Weekly Forex Currency Review 14-03-2014

International risk conditions will remain an important short-term influence. There will be political tensions surrounding the Ukraine situation and there will be economic unease over China.  There will be important reservations surrounding the global economic outlook if China deteriorates. In this context, there will be concerns over the risk of deflationary pressure with additional pressure on the ECB to take more aggressive monetary policy. At this stage, markets are still expecting the Federal Reserve to taper bond purchases further at this month’s meeting.

Key events for the forthcoming week

Market analysis

Dollar:

The latest US economic releases have remained mixed as adverse-weather influences continue. The labour-market data has remained generally firm with a solid payrolls report and a decline in jobless claims. The Fed is watching labour conditions very closely and the evidence overall should be strong enough to maintain a tapering of bond purchases this month which will provide some dollar support on yield grounds. The US currency will also gain some support on risk conditions even though it has been struggling over the last few weeks and there should be protection from significant losses.
 
The dollar remained under pressure for much of the week before finding some support against European currencies later in the week.
 
The headline US payrolls data was stronger than expected with an increase of 175,000 for February from an upwardly-revised 129,000 for January while the unemployment rate ticked up to 6.7% from 6.6%. There was a decline in weekly hours, most likely due to unfavourable weather conditions, while there was a significant 0.4% increase in average earnings which suggested a more robust labour market.

Longer-term yield spreads continued to move in the dollar’s favour with the US Treasury-German bund gap at the widest for eight years while the short end of the yield curve favoured the Euro.  For much of the week, shorter-term trends tended to dominate, although markets were more nervous over the risk of an underlying shift in sentiment if there is evidence of a stronger US outlook.

There was a decline in the US NFIB small-business optimism index which did little to boost confidence in the outlook, although the impact was limited. A slightly weaker than expected US job-openings release did not have a significant impact with markets still expecting a further tapering of bond purchases at March’s FOMC meeting.

The headline US retail sales data was close to expectations with a 0.3% gain for February while the core data also at 0.3% was slightly stronger than expected. There was a small improvement in confidence offset by a downward revision to January’s data.  The jobless clams data was significantly better than expected with a decline to 315,000 in the latest week, the lowest figure for over three months.

The Federal Reserve remains strongly focused on the labour market and the jobless claims data, allied with the payrolls data, should help improve underlying confidence within the Fed which will also make further tapering a strong probability this month.

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The current ECB monetary stance will continue to provide near-term monetary support. Even if deflation fears ease very slightly, real yields will remain attractive. There will be increasing concerns surrounding growth conditions with a high risk that several economies will slide back into recession, especially given very weak money supply and lending. Any deterioration in growth would alter the market dynamics very quickly with the Euro perceived as very vulnerable given pressure for the ECB to relax monetary policy very substantially in order to avoid collapse. There would also be the risk of renewed and substantial capital outflows and the Euro is liable to prove increasingly brittle.

The Euro moved to the highest levels since late 2011 against the dollar and maintained a firm tone on the crosses before being subjected to a significant correction across all major currencies.

ECB member Noyer stated that he was not happy with the Euro’s valuation and that the ending of SMP bond-purchase sterilisation remained an option. There was only limited initial impact given the ECB decision not to make policy changes last week.  

Spanish representative Linde stated that the accommodative ECB policy might lead to a stronger dollar and he also warned that further monetary action may be needed to offset the impact of maturing LTROs in 2015. Fellow member Praet was concerned over the very weak growth in money supply and stated that conditions were difficult.

Euro selling pressure then intensified following ECB President Draghi’s comments which were more forceful than recent remarks. In particular, he stated that the bank was ready to combat deflation and was watching the Euro very closely with the currency’s value an increasingly important factor in policy deliberations.

Yen:

The yen will continue to gain some degree of support when risk appetite deteriorates, especially with the risk of capital repatriation flows in the bond market. Any wider fears surrounding Asian growth prospects would also tend to support the Japanese currency. Underlying confidence in the domestic fundamentals will remain weak, especially with the much weaker balance of payments position. Overall yield considerations for the yen will also remain very negative which limit the scope for any advance.

The yen gained renewed support as risk conditions deteriorated with economic concerns surrounding China and political tensions surrounding Ukraine. The dollar retreated to lows near 101.50 as the Euro dipped below 141.0.
 
The latest Chinese trade data was sharply weaker than expected with a deficit of US$23bn for February following a US$31.9bn surplus the previous month and this was the first deficit for 11 months. Exports fell over 18% over the year while imports posted gains of around 10%. Statistics are always volatile surrounding the lunar new-year period, but underlying trends were weaker.

The Japanese current account data remained very weak with a record headline deficit for January at JPY1.59trn while there was a small downward adjustment to the fourth-quarter GDP figure which maintained unease surrounding Japanese fundamentals.

As expected, the Bank of Japan left policy on hold following the latest policy meeting with no further measures to boost quantitative easing. The central bank was slightly more optimistic surrounding the economy, notably on capital spending. There are still important uncertainties over retail spending given the April sales tax increase.

There were fresh concerns surrounding the situation in Ukraine ahead of Sunday’s planned referendum in Crimea on whether to split from the Ukraine and effectively become part of Russia. There were warnings over an unstable situation with further Russian troop movements while US Secretary of State Kerry warned that there would be serious consequences if the Crimea referendum went ahead as planned.

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The UK economy will continue to grow solidly in the short term with gains for consumer spending. There will be concerns whether growth is sustainable and unease will increase if there is evidence of fresh deterioration in the Euro-zone economy. The Bank of England will continue to resist an early tightening of monetary policy which will tend to limit yield support for Sterling. The balance of payments situation will be watched closely and any evidence of capital outflows would have a negative impact, especially if there is a sustained deterioration in global risk conditions.

Sterling was unable to hold its best levels against the dollar during the week with selling interest above 1.67 while there was some recovery against the Euro from 1-month lows near 0.8380.
 
Bank of England Deputy Governor Bean stated that a further rise in Sterling would hamper exports and could delay any increase in interest rates.  He also stated that markets should not get fixated on the exact timing of any rate hike.

The main focus was Bank of England testimony on last month’s inflation report to the Treasury Select Committee. Governor Carney’s comments were in line with recent rhetoric with comments that the economy is not close to overheating as he looked to emphasise that interest rates would remain at very low levels. There was some divergence of opinion with MPC Weale less confident over the size of the output gap which would lessen the scope to keep monetary policy very loose.

The NIESR GDP estimate was slightly higher than expected at 0.8% which had some positive impact on sentiment. Overall, however, there were still expectations that the central bank would hold off from any near-term tightening. The latest RICS house-price data was weaker than expected at 45% for February from a revised 52% previously with some evidence of cooling demand.

The UK currency did gain support on yield grounds with expectations that the Bank of England would be one of the first major central banks to raise interest rates. In addition, the yield gap on benchmark gilts over German bunds widened to the highest level for four years. In contrast, weaker risk appetite had some negative impact.

Swiss franc:

The Swiss currency will gain further support if global risk appetite deteriorates again with markets focussed on the twin threats of Chinese economic weakness and political tensions surrounding Ukraine. In the short term, the National Bank will continue to defend strongly the 1.20 minimum level. There will be important doubts whether the policy is sustainable, especially if there is any more aggressive monetary stance by the ECB.

Underlying risk conditions continued to dominate Swiss currency moves during the week with net gains for the franc as sentiment deteriorated. The Euro drifted back towards 1.21 while the dollar was trapped close to 3-year lows below 0.8800.

Domestically, there was a weaker than expected reading for retail sales which did not have a significant impact. With reservations surrounding the Euro and dollar, there was renewed interest in the Swiss currency, especially with commodity prices falling.

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The Australian dollar was again subjected to a high degree of volatility during the week, factoring in both domestic and international factors with limited net gains. The currency was undermined by a deterioration in risk appetite as Ukraine tensions increased and there were also fresh concerns surrounding commodity prices as copper and iron ore prices fell sharply over the week. From lows near 0.89 against the dollar, there was a recovery to 0.91 before fresh selling pressure.

There was a much stronger than expected employment report with an employment increase of over 47,000 while unemployment held at 6.0%. There was a decline in business confidence which had some negative impact.

Although domestic considerations may provide some currency support, international risk considerations will tend to dominate with the risk of further net selling pressure.

Canadian dollar:

The Canadian dollar was damaged early in the week from a weaker than expected labour market. The US currency was unable to move above 1.1150 and dipped back to the 1.1050 region despite fragile risk appetite in choppy market conditions. There was evidence that selling pressure had eased with players suspecting depreciation had gone far enough for now as hedges against a weakening currency were reduced.

The Canadian dollar will tend to be more vulnerable if there is a sustained global deterioration in risk conditions, especially if commodity prices weaken further.

Indian rupee:

The rupee initially strengthened to 7-month highs near 60.60 against the dollar before retreating back beyond the 61 level as global influences were less favourable.

Underlying confidence in the domestic economy remained stronger with a slightly stronger than expected reading for industrial production and a decline in whole sale inflation. In contrast, international risk conditions tended to deteriorate during the week as Ukraine tensions increased again.

Although the currency will gain some relief on improved confidence surrounding domestic fundamentals, wider risk appetite concerns will leave the rupee vulnerable.

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The Hong Kong dollar was unable to make any impression on the US currency during the week and retreated to tests support beyond 7.7660. There were fresh concerns surrounding the mainland Chinese financial sector and potential exposure of the Hong Kong banks if there is a surge in non-performing loans.
 
Underlying medium-term doubts surrounding domestic lending trends will continue with an increasing focus on the Chinese mainland economic conditions.

 
Chinese yuan:

The yuan registered net losses against the US currency during the week and moved to lows beyond 6.13 against the US dollar.  The PBOC looked to maintain relatively narrow ranges while also introducing two-way risk which was inevitably a delicate balancing act, especially with increased unease over the economic outlook.

The Chinese data was weaker than expected with a significant slowdown in industrial production growth. Markets were also unsettled by a much weaker than expected trade report as exports declined sharply over the year. There were further concerns surrounding the economic outlook and uncertainty over the capital-account trends.

The PBOC will look for yuan stability in potentially wider ranges. There will still be important concerns surrounding fundamentals which could trigger sharp losses.

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