Weekly Forex Currency Review 07-03-2014

The ECB decision not to provide additional monetary stimulus will continue to have an important impact in supporting the Euro despite potential longer-term vulnerability. At this stage, the Federal Reserve is likely to maintain its policy of tapering bond purchases, but US trends will be watched very closely. The extent of any rebound from weakness triggered by adverse weather conditions would have a major impact on US yield expectations. Tensions surrounding Ukraine and Chinese economic trends will also be watched very closely over the next few weeks.
 
Key events for the forthcoming week

analysis

Dollar:

There will be further short-term doubts surrounding the US outlook with markets still trying to determine how much of recent softness has been weather related.  From a short-term perspective, the latest employment data will have a significant impact and another weak release would increase doubts surrounding both the outlook and bond purchase tapering prospects. For now, the Fed will remain committed to a further reduction in bond purchases and the US economy should still be able to out-perform major rivals which will provide important dollar support. The US currency will also gain some net support on any fresh deterioration in risk appetite.
 
The dollar was unable to sustain initial gains during the week and was then subjected to renewed selling pressure as it retreated to 2014 lows against the Euro and on a trade-weighted basis. Domestic data provided no significant dollar support.
 
The national US ISM manufacturing index registered a monthly improvement to 53.2 from 51.3 previously which also helped ease immediate market concerns surrounding the US outlook. Weakness in the production component was primarily a function of bad weather and was also offset by a recovery in orders.

The US ADP employment data was weaker than expected with an increase in private-sector jobs of 139,000 for February. There was also a sharp downward revision to January’s figure to 127,000 from 175,000 previously.

There was a similar situation surrounding the latest ISM non-manufacturing survey with a decline to 51.6 for February from 54.0 previously. A sharp drop in the employment index caused unease, but it was again difficult to isolate potential weather-related vulnerability and the orders component was more favourable. Data releases as a whole certainly did not provide any direct dollar support.

Fed member Dudley stated that the bar to altering the tapering process was high while regional member Plosser stated that the pace of tapering should be accelerated. Fellow member Lockhart stated that a payroll figure below 100,000 would cause some concerns, but officials should not over react.

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The ECB, in public at least, has taken a more optimistic stance towards the economic outlook and not signalled increased concerns surrounding weak lending and inflation being too low. In the short-term, this policy stance will provide further Euro support, especially with increased doubts surrounding the US outlook.  Confidence will erode rapidly if there are further signs of a renewed downturn in the Euro-zone economy with the ECB then looking very exposed. There is also likely to be a reduction in inward capital flows as valuations become much less attractive with the currency increasingly vulnerable.

After being trapped in relatively narrow ranges, the Euro pushed sharply higher following the latest ECB meeting with a 2014 peak above 1.3850.
 
The Euro-zone PMI services-sector data was slightly stronger than expected with a final February reading of 52.6 from a flash 51.7. Overall improvement was dampened by another weak French performance. The EU Commission also warned that France would not meet budget targets without further action while there were also warnings over the Italian outlook, illustrating underlying structural vulnerability.

As expected by a large majority of analysts, the ECB left interest rates on hold at the latest policy meeting with the benchmark repo rate unchanged at 0.25%. There has been some speculation over a cut at this meeting and an unchanged figure pushed the Euro slightly higher ahead of the regular press conference.

There had been greater speculation that alternative ECB measures such as the ending of SMP bond-purchases sterilisation would be introduced this month. In this context, bank President Draghi’s news conference was inevitably a very important focus.

In the event, there were no fresh measures by the central bank with Draghi’s statements virtually identical to last month. There was a slightly more optimistic tone on the economic outlook with comments that developments since the last meeting have been positive while fears over deflation were pared back. The overall tone was significantly more confident with hopes that lending was starting to improve.

As far as the Euro’s level is concerned, Draghi again rejected the notion of exchange-rate targeting as an instrument of monetary policy.  There were references to the fact that a strong currency would have an effect on inflation which would have an indirect policy impact. Markets inevitably focussed on the lack of fresh policy measures and more hawkish than expected rhetoric which pushed the Euro sharply higher.

Yen:

The yen will gain some degree of support when risk appetite deteriorates, especially with the risk of capital repatriation flows. Underlying confidence in the Japanese fundamentals will remain weak, especially with continuing trade deficits which will undermine the wider balance of payments position. There will be the risk of fresh Bank of Japan action to boost quantitative easing if the economy appears to be stumbling. Overall yield support will also remain very weak for the Japanese currency with potential capital outflows. Overall, the yen has the potential for only limited gains on defensive considerations.

Risk conditions were inevitably an important underlying influence on markets with tensions surrounding Ukraine and equity markets watched closely. The yen initially gained some fresh support on reports of an ultimatum surrounding Crimea.

Russian President Putin stated that there was no need to send troops to the Ukraine at this stage which helped alleviate immediate tensions. This curbed immediate demand for the yen as equity markets recovered ground strongly. The dollar was able to move to the 103 level from lows below 101.50 while the Euro moved sharply higher.

Bank of Japan Governor Kuroda stated that there was still momentum for carry trades while Economy Minister Amari remarked that Japan was not out of deflation which had an impact in weakening the Japanese currency.

Japanese regulator GPIF recommended that pension funds should diversify investments overseas which would imply potential longer-term yen depreciation, especially with a weaker current account position. From a shorter-term perspective, the latest weekly data recorded a substantial flow of funds back to Japan on risk aversion which illustrates the shorter-term risk of yen appreciation.  

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The UK economy will maintain a solid tone in the short-term with firm growth likely for the first quarter. There has been some evidence that momentum is fading slightly and the latest inflation surveys have generally been benign. In this context, the Bank of England will continue to resist pressure for any near-term tightening which will limit Sterling support. There will be important concerns surrounding the balance of payments situation and currency confidence is liable to erode quickly if there is a sustained deterioration in risk appetite.

Sterling moved lower against the Euro during the week while holding firm against the dollar at close to 2014 highs as international trends dominated.

The latest UK manufacturing PMI data was broadly in line with expectations at 56.9 for February from a revised figure of 56.6 for January. The construction PMI index registered a slight decline from last month with a figure of 62.6 from the 27-year high of 64.6 the previous month while the services-sector data was close to expectations with a reading of 58.2 for February from 58.3. The data maintained expectations of some loss of momentum, but there will still be a solid first-quarter GDP expansion.

The housing data remained strong with a strong 2.4% increase in the latest Halifax house-price index and an annual increase close to 10%. The latest BRC data recorded a 1.4% decline in shop prices in the year to February which will ease potential concerns surrounding underlying inflationary pressures and need for a tighter policy.

There were no surprises from the Bank of England with benchmark interest rates held at 0.50% and no change to the quantitative easing targets. Following recent changes to forward guidance, there was also no policy statement from the MPC with expectations for rates to stay on hold over the next few months.

Swiss franc:

The Swiss currency will gain support if global risk appetite deteriorates again, especially as there will be reduced capital outflows from Switzerland. The National Bank will continue to defends the Euro minimum level in the short-term and the most likely outcome is that pressure will be contained given a reluctance to take on the central bank. The Swiss currency should still gain underlying support from confidence in the domestic outlook and a concerted attack on the peg is a possibility if risk aversion increases again.

Underlying international considerations dominated the franc over the week. Rising tensions pushed the Euro to lows near 1.2100 against the franc.  

The Euro was able to make some headway later in the week as immediate tensions subsided and held near 1.22 even though the best levels were not sustained. The dollar was subjected to renewed selling pressure during the day and retreated to re-test recent lows just below the 0.88 level.

The more hawkish than expected ECB tone will continue to provide near-term Euro support and will limit the potential for any franc gains on yield grounds. The currency will still gain some underlying support if there is a fresh deterioration in risk appetite. 

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The Australian dollar was able to gain ground during the week and moved to a peak just above 0.91 against the US dollar despite underlying concerns surrounding commodity prices. There was also some underlying easing of global risk aversion which helped curb selling pressure.

As expected the Reserve Bank of Australia left monetary policy on hold at the latest policy meeting and also expressed further reservations over the Australian dollar’s valuation. The economic data was generally stronger than expected with a rebound in building approvals and retail sales. The fourth quarter GDP data was stronger than expected and there was a second successive monthly trade surplus.

Slightly greater confidence in the economic outlook will support the Australian dollar. The underlying risk conditions will still make it very difficult to sustain gains.

Canadian dollar:

The Canadian dollar was able to regain ground as the US currency weakened back through the 1.10 level. The currency held firm despite weakness in crude prices.

The Bank of Canada left interest rates on hold and the statement was broadly as expected. There were, however, no references to the Canadian dollar which suggested that the bank considered depreciation to have gone far enough, at least on a short-term view.  The building permits and PMI data releases were also stronger than expected.
 
Although a slightly more optimistic tone from the central bank will help underpin the Canadian dollar, it will be difficult to secure further strong gains given fundamentals.

Indian rupee:

The rupee performed strongly during the week and advanced to 2014 highs against the dollar with a move to near 61.0. The currency proved to be resilient early in the week when fears around Ukraine increased and was then able to take advantage of much more benign conditions later in the week.

A better than expected current account figure for the fourth quarter helped boost confidence as the ban on gold imports had a significant effect and there were further inflows into the local equity market which boosted underlying sentiment.

Although the rupee will continue to gain some relief on increased confidence surrounding the domestic fundamentals, wider stresses will tend to cap further gains.

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The Hong Kong dollar found initial support in the 7.7620 area against the US dollar early in the week and was then generally confined to narrow ranges around 7.76.
There was underlying support from a recovery in the Chinese yuan which eased immediate instability fears despite on-going concerns surrounding lending levels.
 
Immediate tensions surrounding the Chinese yuan will help support the Hong Kong dollar. Underlying medium-term doubts surrounding lending trends will continue.

 
Chinese yuan:

The yuan was able to resist further selling pressure during the week and the spot rate gradually recovered to around 6.1150 against the US dollar with US selling by local banks. The currency moves reinforced speculation that losses had been engineered deliberately by the PBOC in order to deter fresh inflows of speculative capital.

There were still significant concerns surrounding the economic outlook and risk of credit-relayed stresses. The government commitment to a broadly unchanged growth framework did not have a major impact as markets waited for fresh evidence surrounding near-term economic trends.

The PBOC will look for a period of stability given that two-way risk has been established. There will still be important concerns surrounding internal fundamentals.

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