Weekly Forex Currency Review 07-02-2014

Global monetary policies will continue to be an important underlying influence, especially given the impact on emerging-market currencies. At this stage, the Federal Reserve remains committed to a gradual tapering of bond purchases. The ECB has decided against greater monetary activism at this stage, but pressures will build sharply if there is evidence of fresh deterioration within the Euro-zone economy.
 
Key events for the forthcoming week

Market analysis

Dollar:

The US economic data indicators are liable to remain mixed in the short-term, especially with some distortions from adverse weather conditions. At this stage, the Federal Reserve is likely to remain committed to a further gradual reduction in bond purchases which will provide some degree of dollar support. Testimony from Fed Chair Yellen will still be watched very closely in the short-term for indications of her policy stance. The underlying US fundamentals should maintain underlying dollar support and there will be some defensive buying of Treasuries if there is a sustained deterioration in risk appetite, but strong dollar gains are unlikely for now.

The dollar was unable to make significant headway during the week, undermined by slightly less favourable US data and the inability to break key technical levels, although the underlying tone was still firm.
 
The latest US ISM manufacturing data was sharply weaker than expected  at 51.3 for January from 56.5 previously, the lowest reading since June 2013. Orders growth declined very sharply from December and the employment component also weakened which will raise concerns surrounding the growth outlook. There was an increase in the prices index which should ease potential concerns over inflation being too low.

Chicago Fed President Evans stated that the barriers to an adjustment of the tapering process were high which suggests that the Fed will be keen to sanction a further reduction in bond purchases at the next FOMC meeting. There were similar comments from fellow regional President Lacker.

the ADP release was slightly weaker than expected at 175,000 for January from a revised 227,000 previously. There was some immediate relief that the data was not even worse and the Euro retreated from the 1.3550 area. There was dollar support from a solid ISM services-sector report which helped offset the negative impact of Monday’s manufacturing report.

Regional Fed President Plosser stated that the Fed should taper bond purchases at a faster rate, although he is at the hawkish end of the FOMC spectrum.

There was a decline in initial jobless clams to 331,000 from a revised 351,000 which provided some dollar support. In contrast, there was an increase in the December monthly trade deficit to US$38.7bn from US$34.6bn previously as exports fell and this will trigger expectations of downward revisions to fourth-quarter GDP data.

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Confidence in the short-term Euro-zone outlook will remain slightly stronger for now, especially as German growth remains firm. There has been some improvement in Spain, but France and Italy are at high risk of fresh contraction. The ECB has looked to play-down deflation concerns, at least in public and maintained a steady policy at the latest council meeting, but concerns over weak monetary growth is liable to increase with the internal debate increasingly fractious and further action is possible in March. Even if the Euro holds firm for now, the medium-term outlook will continue to deteriorate.

The Euro traded with a slightly weaker tone ahead of the ECB policy meeting before regaining ground as the central bank resisted further policy changes.

The latest Euro-zone PMI manufacturing data was marginally stronger than expected as Spain and Italy managed to stay above the 50 level and there was also a positive Greek reading for the first time in over four years. The final PMI services-sector readings had a slight dampening impact on the Euro with a small downward revision from the flash estimate, although the Spanish reading was substantially above the 50 level which limited downside pressures.

The latest Spanish unemployment data was weaker than expected with a January increase of 113,000 over the month. The recent Spanish labour-market data has been very erratic which dampened the impact this time around and the Euro was able to find support below 1.3500 against the dollar.
 
There was also a weaker than expected reading for Euro-zone retail sales with a 1.6% monthly decline for December. Although the Euro did weaken following the release, the pair was generally confined to narrow ranges.

The ECB left all rates on hold as had been expected by a large majority of investment banks. The Euro rallied immediately following the decision before drifting back to the 1.3500 area ahead of President Draghi’s press conference.

Markets were expecting a generally dovish tone from Draghi with potential hints over new policy initiatives and a possible ending of bond-purchase sterilisation. He was still generally very cautious over the outlook and reported that the meeting had been dominated by discussion of possible downside risks and contingency plans.

There were, however, no fresh measures at this stage and he also stated that conditions were starting to show some signs of improvement. Given expectations of a much more dovish slant, the Euro rallied sharply with a move to above the 1.36 level. The German Constitutional Court ruling referred the ECB’s OMT bond buying programme to the European Court.

Yen:   

There will be some scope for further reduction in short speculative positions which will help underpin the yen.  The Japanese currency will continue to gain some degree of defensive support when global risk appetite deteriorates. There will be expectations of a slightly less aggressive Bank of Japan policy this year which will lessen the potential for yen selling, although underlying confidence in the Japanese fundamentals will remain weak. Overall, there is liable to be only limited scope for yen gains from current levels.

The yen held a firm tone over the first half of the week as risk appetite remained on the defensive. There was some improvement in risk conditions following an upgrading of Mexico’s credit rating and the underlying risk tone also improved as immediate emerging-market stresses eased. There were no major Japanese developments during the week with global trends dominating.

The were solid gains for the Nikkei index which curbed demand for the yen and the dollar was able to hold above 102 against the yen. Some stabilisation in emerging markets curbed yen demand and there were expectations of firm US employment data which underpinned the dollar.

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Although the near-term growth rate will remain solid, there will be some speculation that the rate of expansion has peaked given a peaking in the PMI services-sector data.  Bank of England policies will remain a very important focus and next week’s inflation is likely to be crucial for near-term Sterling direction given the possibility that forward guidance will be adjusted. Even if the currency holds firm in the short-term, there will be persistent underlying fears surrounding the underlying balance of payments vulnerability.

Sterling tended to drift slightly weaker during the week with further evidence that UK out-performance could start to fade as it retreated to test 1.6250 against the dollar and levels above 0.83 against the Euro.
 
There was a weaker than expected PMI manufacturing reading of 56.7 from a revised 57.2 previously. The construction data was sharply higher than expected at 64.2 from 62.1 previously which was the highest reading for seven years.

The services-sector report was slightly weaker than expected with a decline to 7-month lows of 58.3 for January from 58.8 previously, contrary to expectations of a small increase. Although still robust from a historic perspective, the data reinforced unease surrounding a potential peaking in UK growth. A further increase in house prices in the latest Halifax survey did not have a significant impact.
 
There were no surprises from the Bank of England as interest rates and  the amount of quantitative easing were both left on hold. There was no statement from the MPC on any change to forward guidance. There had been some speculation of a possible central bank shift at this meeting, Sterling rallied slightly following the decision with a move back above 1.63 against the dollar.

Next week’s inflation report will now be extremely important for markets given the potential that forward guidance will be amended to take account of unemployment falling faster than expected. Any change would inevitably have a big impact on interest-rate expectations and Sterling.

Swiss franc:

With the Swiss economy continuing to perform strongly in the short-term, markets will continue to look at indicators of asset prices and inflation closely. The National Bank will remain concerned surrounding over-heating in the property sector. If direct controls are ineffective, there will be pressure for a tighter monetary policy which would be incompatible with the minimum Euro level. In the short-term, the central bank will still be determined to maintain the peg given the substantial costs of a policy reversal.

The franc held a generally firm tone during the week, although it did retreat from its best levels as risk appetite started to improve slightly.
 
National Bank Chairman Jordan reiterated comments that the Franc would remain in place for as long as necessary. The ECB decision to leave policy on hold will tend to deter near-term capital flows into the Swiss currency.

Domestically, there was a stronger PMI reading for January at 56.1 from 55.0 previously. The monthly trade surplus dipped sharply in the latest report as imports rose strongly. Although this will maintain expectations of solid growth, there will also be some concerns surrounding competitiveness.

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After weeks of being on the defensive, the Australian dollar was able to stage a significant recovery during the week, peaking close to the 0.90 level against the US dollar. Although conditions remained nervous, there was some stabilisation in emerging markets which also eased selling pressure on the Australian currency.

The Reserve Bank left interest rates on hold at 2.50% following the latest policy meeting. Significantly, the bank removed the easing bias for future decisions and switched to a neural policy which pushed the Australian currency higher. There was a stronger than expected trade account in the latest data and a solid reading for retail sales which helped underpin confidence.

The Australian dollar will still be unsettled by unease over emerging markets and risk appetite. In this environment, corrective rallies could reverse relatively quickly.
 
Canadian dollar:

The Canadian dollar was able to stage at least a corrective recovery during the week as the US currency generally struggled to sustain momentum

There was a weaker than expected trade report which limited potential buying support and underlying confidence was still generally fragile which limited the potential for Canadian currency demand.

There will be further expectations that the central bank will welcome further Canadian dollar losses to underpin exports, butt he overall rate of depreciation is likely to slow.

Indian rupee:

The rupee was able to find support weaker than the 63 level against the US dollar during the week and consolidated near 62.50 for much of the time. There was some easing of emerging-market stresses which helped curb rupee selling pressure.

Domestically, there was optimism that the auctioning of mobile phone licences would attract substantial capital inflows and there the government’s decision to cancel a bond auction also boosted confidence in the budget position. There was some caution ahead of the latest GDP report given underlying growth doubts.

Although there has been a net improvement in domestic confidence, there will still be concerns surrounding wider emerging-market trends, limiting rupee support.

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The Hong Kong dollar was able to find support in the 7.7680 area against the US dollar and strengthened to the 7.7590 area. There was an easing of wider emerging-market stresses which helped underpin the Hong Kong currency with liquidity generally weaker due to the lunar new-year holiday period.

The Hong Kong dollar will be vulnerable to renewed modest selling pressure if there is a fresh deterioration in risk appetite and sustained emerging-market losses.
 
Chinese yuan:

Chinese markets were closed for the new-year holiday period during the week. There were underlying concerns surrounding credit conditions with nervousness over potential volatility when markets re-opened which would make it more difficult for the PBOC to keep tight control on the currency.

Credit developments will be watched very closely as Chinese market re-open following holidays with a risk of a serious destabilisation and longer-term yuan losses.

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