Weekly Forex Currency Review 27-09-2013

Immediate attention will tend to focus on the US budget and debt talks given the threat of a government shutdown and default if no deals can be reached. Markets will expect the traditional pattern of brinkmanship and last-minute deal, but there will be a substantial impact and deterioration in risk appetite if there is a shutdown.  Central banks will remain under pressure to maintain very loose policies with a lack of confidence in the Federal Reserve and ECB tending to dampen currency ranges.

Key events for the forthcoming week

Market analysis

Dollar: 

The dollar has still been unsettled by the Federal Reserve decision not to taper bond purchases this month. There has been reduced yield support and the overall data releases have been mixed while robust data would revive speculation over a near-term tapering. There will be further near-term uncertainty surrounding the budget and debt situation. Markets will assume some form of last-minute compromise, but there would be a very sharp reaction if this is not the case with the US currency likely to be vulnerable. Global influences are still likely to be generally positive for the dollar over the next few weeks, especially with emerging markets unable to make any sustained headway.

The dollar made some very marginal gains, but with very little conviction given overall Federal Reserve doubts and only limited trade-weighted gains.

New York Federal Reserve Governor Dudley again expressed concerns that the economy had been weaker than expected in June. In this context, the decision not to taper bond purchases should not be seen as a surprise while commenting that a tapering was still possible later this year. There was a decline in US Treasury yields to just below the 2.70% level which curbed underlying dollar support.

The headline US durable goods orders data was close to expectations with a 0.1% increase for August following a revised 8.1% decline previously while there was a slight decline in underlying orders for the month which did not provide any significant optimism surrounding the outlook. There was an increase in new home sales to 421,000 for August from a revised 390,000 previously which did provide some degree of relief surrounding the housing sector.

On a shorter-term perspective, the growth and monetary policy debate was increasingly overshadowed by the political situation.  Congress was battling both to prevent a government shutdown and raise the debt limit. Secretary Lew warned that the Treasury would have exhausted its special measures by October 17^th and would then be liable to default. Meanwhile, there was still no deal to avert a government shutdown next week as Republicans continued attempts to de-fund Obama’s health-care policies.

The US jobless claims data was slightly better than expected at 305,000 in the latest week from a revised 310,000 and there appeared to be clean data after recent computer problems. Second-quarter GDP was unrevised at 2.5% and pending home sales were weaker than expected with a 1.6% monthly decline. An upward revision to payroll estimates was broadly a technical issue and did not have much impact.

The dollar gained some support from comments by Fed Governor Stein who stated that he would have been comfortable with a September tapering and that it had been a close call, but he was also critical of the Fed decision as it fuelled uncertainty and a lack of confidence. Regional Fed President Lacker stated that it would be difficult to taper in October so soon after the September meeting as uncertainty persisted.

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The Euro-zone data has maintained a solid tone, but there have been some warning signs that conditions will falter again relatively quickly, especially with serious stresses in the peripheral economies. The ECB will also be under strong pressure to resist any further tightening of liquidity conditions given the underlying vulnerability. The Euro will gain near-term support from equity-market inflows and a current account surplus, but it will be very difficult to sustain the gains, especially with underlying political tensions, especially in Italy, likely to intensify following the German Federal election.

The Euro was hampered during the week by concerns surrounding the economic outlook with pressure for a more aggressive monetary policy with consolidation around the 1.35 area against the dollar.

The German Federal Election results recorded a strong performance by Chancellor Merkel’s CDU party, but the party fell short of an absolute majority and, with the FDP failing to reach the 5% threshold for seats, Merkel will be forced into an alternative coalition. This is likely to be the main opposition Social Democrats which could lead to a more moderate policies on the Euro-zone peripheral policies, but uncertainty was an important feature.

The Euro-zone flash PMI releases registered mixed readings. The manufacturing data was weaker than expected with an overall Euro-zone reading of 51.1 compared with an expected 51.8, but the services-sector data was stronger than expected. 

ECB President Draghi maintained his recent stance on the economy with optimism that growth would continue in the third quarter despite weak industrial output data for July. He also remained confident that inflation would stay very low while stating that the ECB was ready to use another LTRO if needed with an underlying dovish tone. 

There was another weak reading for Euro-zone money supply while there was annual 2.0% decline in lending maintaining the run of contraction seen over the past 2 years. The data reinforced pressure on the ECB not to allow any policy tightening through an erosion of excess liquidity and the central bank is likely to maintain a dovish stance with further speculation over another LTRO operation. 

Politically, there were fresh tensions surrounding Italy as the President cancelled his engagements to focus on the crisis with centre-right backers of former Prime Minister Berlusconi again threatening to trigger a government collapse.  There was selling pressure on Italian bonds with benchmark yields rising by over 10 basis points on the day.

Yen:   

The Bank of Japan will maintain an expansionary policy throughout the next few months. The government is likely to announce additional fiscal measures to underpin the economy and the net implications are liable to be negative for the yen given recent correlations. There will also be important reservations surrounding the underlying fundamentals. The currency could still gain some degree of defensive support when risk appetite deteriorates and emerging-markets stumble, especially if there is a US government shutdown. 

There was choppy yen trading, but with little overall direction and dollar selling above the 99 level. The yen did gain some defensive support at times within an overall bearish market framework. 

There were further expectations that the government would announce a cut in corporate taxes as part of a wider fiscal package next week and there was also some speculation that major pension funds would announce an increase in asset allocations overseas. 

The latest inflation data was mixed and did not have a major market impact while there were net purchases of overseas bonds by Japanese funds which will be a slight negative yen factor. Finance Minister Aso stated that there were no immediate plans to cut corporate taxes which supported the yen on Friday

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Underlying confidence in the economy will remain stronger in the short-term, but there will be some speculation that the rate of growth will slow, especially if there is any slippage in forthcoming PMI data.  The Bank of England will not sanction any near-term tightening and yields are unlikely to offer much further Sterling support. There will also be important concerns surrounding the current account deficit following weaker than expected data. Sterling will also tend to be vulnerable if there is any sustained deterioration in risk appetite. 

Sterling held a strong during the week and recovered from intermittent profit taking to move back to 8-month highs around 1.61 against the dollar. There was some evidence that Sterling gained support from doubts surrounding US and Euro-zone fundamentals. 

The latest CBI retail sales survey was stronger than expected with an increase to a 15-month high of 34 for September from 27 previously and retailers were also optimistic for October. 

In the latest Financial Policy Committee Report, there were some concerns over the risks of overheating in the housing sector, but no evidence of any action at this time. There was still speculation that the Bank of England would be forced to increase interest rates earlier than it would prefer if the economy sustains momentum. 

The final UK GDP reading for the second quarter was in line with expectations at 0.7%. There was some disappointment over a weaker than expected annual growth rate, although this was primarily a due to a higher base effect with 2012 growth revised higher.

The second-quarter current account deficit of GBP13.0bn was slightly wider than expected and the first-quarter figure was revised sharply higher to GBP21.8bn. On current trends, the annual deficit could be over 5% of GDP for 2013 and there will be the risk of a loss of underlying Sterling confidence with a deficit on this scale. With investment also revised down for the quarter, there was a negative Sterling reaction.

Support in the 1.60 region against the dollar held and there was a sharp move higher at the European open on Friday with a surge to 1.61 against the dollar as Bank of England Governor Carney stated that there was no case for any further quantitative easing.

Swiss franc:

Underlying confidence in the Swiss economy is likely to remain slightly stronger in the short-term with an easing of deflation fears. Although the franc will still be vulnerable on yield grounds and seen as an attractive carry-trade currency, it could still prove to be resilient in the short-term. The franc could also gain renewed support if there is evidence that global economic conditions are deteriorating and emerging-market stresses intensify.

The franc held a firm tone with a test of support beyond 0.91 against the dollar and 1.23 against the Euro. The franc gained some support from unease surrounding the US budget talks while doubts surrounding the Euro-zone outlook persisted. There were also some fresh doubts surrounding the potential for medium-term weakness given its recent resilience.

National Bank Chairman Jordan maintained the recent rhetoric, insisting that the Euro minimum level was indispensible and that the franc was still highly valued. The bank was generally optimistic surrounding the economic outlook in its latest bulletin, but markets were wary of any attempts by the bank to verbally intervene and push the currency weaker.

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The Australian dollar was subjected to limited net losses for the week as a whole with a decline to lows below 0.9350 against the US dollar in choppy trading conditions. 

The currency found it difficult to sustain gains following last week’s Federal Reserve meeting even though there was also still a slightly more optimistic tone surrounding the Chinese outlook. There was still a high degree of uncertainty over the global outlook which curbed support and confidence in the domestic economy stayed fragile. 

The Australian dollar can gain support at times, especially if China reports stronger growth trends, but little underlying headway is likely given overall fundamentals. 

 
Canadian dollar:

The Canadian dollar was unable to make any further impression on resistance levels during the week with selling interest on moves towards 1.0250 and a move to beyond 1.03, although ranges were relatively narrow. 

There was a decline in oil prices which had a negative impact on the Canadian currency and risk conditions were fragile while valuations hampered the local currency. The impact was offset by a general lack of enthusiasm for the US currency. 

The Canadian dollar will tend to lose support if there is a sustained decline in oil prices. Short-term confidence in the fundamentals should limit near-term losses.

Indian rupee:

The rupee traded in narrower ranges during the week as volatility eased while the currency tested levels stronger than 62 against the dollar. US yields remained lower which helped curb selling pressure on the rupee and the currency gained support from heavy selling pressure by foreign banks which offset underlying fundamental doubts. 

There were still important reservations surrounding emerging markets which curbed Indian currency support and there were still long-term concerns surrounding the budget and current-account prospects with deficits still at elevated levels. 

The rupee will gain support from the easing of upward pressure on US bond yields. Confidence has stabilised, but fundamental concerns will limit any rupee recovery. 

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The Hong Kong dollar was unable to make any further gains during the week and edged lower, but underlying moves were very narrow with support on moves towards 7.7550 against the US dollar. The Federal Reserve policy decision not to taper bond purchases continued to have a beneficial impact on the Hong Kong currency. 

The dovish Fed policy will tend to be supportive of risk appetite in the near term and there will be potential pressure on the band limit if emerging-markets stabilise.

Chinese yuan:

The Chinese yuan was confined to relatively narrow ranges during the week with a spot rate close to 6.12 against the US dollar, 

The PBOC looked to maintain tight control of the market and there was also evidence that the central bank was looking to narrow the gap between the spot rate and daily fixings which triggered some speculation that it was a pre-cursor to an imminent widening of the yuan’s trading band. 

There was a high degree of uncertainty surrounding underlying Chinese economic trends with some evidence of firmer conditions offset by private-sector reports which suggested that growth conditions were slowing. 

There will be further speculation that PBOC will look to widen the  yuan’s trading band.  The overall fundamentals and debt fears are unlikely to support strong gains. 

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