail sales data was in line with expectations with a 0.2% increase for June, but the annual increase was slightly higher than expected. The IMF called for the UK to maintain a very loose monetary policy and to secure a further boost in credit conditions. It remains the case that the Bank of England will look for ways to keep bond yields down which will tend to sap underlying Sterling.

Swiss franc:

There will be scope for defensive franc support when global risk appetite deteriorates, especially if there is a sustained deterioration surrounding emerging markets. Any increase in Euro-zone political stresses would also tend to boost the Swiss currency. The National Bank should be able to defend the 1.20 minimum Euro level comfortably in the short-term and the underlying reserves data does not suggest strong support for the Swiss currency.

The dollar dipped to lows around 0.9350 during the week before finding support as the Euro found support on lows towards 1.23. Any tightening in Euro-zone credit conditions and underlying banking-sector stresses could trigger renewed defensive capital flows into the Swiss currency.  

The Swiss trade account remained in comfortable surplus according to the latest data. There was an annual decline of over 5% for exports and, although this was distorted by a reduced number of working days, the National Bank will remain concerned over underlying franc strength and will be determined to resist gains.  

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The Australian dollar was subjected to heavy selling pressure late last week and dipped to fresh 32-month lows at the 0.90 level against the US dollar.

The latest Reserve Bank minutes were slightly more hawkish than expected with the RBA suggesting that recent currency weakness would have some impact on inflation and this dampened expectations that there would be a further cuts in interest rates.

There were still concerns surrounding the impact of weaker Chinese growth and underlying sentient remained generally negative. There was a round of short covering which pushed the currency to a peak above 0.9250 before selling pressure resumed.

The net global and domestic economic trends are likely to push the Australian dollar lower, especially with sustained fears surrounding financial conditions within China.

Canadian dollar:

The Canadian dollar was unable to strengthen through the 1.03 level against the US dollar early in the week and drifted weaker through the week as a whole, although ranges were narrower with no major domestic influences.

The Bank of Canada left interest rates on hold at the latest monetary policy meeting. The underlying statement from new Governor Poloz was broadly in line with expectations with policy likely to remain on hold for now. Markets will look closely at underlying global growth outlook amid fears over a sharp slowdown.

The net fundamentals and valuations will provide underlying US dollar support against the Canadian dollar despite immediate CAD support from higher oil prices.

Indian rupee:

The rupee was again subjected to heavy volatility during the week. There was were sharp gains over the first half as the Reserve Bank responded to recent weakness by raising two interest rates with the bank rate set at 10.25% from 8.25%, although the key repo rate was left on hold. The move triggered aggressive short covering which pushed the currency stronger and it will be more costly to speculate against it.

The rupee was unable to hold the gains. There were concerns that growth would be damaged and there were also concerns over equity-market outflows.

The monetary tightening is unlikely to provide sustained rupee support, especially as there will be growth fears and the threat of equity-market capital outflows.

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The Hong Kong dollar was confined to very narrow ranges over the week with a slight drift weaker towards the 7.76 area. The comments from Fed Chairman Bernanke were broadly neutral which limited the impact on local market rates and did not have a major Hong Kong dollar impact.

Short-term trends will tend to be dominated by China’s economic and financial concerns Longer-term pressure for a shift in the dollar peg will persist.

Chinese yuan:

The Chinese yuan edged slightly weaker over the week as a whole as it edged towards the 6.14 area against the dollar, although ranges were relatively narrow with the PBOC fixing the currency slightly weaker.

There was some slowdown in the official growth data with GDP slowing to 7.5% for the second quarter from 7.7% previously, although there was speculation that the underlying slowdown was much more substantial with credit concerns persisting.

The IMF again stated that the yuan was under-valued and also expressed concerns surrounding excessive credit growth and risk of a very sharp GDP slowdown.

Concerns surrounding the Chinese growth outlook and risk of serious credit-related stresses are likely to continue and will pose important medium-term yuan risks.

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