Weekly Forex Currency Review 20-12-2013

The Federal Reserve move to taper bond purchases will have an important market impact, although it is also the case that monetary policy will remain very loose throughout the next few months. Early 2014 attention will tend to return to the Euro-zone as the ECB will be under strong pressure to relax monetary policy further.

Key events for the forthcoming week

Market analysis

Dollar:

The Fed tapering move will help strengthen confidence in the US outlook, especially with expectations that there could be further policy moves in the first quarter of 2014. The US economy will also continue to gain an important competitive advantage and the current account deficit should continue to narrow.  The Fed will, however, maintain a very expansionary policy even with a tapering. This will limit the scope for any further increase in bond yields and will also limit the scope for substantial dollar gains even with the currency likely to maintain a generally firm tone.

The dollar was able to make net gains during the week with solid gains on a trade-weighted index despite high volatility following the Fed meeting.
 
The Fed announced a US$ 10bn tapering in the monthly amount of bond purchases to US $75bn starting in January. The Fed was more optimistic surrounding the economic outlook and the labour market with slight upward revisions to growth forecasts.

The Fed is also expecting a further decline in bond purchases during 2014, but there was a shift in forward guidance with comments that interest rates are unlikely to be increased until unemployment is well beyond the 6.5% threshold. In this context, a majority of members do not expect interest rates to increase until 2015.

Bernanke maintained a more optimistic tone in his press conference, especially with a reduced fiscal drag. Rosengren dissented from the decision as he preferred to wait for more evidence that growth was above target and there were some FOMC concerns surrounding low inflation. After initially strengthening, the dollar dipped sharply weaker to beyond 1.38 against the Euro before regaining ground again following Bernanke’s more upbeat assessment.

The latest US economic data releases did not provide the backdrop further dollar buying.  Jobless claims increased to 379,000 in the latest week, contrary to expectations of a sharp retreat, and this was the highest level since March which will raise some unease surrounding labour markets despite expectations that the increase was distorted by seasonal considerations.

There was also a slightly disappointing readings for existing home sales with a decline to an annualised rate of 4.90mn for November from 5.12mn the previous month. The Philly Fed index also increased only slightly to 7.0 from 6.5.  The data did not provide any additional dollar support as disappointing data would make it more difficult to justify further tapering early in 2014

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The Euro-zone economy has stabilised, but the underlying situation remains precarious. There will be particular concerns surrounding France and Italy with both economies at risk of a sustained deterioration which would also increase underlying political stresses. The ECB is very reluctant at this stage to engage in more aggressive monetary policies, but pressure on the bank will increase further if demand dips again. There will also be increased pressure for action to weaken the Euro during the first quarter of 2014. Given the net risk profile, the Euro will struggle to sustain gains once the effect of capital repatriation fades.

The Euro was broadly resilient for much of the time, but did retreat to two-week lows against the dollar below 1.3650. There was further speculation over capital repatriation within the European banking sector, especially with the forthcoming ECB stress tests and this had a significant impact in underpinning the Euro.
 
There were mixed reading for the Euro-zone PMI data with a stronger than expected reading for manufacturing and a slightly weaker than expected services-sector reading. There was a sharp decline for both French readings, maintaining a high degree of unease surrounding the economy and the medium-term prospects.

German economic data was again stronger than expected with a ZEW business confidence reading of 62.0 from 54.6, the highest reading since 2006. The German IFO business confidence index was in line with expectations with an increase to 109.5 for November from 109.3 previously, the highest reading for four years. The overall impact was limited as markets had already priced in a firm German growth rate.

In testimony to the European parliament, ECB President Draghi stated that an exit from a loose monetary policy was still very distant. He also stated that the ECB was aware of downside inflation risks and was ready to act.

Money-market rates remained at higher levels, although there was some sign that liquidity constraints could be easing which would also tend to limit Euro gains. There were also expectations that year-end repatriation flows could start to slow which would also curb Euro buying support and the rate of investment flows also appears to have slowed. There was underlying support from a current account reading.

Yen:   

Yield considerations will remain important and the yen will still be at a disadvantage over the next few months. Fed tapering plans will underpin US yields while there will be speculation over further Bank of Japan action to expand monetary policy next year. The overall Japanese fundamentals are also very weak and there will be further net yen pressure from the balance of payments deterioration. The yen will gain support at times, but overall is likely to remain vulnerable to further losses.

The latest Japanese trade data was again weaker than expected with the 17th consecutive monthly deficit and a seasonally-adjusted deficit of JPY1.35trn from JPY1.09trn the previous month. Although there was a robust export performance, imports rose by over 20% during the year. The deficit will maintain fears over the structural deficit and tend to weaken the yen. There were also reports that the Bank of Japan was confident that it could buy more bonds if required.

There was very choppy price action following the Fed decision with the dollar eventually moving sharply higher to a peak above 103.70. There were heavy yen losses on the crosses as risk appetite remained firm despite rising yields. The Euro pushed above 142 and Sterling posted a fresh five-year high above 170.0

Liquidity issues will be important as markets wind-down for the year-end period. Given low liquidity and an already extremely large short yen position, there will be the potential for short covering which could trigger sharp yen gains despite a lack of confidence in the fundamentals.

As expected, the Bank of Japan held policy unchanged at the latest policy meeting, while there were further expectations that the central bank would inject further monetary stimulus during 2014. The dollar pushed higher to above 104.50 for the first time since October 2008 before being subjected to a limited correction with a reluctance to commit to additional shorts.

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Confidence in the economy will remain firm in the short-term, especially after the stronger than expected labour-market report. The drop in unemployment will also increase speculation that the Bank of England will be forced into an early monetary tightening. There will still be a determination to maintain an expansionary monetary policy and market expectations are liable to be scaled back. Sterling will still face negative real interest rates and concerns over the balance of payments situation. These factors will maintain longer-term vulnerability and limit the potential for any short-term gains.
 
Sterling advanced significantly against the Euro with a strong recovery from lows beyond 0.8450 while Sterling was resilient against the US currency.
 
The headline UK consumer inflation data was marginally weaker than expected with the annual rate falling to 2.1% for November from 2.2% previously and this was the lowest outcome for four years. There were also subdued readings for producer prices which suggested that inflationary pressures should remain generally subdued. The latest CBI industrial orders data was broadly in line with expectations at +12.

The UK labour-market data was again stronger than expected for November, maintaining a very strong run of releases.  There was a monthly claimant count decline of 36,700 and 18 out of the last 20 releases have been better than expected.  There was also a decline in the ILO unemployment rate to 7.4% from 7.6% previously. This took the rate closer to the Bank of England’s 7.0% threshold for potentially considering an increase in interest rates.

The Bank of England’s latest MPC minutes did make reference to the fact that further Sterling gains would undermine exports and potentially jeopardise the recovery and overall rhetoric was not hawkish. Strong employment data was a more important short-term market influence as Sterling spiked higher as a buoyant CBI reading for retail sales also helped boost confidence. Bank of England Governor Carney stated that the economy had grown faster than he expected despite potential headwinds

The latest retail sales release was in line with expectations at 0.3% from -0.9% previously. There was some overall disappointment in the data with robust data earlier in the week leading to expectations of a strong release. There was also a slightly weaker reading for the latest consumer confidence reading.

Swiss franc:

Evidence of firm domestic growth will continue to provide underlying franc support. The Swiss currency will also gain fresh capital inflows if the ECB is forced to take a more aggressive policy tone next year. The National Bank will maintain the Euro minimum level for now, but will be increasingly uneasy over policy if housing-sector inflation accelerates. There will be the potential for fresh speculation surrounding an ending to the Euro minimum level during 2014.

The Euro dipped below the key 1.22 level against the franc before reversing courses and recovering. The dollar also recovered from two-year lows just below 0.8850.

The franc was undermined by solid risk appetite following the resilience in equity markets following the Federal Reserve meeting. The currency was also undermined by the inability to sustain a move beyond the 1.22 resistance level against the Euro.

Domestically, there was a further improvement in the ZEW business confidence index to 39.4 in the latest month, reinforcing expectations of robust growth.

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The Australian dollar was subjected to further selling pressure during the week and dipped to 2013 lows near 0.8825 against the US currency before finding some degree of relief after 8 successive weekly losses. The currency came under pressure following the Fed’s tapering move as commodity prices were generally weaker.

The Reserve Bank was again an important focus. There was a further reference to the Australian dollar being overvalued in the latest minutes which contributed to further selling on the currency. There was a limited recovery late in the week from over-sold conditions given the high number of speculative shorts.

The Reserve Bank push for a weaker currency will continue to undermine the currency, but there will be scope for interim corrections from over-sold conditions.
 
Canadian dollar:

The Canadian dollar was unable to make further progress with corrections quickly meeting selling interest and there was a move to 2013 lows beyond 1.07 following the Fed tapering move. The Canadian currency was also undermined by weakness in oil and gold prices, but did find support beyond 1.07 as domestic influences were limited.

The Canadian dollar will continue to be unsettled by general weakness in commodity prices as longer-term defensive demand for safe-haven assets continues to decline.

Indian rupee:

The rupee was unable to secure any significant relief during the week and tested levels around 62.50 against the US currency. There was solid underlying dollar demand, especially within the energy sector which undermined the local currency.

There was nervousness surrounding the Fed tapering move, although the overall impact was measured, especially as global equity markets were generally resilient. There was some relief surrounding the latest current account data with a lower than expected deficit for the third quarter of 2013 which eased fundamental concerns.

Although the rupee has been generally resilient in the face of Fed tapering, it will be more difficult for the currency to advance and fundamentals doubts will persist.

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The Hong Kong dollar again hit resistance close to the 7.7520 area against the US dollar during the week and retreated significantly back toward 7.7550 over the second half of the week. The Federal Reserve tapering policy did have an impact in curbing currency demand as the Fed reinforced its commitment to very low interest rates.

China’s exchange rate policies will be watched closely and a move to widen the currency band would increase uncertainty surrounding the Hong Kong peg.
 
Chinese yuan:

The yuan was able to maintain a firm tone during the week and consolidated close to 6.07 against the US currency even with the PBOC setting a slightly weaker fix in line with a generally stronger US dollar.

The PBOC injected liquidity to ease renewed pressure on money-market rates which spiked higher during the week and also put downward pressure on equity markets. There was further speculation that the PBOC would look to widen the yuan’s trading band during 2013. A weaker Japanese yen will have some impact on China’s competitive position and lessen the potential for yuan gains.

The PBOC policy will be watched very closely with the potential for a widening of the yuan’s trading band, but the currency will struggle to make much headway.

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