Weekly Forex Currency Review 08-11-2013

Global monetary policies will be watched very closely in the short-term. The ECB has cut rates and the Federal Reserve will be reluctant to taper its bond purchases. The US economy is still in a position to out-perform the Euro area which should provide significant underlying support for the dollar even with the Euro still potentially resilient on repatriation flows.

Key events for the forthcoming week

Market analysis

Dollar:

The US PMI surveys were significantly stronger than expected which will underpin growth expectations. Other data releases have been mixed and the employment data will be very important for policy expectations. The Federal Reserve  still appears to be very cautious surrounding the economic prospects and will continue to be very hesitant over any potential tapering of bond purchases. A strong payrolls report would, however, increase speculation over a possible December move.  The US currency should also still gain some degree of support on competitiveness grounds and some limited gains are realistic.

The dollar pushed higher during the week, especially against the Euro, but he underlying performance still lacked conviction as volatility increased.
 
Regional Fed President Bullard continued to suggest that any tapering decisions would be data dependent. Despite improvements in the labour market, he continued to want to see higher inflation before cutting back on the stimulus programme. There were similar comments from Rosengren as caution prevailed within the Fed.

The latest US ISM non-manufacturing report was stronger than expected with a reading of 55.4 for October from 54.4 the previous month with the orders data strong. A sharp increase in the employment component also boosted confidence in Friday’s payroll report. The stronger data maintained speculation that the Fed could move closer to a tapering of bond purchases.

The impact was offset to some extent by speculation that the Fed’s defined unemployment rate threshold for considering an increase in interest rates could be lowered to 6% from 6.5% which curbed dollar support.

The later US economic data was stronger than expected with a headline third-quarter GDP release of 2.8%  from an expected 2.0%, although this was flattered by a sharp rise in inventories. The jobless claims data was also better than expected with a decline to 336,000 in the latest week from a revised 345,000 previously which sustained some speculation that the Fed could move towards tapering in December.

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The Euro will be hampered initially by the ECB rate cut. Draghi’s press conference also suggested that the ECB could sanction further measures over the next few months. There will be underlying deflation concerns and fears that underlying growth fears will deteriorate again. In particular, there will be major concerns surrounding the Italian outlook. Any increase in political tensions would risk a fresh increase in the Euro’s risk premium and Germany will oppose aggressive action. Underlying structural factors will still provide some degree of support for the Euro, especially with further capital repatriation.

The Euro held steady during the first half of the week before weakening sharply following the latest ECB policy meeting with lows below 1.33 against the dollar before a recovery and sharp losses on the main crosses.

There was a higher than expected increase in Spanish unemployment in October and, although primarily due to seasonal factors, there were still important reservations surrounding the economy. There was a slightly positive tone to the latest data releases with an upward revision to the PMI services index to a final 51.6 from the flash 50.9.

Italy was again the main source of disappointment with a monthly deterioration and divergence was an important theme during the day. There was evidence of further political pressure on the ECB to tackle deflationary pressures and the strong Euro with Italian and French government ministers both calling for action. In contrast, there was a much stronger than expected increase in German industrial orders with a 3.3% gain.

The consensus forecast was that the ECB would leave rates on hold with a few investment houses calling for a cut. In the event, there was a further cut in the repo rate to a record low of 0.25% from 0.50%, the fifth rate cut since Draghi took over as President in 2011. There was no move to push the deposit rate below zero.  

In the regular press conference, Draghi denied the risk of deflation, but did state that the Euro-zone was set for a prolonged period of low inflation and that the rate cut was designed to combat this weakness. The rate decision was not unanimous with Bundesbank head Weidmann dissenting from the decision and there were reports that around 25% of council members opposed the decision.  

The commitment to low rates was extended while Draghi was also keen to point out that the Euro was not factor in the rate cut. There was no move towards a LTRO, but he insisted that the ECB had not reached a lower bound for policy while unlimited liquidity will be provided until mid 2015. Late on Thursday, there was a credit-rating cut for France from Standard & Poors.

Yen:   

The Bank of Japan will maintain an aggressive monetary policy over the next few months. There is some evidence that the bank is more confident that deflation will ease which may limit the scope for any further near-term monetary easing. There will still be important concerns surrounding Japan’s fundamentals with debt fears and trade vulnerability. The yen will gain some degree of support when risk appetite deteriorates and from doubts surrounding the global growth outlook, but strong gains are unlikely.

The dollar struggled to break resistance levels against the yen during the week.
From the Japanese perspective, Bank of Japan Governor Kuroda’s comments on successes in combating deflation curbed expectations of further monetary easing which provided some underlying yen protection as the dollar stalled above 99.

Later in the US session Thursday, there was a very sharp reversal in trends with the Japanese currency advancing strongly against both the dollar and on the crosses. There was a sharp decline in the Nikkei index which pushed the yen stronger and there was a sharp reduction in long dollar positions which triggered high volatility.

The US currency initially declined to the 98.50 area and then dipped sharply again to lows below 98 in very choppy trading conditions. The latest capital data recorded net outflows from Japan which will maintain the potential for underlying selling pressure on the yen.

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Underlying confidence in the economy will remain firm in the short-term, especially after a very strong PMI services-sector report. There will be further expectations that the Bank of England will raise its growth forecasts next week and potentially signal that the central bank will be forced to raise interest rates earlier than expected. Sterling will gain support from a potentially more hawkish monetary-policy tone. There will, however, be important concerns surrounding the underlying fundamentals which could eventually expose the currency to sustained selling pressure.
 
Sterling held firm during the week, underpinned again by robust data releases as it held above 1.60 against the dollar. The latest UK CIPS construction data was stronger than expected with a rise to 59.4 for October from 58.9 previously and this was the strongest reading for six years as residential demand remained firm. Rumours of a strong services-sector index turned out to accurate with a reading of 62.5 for October from 60.3 previously.  This was the highest reading for 16 years as orders were at record levels. The data maintained confidence surrounding the near-term outlook.

The manufacturing data rebounded in September while there was a further monthly gain for the Halifax house-price index. There was a slightly disappointing reading for the latest NIESR GDP estimate at 0.7% for the three months to October.

There were also concerns surrounding the underlying economic direction with the account deficit liable to be close to 4.5% of GDP next year which would potentially expose the currency to heavy selling pressure if confidence falters.

There was no surprise from the Bank of England with interest rates on hold at 0.50% while the amount of quantitative easing was also unchanged at £375bn. There was no statement from the MPC following the decision. Immediately after the decision Sterling held steady before being buffeted by very sharp Euro moves. The UK currency advanced very sharply to 10-month highs near 0.83 against the Euro.

Markets will continue to look ahead to next week’s crucial Bank of England inflation report with expectations that there will be an upgrading of growth forecasts and adjustment to forward guidance which would boost Sterling. The ECB rate cut and expectations that the Fed will be reluctant to reduce quantitative easing will be important in providing underlying short-term currency support.

Swiss franc:

The Swiss growth data has been generally firm which will underpin wider confidence in the economy. The franc will also tend to gain support from the ECB policy stance following the fresh interest rate cut with pressure for all global central banks to maintain a very loose monetary policies. For now, there will still be a determination to resist franc appreciation. The franc could gain fresh support if global risk appetite deteriorates further.

The dollar made net gains against the Swiss currency even though it was unable to hold above the 0.92 level while the Euro surrendered initial gains to near 1.2350.
 
The latest Swiss inflation data was weaker than expected with consumer prices falling 0.1% for October with an annual increase of 0.3% which will maintain National Bank reservations over any currency strength and maintain a determination to maintain the minimum Euro level.

The more aggressive ECB policy will provide near-term franc support and the Swiss currency also gained some degree of support from a decline in global equity markets. A weak US employment report would confirm the franc’s defensive qualities.

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The Australian dollar was subjected to choppy trading during the week with net modest losses to test support levels below 0.9450 against the US currency. As expected, the Reserve Bank left interest rates on hold at 2.50% following the latest policy meeting. The Australian currency was undermined by further references to the currency being overvalued and vulnerable to medium-term losses.

There was a slightly stronger than expected retail sales report, but the latest labour-market data was weaker than expected with an employment increase of around 1,000. There was an improved construction PMI reading which provided some support.

The Australian dollar will gain some protection from a possible improvement in domestic conditions, but the currency is still substantially over-valued.
 
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 Canadian dollar did gain some protection from a stronger than expected PMI report, but the building permits data was again disappointing.

The Canadian dollar will find it difficult to secure a strong recovery given domestic monetary conditions.  It can still prove resilient unless there is a Fed shift in tone.

Indian rupee:

The rupee came under renewed pressure during the week with a retreat to lows beyond 62.70 against the US currency. Standard & Poor’s warned that India’s credit rating could be downgraded due to underlying structural vulnerabilities. There was stronger dollar demand from state-run banks and fresh demand from oil importers.

Internationally, there was some fresh demand for the US currency on fresh speculation over a possible tapering this year. Losses were contained to some extent by reports of central-bank intervention.

The rupee will gain protection from the lose Federal Reserve policy. Overall, there is little scope for significant gains given the important underlying structural concerns.

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The Hong Kong dollar was trapped in very narrow ranges during the week as it hit resistance close to the 7.7510 area which was very close to the band limit. Near-term monetary policies continued to put underlying upward pressure on the Hong Kong currency with continuing uncertainty surrounding the US monetary policies amid longer-term speculation that the currency peg will need to be amended.

Stability will continue to be seen as the top priority for the HKMA. There will still be a continuing debate surrounding the longer-term future of the peg.
 
Chinese yuan:

The yuan was able to maintain a solid tone during the week and, significantly, there was no weakening trend late in the week despite the underlying US currency gains. In this environment, the Chinese currency strengthened to just beyond 6.09.

There was a stronger than expected Chinese trade surplus which provided some degree of support for the local currency. There was inevitably caution ahead of the Chinese policy plenum over the next week with uncertainty over the potential for economic reforms to be announced.

The PBOC is likely to concentrate on stability in the short-term, especially with a key policy forum over the next week. Pressure for yuan appreciation is likely to fade.

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