Weekly Forex Currency Review 28-03-2013

The Euro-zone situation will remain a very important short-term focus. Relief that some form of Cyprus agreement was reached will be countered by fears that the precedent for a haircut on bank deposits will trigger renewed fears surrounding the medium-term Euro-zone outlook. There will be particular doubts surrounding baking union. There will be continuing expectations that the US economy will be able to out-perform the key European economies over the next few months which will provide underlying dollar support.

Key events for the forthcoming week

Dollar:

The US economic data has had a more mixed tone over the past week with a significant decline in consumer confidence increasing doubts surrounding the consumer spending outlook. There will still be expectations that the US economy will out-perform over the next few months with solid manufacturing gains. The Federal Reserve remained generally cautious over the situation despite a slightly more optimistic tone.  Bernanke will certainly remain very reluctant to tighten policy, but with the potential for some adjustment in the rate of bond purchases later in 2013. The dollar should continue to gain important underlying support from renewed fears surrounding the Euro-zone outlook.

The US currency was able to secure net gains against the Euro during the week, but the wider performance was mixed as the currency struggled to secure wider traction as confidence in the US outlook was slightly more measured.
 
The headline US durable goods orders data was stronger than expected with a 5.7% monthly increase. There was a sharp boost from the transport sector with a small decline in core orders. The latest consumer confidence data was weaker than expected with a decline to 59.7 for March from 68.0 previously and the data combined dented optimism surrounding the US economy to some extent.

The US pending home sales data was in line with expectations at -0.4% following a strong increase the previous month. There were generally dovish comments from Fed officials with Regional President Evans stating his preference for a 3% inflation threshold before taking any tightening action. 

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The Cyprus situation will remain an important short-term focus as the banks look to re-open following the imposition of capital controls. There will be important contagion fears following the decision to force haircuts on large depositors with fears over wider capital flight from the Euro-zone. There will also be increased fears that uncertainty triggered by the Cyprus situation will trigger a fresh downturn in the economy which was already showing signs of fresh deterioration.  Peripheral economic remained extremely vulnerable and there will be pressure for a more accommodative ECB stance which will maintain underlying Euro vulnerability

A last-minute deal was secured to prevent collapse in the Cypriot economy and keep the country within the Euro-zone. Under the plan, Popular Bank will be closed and there will be substantial losses for uninsured bank deposits above EUR100,000 with assets above this level also frozen.

The Euro was only able to find very short-term support from the deal. There were important concerns surrounding the Cyprus economy which faces an extremely deep recession and there were also important contagion considerations.

There were very important longer-term consequences of the decision to impose losses on deposits above the EUR100,000 level. There were concerns surrounding the potential for capital flight away from the weaker Euro-zone banks and away from the Euro-zone as a whole given the precedent. Shares in key European banking-sector stocks fell sharply. There were also concerns over the Russian situation with the government extremely angry over the bank deposit situation.

These concerns intensified following comments from Eurogroup head Dijsselbleum who stated that Cyprus could be a model for any future bailouts. These remarks tended to contradict previous insistence that Cyprus was a unique case and also rained an increased contagion threat. The Eurogroup head subsequently attempted to back-track on the comments, but the Euro generally remained under pressure.

The banking sector throughout the Euro-zone also remained an important focus. There was fresh alarm surrounding reports that the EU parliament was considering bail-ins for large depositors under new draft banking legislation. This had another direct negative impact on the Euro, especially with fears over capital flight from the Euro-zone. There were also wider fears surrounding the outlook for banking union which would potentially undermine the longer-term Euro outlook.

Although there was a small decline in 10-year yields at the latest Italian bond auction, there was an increase in 5-year yields and there was also a significant decline in bid/cover ratios which suggested a sharp drop in underlying demand for bonds.

There was further Italian political uncertainty as centre-left leader Bersani attempted to form a coalition. He was rebuffed by Grillo’s five-star party, maintaining fears that it would be impossible to form a government with the risk of fresh elections later in 2013. In this environment, there was a further flow of funds into defensive assets and the 2-year German bund yield dipped into negative territory for the first time in 2013
    
Yen:   

The Bank of Japan will inevitably remain an extremely important focus in the short-term.  The first council meeting under Governor Kuroda will take place next week and there will be strong expectations of a more aggressive policy with the potential move to unlimited bond purchases. A substantial amount of easing has been priced in which may limit the potential for further selling. The yen could also gain some protection if there is a sustained deterioration in risk appetite.

The dollar was unable to move back above the 95 level against the yen during the week and retreated to test support below 94 with slightly narrower ranges with the Euro generally weaker on the cross.
 
There were further expectations of increased Bank of Japan monetary easing in the first week of April which continued to weaken the Japanese currency. There were a flurry of comments from central bank officials overnight, reinforcing how difficult it will be to ease the deflation threat. There was increased speculation that there would be a move to sanction open-ended bond purchases at the early-April meeting. There was some disappointment that the central bank appeared unwilling to consider even more aggressive policy measures.

The dollar dipped to test support near 94 on Thursday as risk appetite deteriorated during the Asian session with Chinese equity markets falling sharply.

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Overall confidence in the UK economy is likely to remain very fragile with a continuing squeeze on real incomes which will undermine consumer spending.  There will be pressure on the Bank of England to sanction further quantitative easing, especially with a slightly more flexible mandate. The central bank will be wary of further aggressive action, especially with unease over rapid Sterling depreciation, but the net outcome is likely to be for further easing.  Sterling is also likely to be undermined by increased balance of payments concerns.

Sterling was unable to make any significant headway against the dollar during the week, but there was support at lower levels as it held above 1.50 and Sterling advanced to beyond 0.85 against the Euro.
 
The latest UK lending data was weaker than expected with a decline in BBA mortgage approvals to 20,500 for February from a revised 32,000 reading the previous month. There have been conflicting signals on consumer lending.

There was no change to the final fourth-quarter GDP figure at -0.3%. There was a wider than expected current account deficit at GBP14bn for the fourth quarter from a revised GBP15.1bn the previous quarter.  For 2012 as a whole, there was a GBP57.7bn deficit at 3.7% of GDP which was the widest since 1989 with a sharp decline in investment income. There will be further concerns that the widening deficit will potentially put further medium-term pressure on Sterling.  

The latest Bank of England report indicated that the UK banks needed to raise fresh capital of around GBP25bn to bolster balance sheets, although the impact was limited.

Swiss franc:

There will be concerns surrounding the growth outlook, especially with concerns surrounding the threat of further deterioration within the Euro-zone which would undermine Swiss exports. The underlying evidence still suggests that there has not been serious pressure on the minimum 1.20 Euro level. Nevertheless, the bank will remain extremely wary of the situation, especially given stresses surrounding Cyprus which could trigger further additional capital outflows.   

The dollar pushed to highs just above the 0.9550 level against the franc during the week before a limited correction as the Euro retreated to lows below 1.22.
   
Following the decision to impose a haircut on Cypriot bank deposits above EUR100,000 there was renewed speculation over a shift of funds into Swiss banks, especially from the largest global investors which could further intensify underlying stresses.  National Bank member Danthine stated that the franc ceiling was an absolute necessity.

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The Australian dollar held a firm tone early in the week, but was unable to move above the 1.05 area and retreated back to below 1.0450 later in the week. The currency was hampered by a less robust tone surrounding risk appetite and by a sharp decline in Chinese stocks which maintained regional growth doubts.

There were little in the way of domestic incentives during the week, with markets waiting for the next round of monthly releases to assess the underlying outlook.

Canadian dollar:

The US dollar found some support on dips to the 1.02 area against the Canadian dollar and edged higher, although ranges were relatively narrow.

There was a stronger than expected reading for the latest consumer inflation data which increased speculation that the Bank of Canada would have to move to a tighter monetary policy.

The underling global growth profile will tend to limit Canadian dollar support, especially with doubts over the housing and manufacturing outlooks.

Indian rupee:

The rupee was unable to make significant headway against the dollar over the week as a whole with tough resistance on any approach to the 54 area.

There were further concerns surrounding the balance of payments position as India recorded a record quarterly deficit of US$31bn for the fourth quarter. The deficit increased underlying balance of payments concerns and also maintained pressure for greater capital inflows.

The rupee was hampered by a general deterioration in risk appetite as the Euro weakened against the US dollar.

In the short and medium term, the rupee is still likely to be hampered by underlying structural budget and current account deficits with little scope for significant gains.

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The Hong Kong dollar was blocked on any strengthening beyond the 7.76 level against the US currency and dipped back towards 7.7640.

There was a more cautious tone surrounding risk appetite which curbed demand for the Hong Kong currency, especially as the Chinese equity market retreated.

The short-term focus will continue to be on attempts to cool the property sector. Medium-term speculation over a peg break will continue given inflation concerns.

Chinese yuan:

The Chinese yuan maintained a solid tone during the week with a brief move beyond the 6.21 level against the US currency before consolidation just weaker than this level.

The currency was unable to sustain the advance and edged slightly weaker with the yuan hampered by a generally firmer tone against the Euro.

There was caution ahead of the next batch of economic data releases with further uncertainties surrounding the underlying Chinese outlook. There was a sharp Friday decline for the main equity market on a tightening of controls on commercial banks

The yuan is unlikely to make strong headway given the underlying growth and capital account profile with increased unease surrounding banking-sector trends.

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