Weekly Forex Currency Review 06-12-2013

Monetary policies will continue to be watched very closely in the short-term. There will be a continued determination to maintain very accommodative policies throughout the major economies. In this environment, relatively small changes will tend to have an important impact. The Fed will maintain a commitment to very loose policy, but is likely to move away from quantitative easing which will maintain underlying dollar support.

Key events for the forthcoming week

Market analysis

Dollar:

The US economic releases have generally been slightly stronger than expected with solid survey evidence and low jobless claims. There will inevitably be doubts surrounding the outlook, but there is enough evidence to justify a tapering of bond purchases this month. The Fed may well wait for more evidence and a key factor is that monetary policy will stay very loose even when tapering starts. This will tend to curb dollar support, but there should still be solid buying support on dips. The US economy has gained an important competitive advantage and potential capital inflows, especially with emerging-market currencies struggling.

The US economic data was generally favourable, but the dollar struggled to hold gains against major currencies and eventually dipped to a five-week low. The latest CFTC data recorded a net short speculative Euro position for the first time since late July which made it more difficult for the dollar to secure further gains.

The US ISM manufacturing data was significantly stronger than expected with an increase to 57.3 for November from 56.4 previously and this was the highest reading since May 2011. The ADP employment data was also stronger than expected with an estimated increase in private-sector jobs of 215,000 for November and there was also a strong upward revision to 184,000 for October from 130,000. Given the Federal Reserve’s strong focus on the labour market, a firm ADP release boosted optimism both in Friday’s payroll data and the potential for tapering of Fed bond purchases at the December meeting, although a majority of analysts do not expect a move.

Subsequently, the ISM non-manufacturing data was weaker than expected at 53.9 for November and there was also a disappointing reading for the employment component. There was a sharp increase in new home sales, but the dollar was unable to make fresh ground. The Fed’s Beige Book was broadly in line with expectations.

Jobless claims fell to 298,000 in the latest week from 321,000 previously while the third-quarter GDP estimate was revised higher to 3.6% from 2.8%. Although higher than market expectations, the dollar was again unable to gain any further traction following the data releases.

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There will be further concerns surrounding Euro-zone growth as a while, especially with evidence of persistent vulnerability in France and Italy. These economic fears will also increase underlying political tensions. The ECB will keep interest rates extremely low and will also be under pressure to adopt more aggressive policies to combat deflation. There will be resistance to substantial easing and the Euro will gain further support from capital repatriation. Underlying vulnerability within the banking sector will still be extremely damaging and eventually trigger heavy selling pressure on the Euro.

The Euro again demonstrated its resilience during the week with strong buying support on dips towards the 1.35 area and a move to five-week highs above 1.3650.
 
The final Euro-zone PMI services data recorded a marginal improvement from the flash reading. There were very important regional differences with Germany’s data revised higher and Spain recording a figure above 50 while there were deteriorations to five-month lows for both France and Italy. This divergence will reinforce concerns surrounding the French and Italian economic outlook with potentially important political ramifications over the next few months.

As expected, there were no changes in interest rates at the ECB policy meeting with the benchmark repo rate left on hold at 0.25%. President Draghi remained generally very cautious surrounding the economic outlook. The 2014 inflation forecast, for example, was cut to 1.1% from 1.3% with the rate expected to stay below 1.5% the following year. There had been expectations of a more substantial downgrade given recent data and growth forecasts were upgraded marginally higher.

Draghi was generally dovish and there were hints over a potential fresh, more targeted LTRO, but there were no fresh measures announced for now. The central bank head also stated that negative interest rates had been discussed only briefly and declined to comment on the Euro’s value which pushed the currency stronger.

There was a decline in German bund prices with some participants expecting a more dovish and aggressive ECB tone.  The failure to break significant Euro support levels initially triggered some short covering which pushed the Euro higher with the single currency again proving its resilience.

Yen:   

There will be further expectations of an aggressive Bank of Japan monetary policy with the potential for further easing next year to offset the impact of an increased sales tax. Although there has been some success in curbing deflation, there is liable to be a damaging impact on disposable incomes which will tend to be counter-productive and undermine growth. The trade account will remain more vulnerable and confidence in the Japanese fundamentals will remain very weak. Overall, despite potentially sharp gains at times, the yen will again be vulnerable to further underlying depreciation.

The dollar initially moved to the 103.50 area against the Japanese currency before being subjected to a sharp correction. The latest data recorded a further increase in net short yen positions to the highest level for over six years which maintained the possibility of a sharp correction. The dollar was unable to move above 103.50 against the yen while the Euro was unable to break above 140.

The inability to push to fresh highs prompted aggressive profit taking on the Euro/yen cross with a liquidation of positions also triggering selling pressure on the dollar. The yen also gained ground as Nikkei futures fell sharply and global equity markets fell.

There was a brief recovery in the US currency following the US data releases. In a repeat of Wednesday’s performance, the US currency was unable to sustain gains and dipped below support levels in the 101.90 area with lows near 101.60.

The GPIF advisory panel stated reported that institutions should act now to reduce their bond holdings given the need to boost returns. This provided some net support to the Nikkei index which also tended to push the Japanese currency weaker and the dollar was able to regain the 102 level.  

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The growth outlook will remain firm in the short-term with robust consumer spending and confidence in the labour market. There will be important doubts whether the strength will be sustained, especially given a sharp decline in the savings rate. There will also be further important concerns surrounding the balance of payments position, particularly if vulnerability in key emerging markets starts to dampen capital inflows into the UK. In this context, there is a high risk that Sterling confidence will start to erode again over the next few months with further gains very difficult to achieve.
 
Sterling held firm early in the week with 2013 highs against the dollar and 10-month highs against the Euro before being subjected to profit taking.
 
The PMI manufacturing index to 58.4 for November from a revised 56.5 and this was the highest reading since March 2011. The pace of job creation was also at the highest level since May 2011 while falling inventories suggested progress would be maintained in the short-term. The construction PMI index rose to a fresh six-year high of 62.6 for November from 59.4 previously with all sectors registering strong demand.

The headline services data was weaker than expected with a decline to 60.0 for November from 62.5 the previous month. In historic terms, the data was still robust with important strength in new business which should provide further near-term economic support which remains critical given the dominance of services.

The UK government’s autumn statement confirmed that GDP growth forecasts had been upgraded moderately for the next two years. The was a slight downgrading of longer-term forecasts, but there was still a reduction in estimates borrowing levels over the next two years. The Office of Budget Responsibility was keen to emphasise that the improvement was cyclical rather than structural.

The Bank of England also left policy unchanged at the latest MPC meeting with little Sterling reaction as no statement was issued with markets having to wait until the minutes are released to assess whether there has been any internal shift in positioning. The UK currency was again unable to hold above the 1.64 and retreated to lows around 1.6310. The pair was unable to gain fresh traction even when the dollar stumbled heavily as the Euro rallied strongly from recent losses to near 0.8370.

Swiss franc:

Evidence of firm domestic growth will continue to provide some support to the franc. The Swiss currency could also gain fresh capital inflows if the ECB is forced to take a more aggressive policy tone. There will be speculation that the bank will be more tolerant of franc gains next year as deflation fears subside. For now, there will be a strong commitment to retain the Euro minimum level, especially as wider Euro strength is putting upward pressure on the Swiss currency against other key currencies.

The Euro was unable to make any headway during the week and was subjected to renewed selling pressure once support in the 1.2280 area was lost. The dollar was also subjected to renewed selling with a move below the 0.90 level.

The Swiss PMI index strengthened to 56.5 for November from 54.2 the previous month, maintaining the run of favourable Swiss data and maintaining expectations of Swiss out-performance during the next six months which could lead the National Bank to accept currency appreciation during 2014.

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The Australian dollar was subjected to sharp price swings with further net losses despite a corrective recovery from the key 0.9000 level late in the week.

The Reserve Bank left interest rates on hold at 2.50%, but there were further comments from Governor Stevens that the currency was overvalued from a medium-term perspective and this was important in triggering fresh selling pressure.

The economic data releases were mixed with a solid reading for retail sales and building approvals, but the trade account was again weaker than expected which maintained underlying unease over commodity exports.

The Reserve Bank desire for a weaker currency will continue to unsettle the Australian dollar, especially if there is evidence of renewed Chinese deterioration.
 
Canadian dollar:

The Canadian dollar was subjected to further selling pressure during the week and retreated to fresh three-year lows around 1.07 against the US currency. There was a further decline in gold prices and move away from commodity currencies into the Euro which hampered the Canadian currency.

The Bank of Canada left monetary policy on hold at the latest policy meeting with no major changes in the statement. There was a stronger than expected trade account reading with a small surplus for October.  

The Canadian dollar will tend to be hampered by expectations of medium-term losses on valuation grounds, but the currency may prove resilient at lower levels.

Indian rupee:

The rupee maintained a firmer tone during the week and pushed to five-week highs beyond 61.70 against the US dollar. There was a slightly stronger than expected GDP report which helped underpin sentiment and equity markets rallied. There were still some underlying concern surrounding emerging markets as a whole.

Exit polls suggested that the opposition BJP had won state elections which bolstered expectations that the opposition could win next year’s general election which would also boost optimism surrounding reform.

The rupee will tend to be vulnerable if the Federal Reserve tapers bond purchases with potential vulnerability in emerging markets also hampering the local currency.

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The Hong Kong dollar edged slightly weaker during the week with a move to 7.7535 against the US currency. The growth of yuan deposits continued to out-pace Hong Kong dollar deposits, increasing fears that the local currency would lose ground.

A liberalisation of the Chinese capital account and a wider trading band would invite further speculation and debate surrounding the longer-term peg implications.
 
Chinese yuan:

The yuan was again confined to relatively narrow ranges and settled just weaker than 6.09 against the US currency for the second consecutive week. The PBOC appeared happy with a generally stable currency while a further narrowing of  the gap between the fixing and spot rate continued to fuel speculation that there would be a widening of the trading band early next year.

In the meantime, there were expectations that the PBOC would prefer a stable or slightly firmer currency. The latest data indicated that the yuan was now the second-most traded global currency having moved past the Euro.

There will be expectations of a more flexible currency within the next few months. Shifts in capital-account trends will make it more difficult for the yuan to gain ground.

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