Weekly Forex Currency Review 19-11-2010

The Euro-zone stresses have tended to be the dominant focus over the past week and there are still very important areas of vulnerability which will maintain a high degree of uncertainty over the Euro outlook.  Global currency policies and the potential for deliberate devaluation policies will also remain a key focus for markets over the next few weeks.            

Key events for the forthcoming week

Dollar:

There have been some further tentative signs of improvement in the US economy and Treasury yields have risen which will continue to give some support to the dollar, although the data has by no means been convincing given weakness in housing starts. There will still be an underlying lack of confidence in the fundamentals and the Federal Reserve decision to boost quantitative easing will continue to dampen market confidence in the US currency.  There will be resistance to further emerging-market currency gains, but the dollar will continue to remain dependent on vulnerabilities elsewhere to make strong headway on a trade-weighted basis.

The dollar secured a firmer tone for the week as a whole with gains when risk appetite deteriorated, but it failed to hold its best levels.

The US retail sales data was stronger than expected with a 1.2% increase for October while there was a solid 0.4% increase in underlying sales. In contrast, there was a much weaker than expected New York Empire PMI index which fell to -11.1 from 15.7 the previous month.

Housing starts also fell to an annualised rate of 0.52mn for October, the lowest rate since April 2009 and significantly weaker than the markets expected. The latest consumer inflation data was also benign with core prices rising 0.6% over the year, the slowest increase since 1957.

Later in the week, the data was more encouraging as jobless claims edged lower to 439,000 in the latest week from a revised 437,000 previously. There was also a sharp rise in the Philadelphia Fed survey to 22.5 for November from 1.0 which helped offset the damage caused by the much weaker than expected New York survey.

The data overall maintained expectations that the Federal Reserve would sanction all the planned quantitative easing planned over the next few months and this was significant in curbing any additional yield support for the US dollar.

The latest capital account data recorded net long-term inflows of US$81bn for September from US$128.7bn the previous month. Solid long-term inflows should help underpin underlying confidence in the dollar to some extent.

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The immediate tensions surrounding Ireland could be on the point of easing with the potential for a support package to be put in place and this would further ease near-term selling pressure on the Euro. There will continue to be the contagion risk and market attention is liable to switch to other weaker members such as Portugal. Longer-term confidence in the Euro-zone will tend to remain weaker and there will be further speculation that the underlying structure and policies will not be compatible with the Euro surviving in its current form.

The Euro came under significant selling pressure during the first half of the week on fears over widening Euro-zone debt difficulties, but it found some respite later with support below 1.35 against the US dollar.
There were further major tensions within the Irish markets as yields continued to rise and there was strong speculation that a rescue package would be needed. The Austrian government also warned that it could block further aid for Greece under the existing support programme and speculation that amendments to the budget would potentially invalidate the EU support package agreed earlier this year.

The German ZEW index was stronger than expected with a gain to 1.8 for November from -7.2 the previous month. The data helped boost confidence in the German economy, but there fears over economic divergence as the weaker economies remain under recession conditions.

Later in the week, there was strong speculation that Ireland was poised to reach an agreement with the IMF and EU over a support package for the banking sector. There were further discussion during the day and the evidence suggests that a deal could be reached on Friday, potentially in the region of EUR100bn.

Expectations of an agreement supported the Euro and a move above 1.36 created some stop-loss momentum with highs near 1.3680 with the currency also gaining some support from a relatively successful Spanish bond auction.

Yen:

The yen will lose support when there is an increase in US bond yields and any improvement in risk appetite would lessen defensive demand for the Japanese currency. There will be continuing pressure on the Bank of Japan to maintain a highly expansionary and unorthodox monetary policy to combat deflation and this will tend to limit yen support. There will still be a reluctance to channel substantial funds out of Japan, especially if Euro-zone tensions intensify again and this will offer some currency protection.

The yen was generally on the defensive against the dollar and the US currency advanced to a six-week high near 83.70 during the week. The yen also failed to sustain gains on the crosses as international sentiment fluctuated.

Yield considerations remained important with the dollar gaining additional support from a rise in US Treasury yields with markets attempting to take a more optimistic tone on the US economic prospects. A weaker than expected report on Japan’s services sector also had some negative yen impact.

There were fears that Euro-zone tensions will trigger capital repatriation of European bond holdings and the mood of caution was enhanced by speculation that China will need to increase interest rates further to cool inflationary pressure.

Domestically, the government issued a generally downbeat assessment of the economy with comments that growth was at a standstill.

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The economic data has not given a clear insight into the economic trends and uncertainty will remain a very important factor in the short-term, especially with the Bank of England admitting that widely varying outcomes are possible. Expectations of a wait and see attitude by the central bank will limit any Sterling selling pressure, but is unlikely to provide strong support. There will be further protection from a lack of confidence in the other major economies, although a key feature is likely to be sharp fluctuations in sentiment and Sterling could still be vulnerable if there is an increase in fears surrounding the debt situation.

Sterling registered only small net losses for the week as it recovered back to above 1.60 from a sharper intra-week decline to near 1.5850 against the dollar
 
The headline UK inflation rate was slightly higher than expected for October with a rise to 3.2% from 3.1% while the core rate was steady at 2.7%. The Bank of England Governor was forced to write a letter to the Chancellor to explain why the rate was more than 1.0% above the 2.0% target rate. In the letter, King stated that the inflation outlook was highly uncertain and also commented that the bank could do more quantitative easing if required.

The latest UK labour-market data was stronger than expected with a decline in the unemployment claimant count for the first time since July. A stronger than expected headline retail sales figure for October was offset by downward revisions. There was an improvement in the latest CBI industrial trends survey.

The latest Bank of England MPC minutes were broadly in line with expectations as there was a 7-2 vote for an unchanged policy with Sentence again voting for a 0.25% interest rate increase while Posen wanted an expansion of quantitative easing. The noting of inflation concerns by a majority of members provided some Sterling support although expectations surrounding Bank of England intentions continued to fluctuate.

There are still very important vulnerabilities surrounding the government fiscal situation with a GBP9.8bn requirement for October, a record for that month.

Swiss franc:

There will be some further speculation that the Swiss economy is slowing more sharply than expected which will dampen sentiment. International developments are still liable to dominate in the short-term and the franc will tend to lose defensive support if there is a sustained improvement in Euro-zone sentiment. There will still be fears over structural vulnerability in the Euro and unease over global policies to boost competitive advantage will also tend to limit selling pressure on the franc.

The franc maintained a strong tone over the first half of the week as defensive demand for the currency remained strong as Euro-zone confidence faltered.

The Swiss currency fell sharply on the crosses with the Euro advancing to near 1.36 as immediate defensive demand for the franc eased in tandem with expectations of an Irish rescue package and the dollar rallied to near parity.

There was a 0.4% decline in Swiss producer prices for October compared with expectations of an increase which tended to increase deflation fears to some extent.

The ZEW expectations index fell to -30.9 for November from -27.5 previously which will reinforce expectations of a weaker economy. Although the export data was encouraging, there will be speculation that the National Bank will seek to engineer a weaker currency.

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The Australian dollar dipped to lows just above 0.97 against the US currency before recovering to a peak just above 0.99 late in the week.

Domestically, Reserve Bank of Australia deputy Governor Battellino stated that there were still inflation pressures within the economy which provided some yield support, although international considerations tended to dominate.

The Australian currency lost support as risk appetite deteriorated and there were also persist fears within markets that the Chinese central bank would increase interest rates again which dampened demand for the Australian currency.

The Australian dollar will remain prone to sharp corrections weaker following the sharp gains seen over the past few weeks with greater doubts over the economy.

Canadian dollar:

The Canadian dollar was unable to mount a further challenge on parity against the US currency and had a weaker tone, although losses were still measured. International considerations tended to dominate with the Canadian currency losing support when there was a deterioration in risk appetite and decline in commodity prices.

Domestically, there was some speculation that the Bank of Canada would not raise interest rates at the next monetary meeting which dampened demand for the Canadian dollar to some extent.

There is likely to be further selling pressure on any renewed move stronger than parity, although the fundamentals suggest that Canadian dollar losses will be limited.

Indian rupee:

The rupee weakened significantly over the week and dipped to a two-month low beyond 45.55 against the dollar before finding some degree of support. International influences remained very important and the Indian currency was unsettled by a general decline in global equity markets as risk appetite deteriorated.

There were also net outflows from the local share market for the first time in November which had a negative influence, but the currency did recover from its worst levels as risk conditions improved.

The rupee should be able to resist further heavy losses, although it will be difficult to advance far in the very short-term given a more cautious attitude towards risk appetite.  

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The Hong Kong dollar again tested the 7.75 intervention limit early in the week, but then weakened significantly over the remainder of the week.

The currency was undermined by a decline in risk appetite which curbed the potential for capital inflows and demand for the US currency was generally higher. There was still longer-term speculation over a move to revalue the Hong Kong currency.

The Hong Kong dollar will lose ground when risk appetite deteriorates, but heavy selling pressure is unlikely given medium-term revaluation speculation.

Chinese yuan:

After strong gains during the previous two weeks, there was a softer yuan tone as it lost ground against the US dollar with a move back to 6.645.

Internationally, the US currency had a firmer tone which curbed appreciation pressure on the yuan, especially as risk appetite was generally weaker.

Domestically, the focus was still on inflation following the higher than expected consumer inflation data previously and there was further speculation that the Central bank would increase interest rates again

From a medium-term perspective, there was continuing speculation of yuan gains with further international pressure for a stronger currency. The IMF stated that the Chinese currency was not usable in the SDR basket at this time.

There will be continuing strong expectations of further yuan appreciation in the medium term due to underlying capital inflows and international pressure. The central bank will continue to fine-tune movements closely.

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