Weekly Forex Currency Review 21-12-2012

Monetary and currency policies will remain a very important focus following the Federal Reserve decision to sanction additional quantitative easing during 2013 and further action by the Bank of Japan.  There will be further unease over the implications of currency gains and resistance is liable to increase which will risk fuelling a more aggressive phase of currency wars as central banks look to resist currency appreciation.

Key events for the forthcoming week

Dollar:

Fiscal policy will remain important in the short-term as fiscal talks continue and there is likely to be a deterioration in risk appetite which would support the dollar if there is no progress. The Federal Reserve stance will remain an important focus throughout the next few months and the dovish policies will have a negative impact on the US currency as the Fed continues its policies of bond purchases. There will still be expectations that the US economy will out-perform the Euro-zone which should provide some degree of dollar support. There has also been a retreat in precious metals prices which suggests that underlying dollar selling is likely to be contained.  

The dollar remained on the defensive for much of the week, but did find some respite as risk appetite faded again as the Euro retreated from the 1.33 area.

Regional Fed Presidents Lacker and Fisher continued to voice opposition to the recent additional quantitative easing. There were, however, strong expectations that the dovish view would prevail, especially with the doves maintaining a strong position on the 2013 FOMC which will keep policy loose.

The US current account deficit narrowed to US$107.5bn from a revised US$118.1bn the previous quarter. As a percentage of GDP the deficit was below 3.0% compared with a peak above 6% of GDP in 2005. There is the potential for a medium-term decline in the deficit as the energy deficit narrows and the US currency will be slightly less vulnerable to underlying selling.

The US jobless claims data was slightly weaker than expected with an increase to 361,000 in the latest week from a revised 344,000 figure the previous week. The other releases were stronger than expected with the third-quarter GDP estimate revised up to 3.1% from 2.7%. In addition, there was a stronger than expected reading for existing home sales at 5.04mn from 4.76mn the previous month while the Philadelphia Fed index increased to 8.1 from -10.7 the previous month.

US budget negotiations remained an important focus as the House of Representatives debated the so called ‘plan B’. Speaker Boehner insisted that the House had the votes to pass the bill while President Obama stated that it would be vetoed.  As the vote deadline approached, Boehner admitted that he did not have enough support and the vote was cancelled as some Republicans refused to back any tax increases. Further votes are not scheduled until at least December 27th which triggered a sharp deterioration in risk appetite on fears that the year-end deadline would be missed.

Markets still expect that a compromise deal will be reached eventually which helped cushion the impact, but sentiment could deteriorate sharply if deadlock persists

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There will be further relief that the acute Euro-zone crisis phase has eased with the Greece debt buyback completed while there has been a further decline in peripheral bond yields.  There is a very heavy schedule of peripheral debt issuance during the first quarter of 2013 which will make it difficult for Spain to resist a bailout. The underlying growth outlook remains extremely weak which will maintain pressure for a more aggressive ECB policies. Political tensions will also intensify with Italian elections likely in February and the Euro will find it very difficult to make any sustained headway given the net economic risks.   

The Euro advanced to 7-month highs against the dollar on an easing of Euro-zone fears and improved risk appetite and peaked at 1.33 before edging lower.

ECB President Draghi was also cautiously optimistic surrounding the 2013 outlook as Euro-zone officials continued their attempts to play-up the economic prospects. Draghi expressed confidence that competitiveness in Spain was starting to improve and was optimistic over the benefits of a single bank supervisor.

There was a further increase in bad debts within Spanish banking sector as the ratio rose to a fresh historic high of 11.2% in November from 10.7% previously which will maintain fears over the Spanish outlook.  For now, however, wider fears surrounding the Euro-zone have eased which has encouraged a further drop in speculative short positions against the currency and the Greek credit rating was revised to B- from selective default with a stable outlook.

The German IFO index was slightly stronger than expected with a second successive monthly increase to 102.4 from 101.4. Although there was a lower than expected reading for current conditions, the data maintained a more favourable tone.

There was a further decline in peripheral bond yields which helped underpin sentiment as Italian benchmark yields declined to a two-year low.  ECB member Asmussen stated that he would be very reluctant to cut the deposit rate to below zero which cast some doubt over the prospects for an ECB rate cut.  

Yen:

The LDP won a huge victory in the recent lower-house elections and the strength of their majority should mean that they can over-ride any veto attempt from the Upper House. The government will push ahead with aggressive policies to combat deflation. There will also be intense pressure on the Bank of Japan to take an even more aggressive stance on monetary policy and the bank will consider an increased inflation target early in 2013.  These pressures will exert downward pressure on the yen, but the currency could still gain at times when there is a deterioration in global risk appetite.

The Japanese election result recorded a major LDP victory as they won 294 of the 400 seats in the lower house with their partner winning a further 30. The results give the coalition a two-thirds majority and this is extremely important as the government can over-rule opposition from the Upper House

The latest trade data recorded a headline deficit of JPY953bn from a revised JPY549bn previously as exports recorded a 4.1% annual decline. The data reinforced fears surrounding the export outlook and reinforced negative yen sentiment.

The Bank of Japan announced a further JPY10trn in quantitative easing which was in line with market expectations. There is still a high degree of pressure on the central bank to take additional steps to boost the economy and sanction additional policy measures. Incoming Prime Minister Abe stated that the central bank was carrying out policy steps sought by the government one at a time in a clear reference to the government expecting further action. The administration is planning an emergency economic package in January and the yen remained under heavy selling pressure.

The yen found support towards the 84.50 area against the dollar and recovered ground as risk appetite deteriorated sharply following the collapse in US fiscal cliff talks. The US currency moved back to the 84 area as the Euro retreated to below 111.

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There will be further unease surrounding the UK economic outlook with expectations of a weak fourth-quarter.  There will be major uncertainties surrounding Bank of England policies and there will certainly be pressure for the central bank to maintain an aggressive stimulus policy to underpin demand.  There will be speculation over a shift towards nominal GDP targeting when Carney takes over as Governor later next year.  The UK currency will continue to gain some protection from the aggressive policies pursued by other global central banks, but Sterling is unlikely to make significant headway.

Sterling was resilient during the week and challenged 3-month highs around 1.63 against the dollar before consolidating slightly lower.
 
There were further concerns surrounding the AAA credit-rating following the Standard & Poor’s decision to downgrade the outlook to negative and there was further speculation that the rating would be lost during 2013.  With the Federal Reserve increasing its bond purchases and the Bank of Japan expand policy further this week, there will be some initial Sterling support on relative grounds with expectations that the Bank of England will hold policy steady in the short-term..

The latest inflation data recorded an unchanged annual rate of 2.7% for November compared with expectations of a marginal decline. Although the RPI rate dipped to 3.0% from 3.2%, there were some expectations that the stickiness in inflation would curb any further quantitative easing by the Bank of England.

The Bank of England minutes were broadly in line with expectations as the MPC voted 9-0 for unchanged interest rates while there was a 8-1 vote in favour of leaving quantitative easing on hold as Miles again voted for a further £25bn expansion in bond purchases. The bank was generally pessimistic over the growth outlook and warned over the stickiness of inflation. There were also further calls for a weaker exchange rate with Sterling’s gains described as unhelpful and a headwind for recovery and this is likely to be an important issue during 2013.

The headline retail sales report was weaker than expected with sales unchanged for November following a revised 0.7% decline for October. There was also a sharp decline in the latest GfK consumer confidence reading from -22 to -29.

Swiss franc:

The National Bank will remain strongly committed to maintaining the 1.20 minimum Euro level in the short-term, especially with a strong determination to resist franc appreciation to protect competitiveness. Aggressive policy relaxation elsewhere will maintain the risk that upward pressure on the franc will intensify again as investors look for a safe-haven, especially if the Japanese yen is subjected to further selling pressure.

The dollar remained firmly on the defensive against the franc and dipped to fresh 7-month lows just below 0.91 before staging a weak corrective recovery. The Euro consolidated around the 1.2080 area with narrow ranges prevailing.

With liquidity declining into the Christmas period there is likely to be an increased reluctance to take on the National Bank and the 1.20 minimum level and a potential for a further round of short Euro covering. There were wider concerns surrounding the risk of renewed tensions during 2013 and the franc also gained support from a lack of attractive safe-havens, especially with the yen under serious selling pressure.

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The Australian dollar continued to probe resistance above 1.05 against the dollar during the week, but it was unable to sustain the gains and retreated back to below the 1.05 level. The currency was unsettled to some extent by a decline in gold prices and dipped again when there was a deterioration in risk appetite.

The monetary policy minutes suggested that the bank could be cautious over further interest rate cuts, but Reserve Bank Governor Stevens also continued to suggest that the currency was over-valued and that it should be weaker.

There is likely to be resistance to currency gains with the Reserve Bank under pressure to push the currency weaker, especially if growth fears intensify.

Canadian dollar:

The Canadian dollar was unable to make further headway during the week and edged back to the 0.99 area as narrow ranges generally prevailed.  

The latest retail sales data was stronger than expected which provided some relief and oil prices were generally firm, but a decline in gold prices had some negative impact.

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 impression against the dollar and retreated to lows near 55 against the US currency. There was solid dollar demand from oil and gold importers which had some negative currency impact.

There was some disappointment that there was no cut in interest rates at the latest monetary policy meeting and the rupee was unable to make any progress despite a generally robust tone in the local stock market.

Overall, there is likely to be scope for only limited rupee gains given wider risk conditions, especially as domestic growth concerns are liable to increase again.

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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.

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. The HKMA warned over the risks of an overheating property market in its latest quarterly report which will maintain concerns surrounding the medium-term peg outlook.
 
With inflation fears continuing, medium-term speculation surrounding the Hong Kong peg and a potentially radical change in policies is likely to continue.

Chinese yuan:

The yuan maintained a generally robust tone during the week, but it was unable to sustain gains beyond the 6.23 level against the dollar as the PBOC continued to resist gains in relatively subdued conditions.

There was caution over buying the yuan, especially with evidence that the central bank was buying dollars. There were no major economic data releases and the PBOC suggested that there would be a cautious monetary policy during the course of 2013.  

Overall, the yuan will find it difficult to make much headway from current levels as the more optimistic tone surrounding the Chinese economy is likely to fade.

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