Weekly Forex Currency Review 22-06-2012

The Euro-zone stresses and structural vulnerabilities will continue to be an extremely important focus. As well as serious underlying concerns surrounding the Greek outlook, the stresses in Spain and Italy are likely to have greater longer-term impact on the Euro’s prospects.  There will be further underlying defensive dollar demand, especially if growth prospects continue to deteriorate. There will also be pressure for more aggressive central bank policies which should help limit support for the US currency.

Key events for the forthcoming week

Dollar:

The US economic releases have remained generally weaker with some notably sharp declines in regional PMI indices which will reinforce concerns surrounding the outlook.  Although the Federal Reserve resisted a further round of quantitative easing, there was an extension of operation twist to keep longer-term interest rates down and there was also the potential for further action if the economy deteriorates further.  These factors will tend to undermine the dollar, but global factors will continue to provide underlying support, especially with expectations that global central banks are building dollar reserves.  These factors should continue to provide underlying US currency support.

The dollar drifted lower over the first half of the week before regaining ground as risk conditions tended to deteriorate again with solid buying support as European currencies weakened and the Euro retreated towards the 1.25 area.
 
The Federal Reserve announced no change in interest rates at the latest FOMC meeting. There was also no move to launch a third round of quantitative easing, but the Operation Twist was extended until the end of 2012 with the Fed continuing to buy longer-dated securities while selling shorter dates to keep long-term interest rates down. There was an 11-1 vote as regional President Lacker dissented.

The Euro dipped sharply following the announcement before reversing all the losses in choppy trading. The Fed also cut its growth forecasts with the 2012 estimate lowered by 0.50% and Chairman Bernanke insisted that all policy options were open. Expectations that the Fed will act if necessary to expand monetary policy was still important in holding back the US currency.

The US data was generally weaker than expected as initial jobless claims only declined to 387,000 from a revised 389,000 previously while existing home sales fell 1.5%. The latest PMI manufacturing index recorded a decline to 52.9 from 54.0 and there was a second successive sharp monthly decline for the Philadelphia Fed index as it fell to -16.6 from -5.8.  The data will maintain fears over a significant deterioration in the US outlook and will maintain speculation that the Fed will eventually move to an even more aggressive stance in boosting monetary policy further.

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There will be further intense uncertainties surrounding the Euro-zone outlook with a continuing focus on Spain and Italy as well as the underlying Greek stresses. There will also be speculation that Spain and Italy will move closer to requiring sovereign bailout funds. There will be further strong pressure for a shift in German policies and there will also be an increasing potential for a more aggressive ECB stance on monetary policy as the Euro-zone has little chance of escape unless growth conditions improve. In this environment, the Euro is likely to remain generally vulnerable despite rallies at times.  

The Euro registered net losses over the week in choppy trading conditions.  Following a narrow victory for New Democracy in the weekend Greek election, coalition talks were completed relatively quickly. There was agreement to form a coalition government with Pasok and Democratic Left.  There was, however, a marked reluctance to formally enter government as they rejected cabinet posts.

There were further concerns surrounding the Spanish banking sector with some media reports that funds required for a bailout could reach EUR150bn compared with the maximum EUR100bn pledged by the Euro-zone governments. The Bank of Spain also reported that non-performing loans in the banking sector increased to an 18-year high. The initial Spanish banking-sector stresses tests indicated that an additional EUR51-62bn in capital would be required under adverse conditions. The Eurogroup informally agreed that EFSF funds should be used to fund a Spanish bank bailout with a formal request expected by the beginning of next week.  

The German ZEW index fell sharply for June with a reading of -16.9 from 10.8 the previous month which was worse than expected and the sharpest rate of decline for over five years. The Euro quickly regained ground following the release with speculation that the weak data, allied with a slowdown in inflation pressures would push the ECB to cutting interest rates.

There were media reports that ESM and EFSF funds could be used to buy bonds directly which helped bring peripheral bond yields down, but German officials denied the suggestion as uncertainty dominated. There was also no mention of such a plan in the final G20 communique which concentrated on promotion of growth measures.

The latest German PMI manufacturing sector data recorded a decline to 44.7 from 45.2 previously which was a fresh three-year low for the series while the Euro-zone figure as a whole edged lower to 44.8, maintaining fears surrounding the economic outlook. The weak data will maintain pressure for an even more aggressive ECB monetary policy and the bank also relaxed collateral rules to help peripheral banks.

The new Greek government stated that it was aiming to revise the terms of the Greek loan package, but comments from German officials continued to suggest that concessions would be limited with the troika due to visit Greece as soon as possible amid reports that fiscal targets had not been met.  There were further concerns surrounding the Italian and Spanish outlook, although there was a sharp decline in Spanish benchmark yields which provided some relief.

Yen:

Defensive considerations will remain very important and there will be still be safe-haven yen demand when global risk appetite deteriorates. There will be further pressure to maintain regional competitiveness which will reinforce pressure for yen gains to be resisted, especially if there are significant Chinese yuan losses.  There will continue to be an important lack of confidence in longer-term Japanese fundamentals which should limit the potential yen buying. There will also be further speculation over intervention to curb any gains.    

The dollar found support below 79 against the yen before finding support and advancing following the Federal Reserve interest rate decision. The dollar maintained a strong tone on Thursday and pushed above the 80 level for the first time in a month with a peak in the 80.50 area.

The yen initially failed to gain support from increased caution surrounding risk appetite and there were only temporary net yen gains when the Euro came under pressure as the yen tended to under-perform on the crosses.

This pattern persisted in Asian trading on Friday with the dollar nudging highs above 80.40 with some further comments that the Bank of Japan was prepared to act aggressively to support the economy which increased speculation over further action.

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There will be further concerns surrounding the economic outlook, especially with weakness in the global economy limiting the potential for export growth which will maintain pressure for measures to boost domestic demand.  There will be further expectation over additional Bank of England quantitative easing, especially after the close vote at June’s meeting. Safe-haven considerations will remain important and there will be scope for additional inflows if Euro-zone fears intensify. It will, however, be difficult to secure strong support, especially with concerns surrounding the banks and volatility is likely to remain higher.

Sterling was unable to hold a peak close to 1.58 against the dollar before dipping weaker.  The latest headline consumer inflation rate did decline to 2.8% for May from 3.0% previously and was the lowest rate since late 2009 while the core rate was just above the 2.0% level which will make it easier for the Bank of England to jusify further monetary policy action.

In the Bank of England minutes from June’s meeting there had been some discussion over whether to cut rates from the record low of 0.50% to help lessen upward pressure on market rates. There was a close 5-4 vote for the amount of quantitative easing to be left on hold at GBP325bn as three members, including Governor King, voted for a GBP50bn extension to bond purchases while Fisher vote for an additional GBP25bn.  The quantitative easing vote will increase speculation that the MPC will vote for additional quantitative easing at July’s meeting.  

The latest retail sales data was slightly stronger than expected with a 1.4% gain for May, although this followed a revised 2.4% decline previously. The latest CBI industrial orders data recorded an improvement to -11 from -17 previously. Sterling tested resistance above 1.57 following the sales data, but failed to sustain the gains.

There were rumours that the UK banks would be downgraded by Moody’s which had some impact in undermining sentiment towards Sterling, although the dominant move was underlying US strength rather than UK weakness. Sterling weakened to lows below 1.56 against the dollar after a downgrade of three UK banks was confirmed.  

Swiss franc:

With confidence in the Euro-zone outlook remaining extremely weak, defensive flows into the Swiss currency could intensify. The 1.20 minimum Euro level could come under severe pressure, especially if there are increased fears surrounding Spain and Italy. The central bank will continue to intervene aggressively to curb franc gains in the short-term and will consider additional policy measures such as capital controls.  There is still the possibility that the minimum Euro level will be broken given the weight of capital flows.

The dollar found support on dips towards 0.9425 against the franc and nudged higher over the second half of the week while the Euro was again trapped close to 1.2010. There were persistent fears that Spanish and Italian vulnerability would trigger defensive inflows into the Swiss franc.  

The latest Swiss ZEW business confidence survey recorded a very sharp decline to -43.4 for June from -4 previously, increasing fears over a sharp economic slowdown and the data will also maintain pressure on the National Bank to preserve competitiveness by resisting franc gains.

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The Australian dollar held firm for much of the week and pushed to highs just above the 1.02 level as the US currency retreated and there was some improvement in risk appetite. Later in the week, there was a decline in commodity prices and fresh doubts surrounding the global growth outlook which had a negative impact and pushed the currency back to lows near parity.

The latest Reserve Bank minutes were broadly neutral with the June decision described as finely balanced. There were further concerns surrounding the regional and domestic growth outlook, especially with sustained weakness in the housing sector which maintained expectations of further medium-term rate cuts.  

The Australian dollar will continue to rally at times, but the underlying trend is likely to be for further net losses given unease surrounding the growth outlook.

Canadian dollar:

The Canadian dollar pushed to highs around the 1.0150 region against the US currency during the week, but was unable to sustain the gains and retreated back towards 1.03 later in the week.

The Canadian currency was undermined by a decline in commodity prices and by a slide in crude oil prices to eight month lows.  The latest retail sales data was weaker than expected which had some negative impact on the currency.

Concerns surrounding the global economy will tend to limit scope for Canadian dollar gains and there is a greater threat of further short-term losses.

Indian rupee:

The rupee remained under selling pressure during the week and dipped to fresh record lows just beyond 57.0 against the US currency. There was some evidence of limited Reserve Bank intervention to limit losses, but sentiment remained weak.

There was an underlying lack of confidence in the fundamentals with doubts over the fiscal and monetary outlook while there were further concerns surrounding the structural outlook as there were further warnings over the rating outlook.

Doubts surrounding the domestic and regional economy will continue to unsettle the rupee with little immediate chance of more than a limited recovery.

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The Hong Kong dollar was broadly unchanged over the week as a whole and settled just stronger than 7.76 against the US currency. There was a further debate surrounding the longer-term Hong Kong currency peg against the US dollar, although there were no major policy developments during the week.

Even with speculation over a medium-term policy shift, uncertainty surrounding the Chinese outlook will tend to limit scope for Hong Kong dollar gains.  

Chinese yuan:

The Chinese yuan remained generally on the defensive during the week with the spot rate dipping sharply during Thursday as the US currency advanced. The PBOC set the mid rate just weaker than 6.30 with a spot rate around the 6.36 area against the dollar.

There was evidence of underlying US demand from domestic corporation and there were further concerns surrounding the capital account. The domestic economic data also maintained a generally weaker tone with the HSBC flash PMI index remained below the 50 level for the eighth consecutive month with a dip to 48.1

The yuan is likely to be subjected to underlying selling pressure given the deteriorating economic fundamentals with the PBOC looking to limit potential losses.

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