Weekly Forex Currency Review 25-10-2013

Underlying dollar sentiment remains weaker on monetary policy and fiscal grounds with fresh speculation that the longer-term reserve status will be in jeopardy which will tend to trigger net capital outflows. The US still has important competitive advantages and there are very important vulnerabilities surrounding major alternatives. In particular, the Euro-zone vulnerability is likely to become a greater focus with increasing pressure for a policy response from the ECB.

Key events for the forthcoming week

Market analysis

Dollar:

US sentiment has weakened since the US short-term budget deal. There has been further speculation that the Federal Reserve will delay any tapering of bond purchases until 2014 due to economic and budget uncertainties. Data releases have also been generally fragile and there has been speculation that there will be a switch way from US assets following the political battles. The US economy still has an important competitive advantage which will provide underlying currency support.  There are also likely to be renewed concerns surrounding the European economies which will provide significant dollar protection. 

The dollar remained firmly on the defensive during the week with 8-month lows on a trade-weighted index as the US currency was undermined by economic doubts.

In the delayed report, the US headline employment data was weaker than expected with an increase of 148,000 monthly gain for September compared with expectations of around 180,000. There were again significant revisions with the August figure revised up to 193,000 from the original 169,000. There was also a decline in the unemployment rate to 7.2% from 7.3%.

Following the US payroll data, markets continued to assume that the Federal Reserve would maintain the aggressive quantitative easing programme.  Regional Fed President Evans again stated that it would be difficult to taper bond purchases at the December Fed meeting, especially with fiscal uncertainty still over-hanging both the markets and Fed given the need for a fresh deal early next year.

There was further speculation that the government shutdown had damaged the domestic economy and the dollar’s underlying global status with the possibility of a longer-term shift away from the US currency. Valuation factors were, however, also important and there was a reluctance to aggressively given that the Euro were seen as very expensive in relation to the US currency.

US initial jobless claims declined to 350,000 in the latest week, although this was slightly higher than expected while the delayed job openings data was stronger than expected at 3.88mn from a revised 3.81mn for August.

There was a lower than expected trade deficit at US$38.8bn, little changed from the previous month with exports and imports broadly static over the month, while the PMI manufacturing index dipped to the lowest level since April 2012 at 51.1. Markets continued to expect that Fed tightening would be pushed back to at least the first quarter of 2014 which sapped underlying dollar support.

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Underlying Euro-zone growth conditions are still extremely fragile and the slightly weaker than expected PMI releases will maintain concerns that economies will falter quickly. Although Spain probably registered positive growth for the third quarter, the underlying situation remains precarious and there will be growing concerns surrounding the French outlook. The ECB will be under increasing pressure to relax monetary policy aggressively in order to stem deflationary pressure and there will also be pressure for verbal intervention against the Euro given the underlying economic damage. 

The Euro continued to gain ground during the week as it pushed to two-year highs above 1.38 against the US currency and held firm on the crosses. 

There were signs of increased unease over Euro gains, especially within the French government as industry minister Montebourg stated that the Euro was too strong and also too German in its orientation. If the currency appreciates further, there will be strong pressure for verbal intervention to push the currency weaker. In particular, the ECB has previously been sensitive to any rate near 1.40 against the Euro and there will also be additional pressure for the central bank to cut interest rates. 

The Bank of Spain estimated that there was marginal GDP growth for the third quarter after over two years of contraction which provided some support, although there were still important underlying concerns given that there was only a marginal gain and domestic demand continued to contract.

The Euro-zone data was weaker than expected as the flash PMI manufacturing reading managed only a marginal gain to 51.3 from 51.1 while there was a significant decline in the services sector index. There was also a fragile set of readings for France which increased fears that any Euro-zone recovery would stall very quickly. 

The Euro dipped sharply lower following the releases, although there was no test of major support levels as dips soon attracted solid buying interest. The Euro is continuing to outpace global rivals given that monetary policy is tighter. There will be increasing concerns over deflation and there will be strong pressure for the ECB to relax policy either through a further LTRO, lower interest rates or quantitative easing. 

Yen:   

There will be further speculation that the Federal Reserve will delay a tapering of bond purchases which will curb US yield support and lessen the potential for dollar gains. The yen could also gain defensive support if there are increased fears surrounding the Chinese outlook. There will, however, be further important concerns surrounding the Japanese fundamentals and longer-term fears over a substantial yen decline given the debt profile. 

The dollar stayed on the defensive against the yen with a test of support in the 97 area against the yen with the yen mixed on the main crosses. 

The latest US capital-account data recorded net long-term outflows of just over US$8bn for August with a further reduction in Treasury bond holdings by China. In isolation, the data should not cause undue alarm, but market sentiment towards the dollar has deteriorated and the data reinforced a bearish dollar stance. 

Markets were still unsettled by the rise in short-term Chinese money-market rates, although there was an important divergence of opinion on how significant the development was. The latest Chinese flash HSBC PMI index was stronger than expected at a 7-month high of 50.9 which helped underpin risk conditions. 

The latest capital-account data recorded a strong flow of domestic funds into foreign bonds which will also tend to be a negative factor for the Japanese currency. Underlying confidence in the Japanese fundamentals remained extremely fragile with expectations of longer-term yen depreciation given the massive fiscal difficulties. 

The inflation data was close to expectations with a core 0.7% annual increase which should keep the Bank of Japan on track for the expansionary policy. Dollar weakness was the main feature on Friday with the US currency testing support close to 97.

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There will be a solid third-quarter GDP release which will help underpin sentiment. There will also be speculation that unemployment will decline faster than expected which will increase potential pressures on the Bank of England to bring forward any potential tightening of monetary policy. There is, however, an important risk that the economy will start to slow given underlying income pressures and a less favourable global outlook. In this context, Sterling is likely to be re-rated slightly weaker given the amount of positive news priced in. 

Sterling found solid support on dips against the US currency and challenged levels above 1.62 against the US currency with modest losses against the Euro. 

The government borrowing requirement of GBP56.7bn for the first half of the year fell by over 9% compared with 2012/2013. The improvement in tax receipts will maintain optimism surrounding the overall growth profile. 

There were no major surprises in the Bank of England October minutes with unanimous votes to hold interest rates and the amount of quantitative easing steady. There was greater optimism surrounding the growth outlook with comments that unemployment was falling faster than expected. In this environment, there was no suggestion that further quantitative easing was required at present. 

There will be expectations that the central bank will bring forward its assessment of when unemployment will decline to below 7%, which could also bring forward any potential tightening, although this should be at least partially priced in given recent data. A stronger UK currency was seen as having a mixed impact with a positive influence on containing inflation while having some negative impact on exports. 

Bank of England MPC member Miles expressed optimism over a self-sustaining UK economic recovery. Governor Carney made little comments regarding monetary policy, but did state that an assessment will be made at the appropriate time if unemployment falls faster than expected towards the 7% level. GDP rose 0.8% in the third quarter according to the flash estimate.

Swiss franc: 

Defensive considerations will be important and the franc will tend to lose ground following the US budget deal. The franc will also remain vulnerable on yield grounds and there will tend to be net capital outflows from Switzerland when overall risk appetite improves. The underlying economy is still performing relatively strongly which will provide support. Overall, despite gains at times, the most likely outcome is that there will be net selling pressure on the franc.

The franc maintained a firm tone during the week with an advance against all major currencies. The US currency retreated to two-year lows below 0.89 against the franc while the Euro retreated back below the 1.23 level for the first time in two weeks. 

The franc gained support from concerns surrounding the Chinese banking sector with an underlying lack of confidence in the dollar and Euro reservations also having a impact.   

There was speculation that the ECB would have to adopt a more aggressive monetary policy which curbed Euro support against the Swiss currency. The National Bank will, however, also be on alert over the internal deflation threat. 

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The Australian dollar briefly extended gains to above 0.97 against the US dollar before being subjected to renewed selling. The latest inflation rate was stronger than expected which dampened expectations of further rate cuts by the Reserve Bank 

There were renewed concerns surrounding Chinese money-market rates which dampened risk appetite and also triggered selling pressure on the Australian currency. 

The Australian dollar will continue to be influences strongly by global risk conditions and the Asian outlook with the potential for modest losses from current levels. 

Canadian Dollar:

The Canadian dollar held a firm tone at the start of the week before weakening significantly with a move beyond 1.04 against the US dollar. The currency was undermined by a decline in oil prices during the week.

The Bank of Canada left interest rates on hold at 1.% following the latest policy meeting, but there was a downgrading of growth and inflation forecasts with the bank also dropping its tightening policy bias which pushed the Canadian currency weaker. 

The Canadian dollar will be undermined by the Bank of Canada’s policy shift and a dropping of the tightening bias. Lower oil prices will also have a negative impact.

Indian rupee: 

The rupee was unable to make further headway during the week, although losses were generally contained with support on any approach to the 62 area against the dollar. 

There was increased dollar demand from the energy sector and emerging-market sentiment was more cautious following the rise in Chinese money-market rates.

There was, however, evidence of foreign capital inflows and a generally weaker US currency was also important in helping to cushion the rupee. 

The rupee will gain protection from a generally fragile US currency and optimism surrounding capital inflows, but it will be difficult to secure significant gains. 

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The Hong Kong dollar strengthened to highs just beyond 7.7520 against the US currency, before retreating to the 7.7550 area. There was further speculation over the peg’s medium-term outlook with pressure for the Hong Kong link to be broken. HKMA officials continued to voice strong support for the existing arrangement. The spike higher in Chinese money-market rates translated into increased volatility.

There will be a continuing debate surrounding the longer-term Hong Kong peg, especially if the yuan continues to strengthen and should underpin the currency.

Chinese yuan:

The Chinese yuan remained strong during the week pushed to fresh all-time highs near 6.08 against the US currency as the PBOC let the official rate gain ground 

There were fresh stresses in domestic money markets as the PBOC refused to inject liquidity. Higher yields would in theory underpin the yuan, but there were also concerns surrounding the growth environment and banking sector as loan write-offs continued to rise sharply. The HSBC PMI index strengthened to a seven-month high which provided some underlying support for the currency. 

The fragile dollar dynamics and potential capital flows will tend to support the yuan in the short-term. The banking-sector stresses will tend to deter strong inflows.

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