Weekly Forex Currency Review 22-02-2013

Monetary and exchange rate policies will continue to be a very important focus over the next few weeks.  The ECB will be under pressure to ease monetary policy, especially after a series of generally disappointing releases. Expectations that the Federal Reserve will move towards a policy tightening are liable to reverse very quickly, but the US economy should still out-perform which will provide net dollar support.

Key events for the forthcoming week

Dollar:

The US economic indicators have remained broadly mixed with some evidence of a slowdown in consumer spending growth due to tax changes while the PMI readings continue to suggest moderate expansion. The Federal Reserve will remain committed to an expansionary monetary policy and will be extremely reluctant to tighten policy given fears that any premature move could push the economy back into recession. The dollar should still gain support from expectations of longer-term out-performance and an improving trade situation.

The dollar pushed higher during the week with a significant advance against the Euro and notable gains against Sterling with the trade-weighted index at a five-month high.
 
The headline US housing data was slightly weaker than expected as starts retreated to an annual rate of 0.89mn from a revised 0.97mn previously, but there was a modest increase in permits which helped maintain underlying confidence in the sector.

A warning over weaker sales from Caterpillar increased unease surrounding the global growth outlook and also helped spark a sharp decline in commodity prices with some rumours of a major fund liquidating positions which helped underpin the dollar.

The Federal Reserve minutes had a mixed tone reflecting an important diversity of opinion on the FOMC. Some members were concerned that there might need to an earlier than expected slowdown in the rate of bond purchases even if the unemployment rate did not fall to desired levels while others warned against a premature ending of the stimulus.

There was a moving away from any direct talk of dates with the Fed still fretting over the communication of exit strategies. Overall, there was a marginally more hawkish tone than expected even though a core surrounding Chairman Bernanke still supported a very accommodative policy.

Existing home sales were slightly stronger than expected at an annual rate of 4.92mn.  Initial jobless clams were slightly higher than expected at 362,000 from a revised 342,000 while there as a further deterioration in the Philadelphia Fed index to -12.5 from -5.8. The Markit PMI index was little changed at 55.2.

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There will be further solid expansion within the German economy, but confidence surrounding the Euro-zone as a whole will remain very fragile, especially after a set of disappointing PMI releases. There will be continuing unease surrounding the French economy and an indecisive Italian election result would also trigger fresh tensions. The ECB will be extremely reluctant to target the exchange rate and there will be German opposition to any attempts designed to weaken the Euro. The ECB will, however, need to maintain a highly-expansionary monetary policy and indirectly curb any significant Euro gains.

The Euro retreated over the week with renewed unease surrounding the economic outlook after a run of weaker than expected releases and a retreat to below 1.32 against the dollar. There was a decline in the ratio of Spanish bad bank loans to 10.4% in January from 11.4% the previous month, although this reflected the transfer of problem loans to the bad bank rather than any underlying improvement.

ECB President Draghi again cautioned over downside risks for the Euro-zone economy and emphasised that there was a lot of government efforts required to improve the underlying situation, although he expected a very gradual economic recovery to develop during 2013. Draghi repeated that there was no target for the exchange rate and continued to reject all rhetoric surrounding a currency war. Nevertheless, he also repeated comments that a stronger currency did have implications for inflation and monetary policy. In this context, there were concerns that a stronger Euro could push inflation too low which would be likely to trigger a monetary response from the ECB.

The German ZEW business confidence index was again stronger than expected with a third successive robust gain to 48.2 from 31.5 the previous month, the highest reading since April 2010. The data maintained near-term optimism surrounding the German outlook, although there was a disappointing reading for the current situation index which will cause some unease. The IFO index strengthened further for February.

There were further concerns surrounding the Italian political situation with important elections due to be held on February 24-25. There were further concerns over the risks of a deadlocked situation. Any clear victory for the centre-left coalition would be likely to provide some important Euro relief.

The latest Euro-zone PMI data was weaker than expected with the flash manufacturing edging marginally lower to 47.8 from 47.9, in contrast to expectations of a small recovery, while there was a significant deterioration in the services sector. The data increased unease surrounding the overall Euro-zone outlook and there were fresh concerns surrounding the French economy.
    
Yen:   

The appointment of the next Bank of Japan Governor will be extremely important in the short-term, especially given delays and confusion over potential candidates.  The nomination of a dovish candidate would tend to weaken the yen, although there will also be potential parliamentary opposition to ratification. There will be further intense pressure on the Bank of Japan to relax monetary policy aggressively in an attempt to eliminate deflation.  The weak trade position will also tend to undermine the yen, but the currency could still gain some degree of protection if global risk appetite deteriorates.

The dollar was unable to sustain a move above 94 against the yen during the week and the yen also secured some significant relief on the crosses. The yen continued to gain some support from denials that the Bank of Japan would buy foreign bonds with Prime Minister Abe stating that there was less need for this option.

The latest trade data was again weaker than expected with a JPY1.63trn deficit for January, the weakest monthly performance for over 60 years.  Energy imports rose strongly which will also create some unease over the risks associated with a sharp yen weakening.

Domestically, there was further uncertainty and debate surrounding the next Bank of Japan Governor appointment. The government will need to gain the support of opposition parties to gain approval for any nomination and this is increasing uncertainty surrounding the process. Overall, there were expectations that a very dovish nomination would be rejected which curbed yen selling

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Underlying confidence in the economy will remain extremely fragile in the short-term with fears that the squeeze in real incomes will undermine spending. Bank of England policies will remain an extremely important focus in the short-term following the more dovish than expected minutes. The 6-3 vote this month will increase speculation that the MPC will move to expand quantitative easing next month.  Monetary policy will certainly remain extremely loose which will undermine Sterling even with the potential for intermittent rallies.

Sterling was subjected to heavy selling pressure with 30-month lows below 1.52 against the dollar and a slide to lows beyond 0.87 against the Euro before a limited technical recovery.
 
The latest UK headline clamant count data was stronger than expected with a second successive monthly decline of over 12,000. Although the unemployment rate increased to 7.8% from 7.7%, the net report was stronger than expected.

The labour-market data was overshadowed by the latest Bank of England minutes. There was a surprise 6-3 vote for quantitative easing to be maintained at the current level with Governor King and Fisher joining Miles, who had previously vote for further bond purchases, in voting for a further GBP25bn increase in bond purchases. The tone of the minutes was very dovish which also increased speculation that the Bank of England would move towards relaxing policy further, potentially in March.

The headline UK government borrowing data was stronger than expected with a net repayment for January of close to GBP10bn. There was relief over the level of tax receipts, although the improvement was also related to one-time payments associated with Bank of England earnings under the quantitative easing programme. There was still an underlying deficit increase of over 6% for the year so far, maintaining underlying fears that the full 2012/2013 deficit would not show an underlying decline, increasing the threat to the AAA rating.

The latest CBI industrial orders reading registered an improvement to -14 for January from -20 the previous month.  Bank of England MPC member Miles stated that there was a good case for a further expansion of monetary policy, especially given the substantial output gap, maintaining expectations of further bank action.

Swiss franc:

There will be concerns surrounding the growth outlook, although the improvement in business confidence surveys will provide some degree of relief. The National Bank will remain strongly committed to the 1.20 minimum Euro level especially as renewed Euro-zone stresses could quickly trigger a resumption of upward pressure on the Swiss franc. The central bank has pledged to engage in further measures to stem capital inflows if required.  

The dollar pushed to highs above 0.93 against the franc while the Euro was unable to hold above 1.23 against the Swiss currency. National Bank head Jordan reiterated that the 1.20 minimum Euro level would be enforced with the utmost determination and that the rate was widely accepted within organisations such as the IMF.

There were concerns that renewed political pressures within the Euro-zone could lead to fresh demand for the franc. Domestically, the ZEW business sentiment index rose to 10 from -6.9 previously, only the third positive reading since mid 2010 which will provide some degree of confidence in the domestic economy.

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The Australian dollar rallied at times, but was unable to sustain buying attempts with resistance near 1.04 and weakened back to test 2013 lows in the 1.0220 region later in the week before a recovery.

The Reserve Bank minutes were broadly in line with expectations, butt he bank was cautious over the potential for further cuts in interest rates which provided some initial currency support.  There were no major economic releases during the week and there was some relief following Reserve Bank Governor Steven’s comments that only evidence of serious over-valuation would prompt intervention.

Although some scaling back of interest-rate cut expectations may provide some support, the Australian dollar is likely to remain generally vulnerable to further losses.

Canadian dollar:

The US dollar secured a firmer tone over the week and pushed to 2013 highs just above the 1.02 level during the week. The Canadian dollar was undermined by a sharp drop in oil and commodity prices.

There was a weaker reading for wholesale sales which had some negative impact and there was further speculation over a sharp slowdown in the housing sector which would undermine the wider fundamentals.

There are likely to be further concerns surrounding domestic fundamentals with a particular focus on the housing sector which will curb Canadian dollar support.

Indian rupee:

The rupee was again subjected to volatile trading during the week. The currency gained initial support from expectations of strong capital inflows associated with a bond auction.

The currency was subjected to renewed selling pressure later in the week with a deterioration in risk appetite. The equity market was weaker which curbed support for the currency as risk appetite was generally weaker.  There were underlying concerns surrounding the budget deficit and export prospects which curbed rupee support.

The rupee is likely to be unsettled by underlying structural budget and current account deficits, especially with expectations of slightly weaker net capital inflows.

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The Hong Kong dollar was confined to narrow ranges around the 7.7550 area against the US currency. There were still longer-term concerns surrounding the potential inflation threat until there is any underlying policy shift by the Federal Reserve and the slightly more hawkish Fed minutes did little to change the underlying perception.

There may be an easing of immediate speculation surrounding the Hong Kong dollar peg, but medium-term speculation will continue, especially given inflation concerns.

Chinese yuan:

The Chinese yuan was generally restrained during the week with a slightly weaker tone and consolidation near 6.24 against the US currency. There was a weaker trend in risk appetite markets which dampened demand for the yuan and the PBOC was happy to nudge the currency slightly weaker.

There were underlying concerns surrounding the Chinese economy with speculation over capital outflows also having a negative underlying yuan impact.

The Chinese yuan will find it difficult to make significant headway given persistent doubts surrounding the economy and risk of capital outflows.

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