Weekly Forex Currency Review 01-11-2013

The Euro-zone will be an important focus during the next few weeks with the central bank under additional pressure to sanction additional policy easing, including interest rate cuts, to combat potential deflation. The US economic data and potential implications for Federal Reserve monetary policy will also be watched very closely as the Fed prepares for Yellen to take over as Chair from Bernanke next year. 

Key events for the forthcoming week 

Market analysis

Dollar:

The US labour-market data has been generally subdued while the underlying data releases have been generally mixed with no clear pattern. Markets had become increasingly sceptical whether any Fed tapering would be a realistic possibility before March 2014 which kept the dollar under pressure. The latest Fed statement was, however, slightly less dovish than expected which triggered some reassessment of potential timing. The dollar will also gain some degree of protection from fresh doubts surrounding Euro-zone economies and should continue to prove broadly resilient in the short-term. 

The dollar secured sharp gains against the Euro over the second half of the week and made some progress on a wider trade-weighted basis as it recovered from seven-month lows and advanced strongly against the Euro.

The headline US retail sales data, delayed by the government shutdown, was weaker than expected with a 0.1% decline for September. The underlying figure was more positive at 0.4%, in line with expectations. Consumer confidence dipped to 71.2 for October from 80.2 previously which was the lowest figure since March. 

The US ADP employment report was weaker than expected with a headline increase of 130,000 for October compared with expectations 150,000 and there was also a downward revision to September’s data. The headline CPI data was in line with expectations while the core increase was slightly lower than expected at 0.1%.  The data releases combined maintained expectations of a dovish Fed statement. 

There were no major surprises from the Federal Reserve statement as the amount of bond tapering was left on hold at US$85bn per month with no tapering. Kansas City head George again dissented from the decision, wanting at least a limited tapering. 

There were also comments that growth was being hampered by the fiscal tightening in place. The overall tone on the economy was, however, slightly more optimistic than expected with no real warnings over the impact of the government shutdown. The Fed was also more comfortable with financial conditions as bond yields have fallen. 

The slightly less dovish than expected statement did provide some dollar support

The US jobless claims data was slightly better than expected at 340,000 from 350,000 previously, but the Chicago PMI release was much stronger than expected with a headline figure of 65.9 for October from 55.7 previously as orders surged.

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Underlying Euro-zone growth conditions are still extremely fragile. Although Spain managed to record marginal growth for the third quarter, there was further contraction within Italy and conditions are liable to deteriorate again given the current ECB stance. There will be increasing concerns surrounding potential deflation and increasing pressure on the ECB to sanction additional easing following the weak CPI data.  There are also extremely important underlying political stresses. The Euro will still gain some degree of protection from the current account surplus and potential capital repatriation.

The Euro was subjected to sharp selling pressure with a move to near 1.35 against the dollar. There was frustration at the inability to push through resistance levels and economic fears also increased which had an important negative impact.

ECB’s Nowotny stated that there was no realistic prospect of a rate cut and that there were no tools which could be deployed against Euro strength. There were still speculation that the ECB would be forced to take action, either in the form of rate cuts, another LTRO or verbal intervention. There was evidence of divisions within the central bank and Nowotny subsequently suggested that a further LTRO was possible.

German unemployment rose marginally for the third successive month while Spanish GDP was confirmed as rising 0.1% for the third quarter. There was a decline in German consumer prices of 0.2% for October to give a year-on-year increase of 1.2% compared with an expected 1.4%. The latest bank survey suggested a slight easing in credit standards which will provide some degree of relief.

The headline Italian unemployment rate also rose to 12.5% from a revised 12.4% with youth unemployment moving above 40%. Stresses increased sharply following the Euro-zone data as the unemployment rate was a record 12.2%, maintaining labour-market concerns. In addition, there was a sharp decline in the flash inflation rate to 0.7% from 1.1% previously. The decline in inflation was influenced mainly by lower energy prices, but the data still increased fears surrounding a deflation threat. There was also increased pressure on the ECB to take more aggressive policy action. 

Yen:   

As far as domestic policy is concerned, the Bank of Japan will maintain an aggressive policy to exert pressure against deflation and underpin the economy.  Stronger growth trends would help underpin confidence in Abenomics, but the underlying fiscal situation remains precarious and yen sentiment could deteriorate rapidly. The dollar will struggle for traction unless there is a series of stronger US data and a more towards a Fed bond tapering. The yen could also gain some support if there is a deterioration in global risk appetite. 

The yen proved to be resilient during the week as the US currency was unable to move above the 98.50 area with a retreat back towards 98 as the yen recovered significantly against the Euro. 

The Bank of Japan left monetary policy on hold following the latest policy meeting. The bank also published its economic report and maintained its forecast of 2% in the fiscal year starting in 2015. The monetary policy trends were seen as negative for the Japanese currency, but the short-term impact was offset by a decline in the Nikkei index which tends to support the yen.

The dollar was unable to push above 98.50 against the yen and generally consolidated weaker as the Japanese currency gained ground sharply against the Euro. Significantly, the US currency was unable to gain any significant ground following the stronger than expected Chicago PMI data and also failed to gain support from a rise in US Treasury bond yields as the yen gained ground.

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Underlying confidence in the economy will remain firm in the short-term. There will be concerns that that growth led by consumer spending on the back of a stronger housing sector will stall quickly and also increase longer-term vulnerability. In this context, there will be important concerns surrounding the underlying balance of payments position. A determined Bank of England stance to defend forward guidance would also tend to curb Sterling support and it will be difficult to secure much in the way of short-term gains.

Sterling did retreat against the dollar as it tested support levels near 1.60 against the US dollar, but there was a sharp recovery against the Euro with little in the way of major domestic developments.

The GDP data was met expectations with a 0.8% flash estimate of third-quarter growth from 0.7% previously. The services sector moved above the pre-2008 peak for the first time while construction and manufacturing sectors were still below the peaks.

The latest CBI retail sales data was sharply weaker than expected with a reading of 2 for October from 34 previously, the lowest since July. Retailers were still optimistic surrounding the outlook with sales expected to improve in November

There was a significant increase in mortgage approvals to the highest level for over five years while consumer lending was slightly weaker than expected. The data maintained optimism surrounding the housing sector, but there was also some concerns that the rate of consumer spending growth could slow.

Bank of England MPC member Miles stated that it would be catastrophic to raise interest rates unless there was a substantial improvement in the labour market.

Sterling strengthened through the 0.85 level against the Euro with a move to near 0.8460. The performance was particularly impressive given that the UK currency is often subjected to selling pressure at month-end.

Swiss franc: 

The Swiss growth data has been generally firm which will underpin wider confidence in the economy. There is also the possibility that the National Bank will be less concerned over the deflation threat and more tolerant of any franc gains. For now, there will still be a determination to resist franc appreciation. The franc could gain fresh support if the ECB embarks on more reflationary policies, although growth hopes would also be higher.

The dollar maintained a firm tone against the franc later in the week with an advance to a high around 0.9075. The Euro was unable to make any headway, undermined by wider losses on the crosses with a retreat to near 1.23.

There was increased speculation that the ECB would be forced to take more aggressive action to curb a deflation threat within the Euro area which would tend to provide underlying support for the franc, at least on yield grounds.  

The latest KOF business confidence index was stronger than expected at 1.72 in October from a revised 1.54 the previous month, maintaining expectations of solid growth in the Swiss economy. In theory, the National Bank should also be less concerned over potential deflation and more tolerant of currency strength.   

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The Australian dollar was subjected to volatile trading during the week and registered net losses with a test of support below the 0.95 level against the US dollar. The economic data was generally stronger than expected with a sharp increase n building approvals in the latest month and another solid increase in home sales. 

The currency was, however, undermined by a speech from Reserve Bank Governor Stevens as he again stated that the currency was likely to weaken in the medium term, potentially sharply given the deterioration in terms of trade.

The Australian dollar will continue to be influences strongly by global risk conditions with signs of stronger performance offering some degree of currency protection. 

Canadian Dollar:

The Canadian dollar dipped to lows near 1.05 against the US currency, but proved to be resilient later in the week as it also recovered ground against currencies such as the Euro and Australian dollar.

The latest GDP data was stronger than expected which provided some relief over the economy. Bank of Canada Governor Poloz was broadly consistent in his assessment of the economy compared with the statement following the central bank rate decision.

The Canadian dollar will find it difficult to secure a strong recovery given the recent shift in policy stance by the Bank of Canada and a slightly less dovish Fed tone.

Indian rupee: 

The rupee was confined to narrower ranges during the week as intense volatility seen earlier in the third quarter continued to fade. The rupee edged weaker later in the week, but still registered the second consecutive monthly advance. There were net inflows into the local equity market for the 19^th consecutive session which provided underlying rupee support.

The central bank increased the repo rate to 7.75% to contain inflationary pressures, but there was a cut in the marginal lending rate.

The rupee will gain protection from a slightly more confident Asian economic tone and optimism surrounding capital inflows, but with little scope for significant gains. 

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The Hong Kong dollar maintained a firm tone, hitting resistance close to 7.7520, but not being subjected to any significant selling pressure. Debate surrounding the peg’s future faded slightly now the 30^th anniversary of its introduction has passed, but underlying speculation will continue. 

For now, stability will continue to be seen as the top priority for the HKMA. There will, however, be a continuing debate surrounding the longer-term Hong Kong peg.

Chinese yuan: 

The Chinese yuan was unable to strengthen further during the week and drifted slightly weaker consolidation close to 6.09 against the US dollar. There was speculation that the PBOC was content to let the currency stabilise and drift slightly weaker, especially with a key party plenum due in November 

The latest US Treasury currency report continued to call for a stronger Chinese currency, but again decided not to call China a currency manipulator. The latest official PMI index was slightly stronger than expected, but there were still concerns surrounding the banking sector and risk of instability from debt write-offs. 

The short-term balance of payments position will underpin the yuan. The PBOC is likely to be way over significant gains and fundamentals are liable to deteriorate.

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