Weekly Forex Currency Review 21-02-2014

The Euro-zone outlook will be an important focus over the next few weeks. The ECB has managed to resist taking more aggressive policy action because of evidence of a recovery in growth, but pressure will build substantially if there is significant evidence of renewed deterioration. Emerging-market concerns will also be an important underlying influence on global currency trends with a notable focus on China.
 
Key events for the forthcoming week

Market analysis

Dollar:

There will be further uncertainty surrounding the US economy in the short-term after a stream of mixed economic releases. There is little doubt that adverse weather has had an impact, but there will also be some speculation that underlying conditions have weakened. For now, the Federal Reserve appears determined to maintain a gradual tapering of bond purchases which will provide some underlying dollar support. There should also still be net US protection from fundamentals and the dollar will also gain some net backing if there are renewed stresses in emerging markets.

The dollar struggled to gain any momentum, but did edge away from seven-week lows on a trade-weighted basis over the second half of the week.  

There was a weaker than expected reading for the New York Empire manufacturing index at 4.5 from 12.5 previously.  Housing data was weaker than expected with starts falling to an annualised rate of 0.88mn from 1.05mn previously and permits declined, although there were expectations of a weaker number given adverse weather.

Minutes from January’s policy meeting indicated that several Fed officials were looking to drive home the idea that further tapering of bond purchases would take place in a predictable manner. Some members did take a more cautious tone which was broadly predictable given the diversity of opinion within the committee.  There were potentially significant comments suggesting that financial stability should appear more explicitly in the list of factors which would guide rate decisions.

The consumer inflation and jobless claims data did not have a major impact as they were broadly in line with expectations, but a measured decline in claims  did offer some US protection. Uncertainty surrounding the manufacturing sector intensified following the latest data releases. There was a much weaker than expected reading for the Philadelphia Fed index at -6.3 from 9.4 previously. In contrast, there was a sharp improvement in the Markit PMI index to a four-year high of 56.7 from 53.7.

Overall, there are still expectations that the Fed will continue the gradual tapering process which will provide underlying yield support for the US currency. Weaker than expected capital flows data did raise doubts over the underlying investment flows.

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The Euro-zone data will remain an important short-term market focus.  The ECB is looking at forecasts for a rebound in growth and a limited recovery in inflation to justify not moving to a more accommodative monetary policy. There are important doubts surrounding the economic outlook and further evidence of weakness following the disappointing PMI data would be very important in increasing underlying concerns and raising pressure on the ECB.  There will be a risk that confidence suddenly deteriorates sharply. In the short-term, the current account surplus and potential capital repatriation will still provide important underlying Euro protection.

The Euro held relatively steady as it was again able to find support on any significant dips and tested 3-week highs near 1.3800 against the dollar before fading.

As expected Renzi was handed the presidential mandate to attempt to form a new Italian government following Prime Minister Letta’s resignation on Friday. The immediate market impact was very limited with no evidence of stresses in Italian bond markets as sentiment was supported by Moody’s return of Italy’s credit rating to stable from negative.  There will be a potentially less forgiving tone if Renzi struggles to put together a workable coalition.

In its latest monthly report, The Bundesbank expressed its opinion that it was possible to stop sterilisation of bond purchase related to SMP bond purchases. This will increase speculation that it’s a possible move at March’s ECB council meeting which would represent a limited monetary easing.

There will be some further speculation over various policy actions in March, but overall sentiment has edged away from expecting major measures given that medium-term inflation forecasts have not signalled deflation concerns. There was a weaker than expected reading for the German ZEW business expectations index which declined to 55.7 from 61.7 previously which did not have a major impact.

There was a notable decline for the French manufacturing PMI index, compounded by a sharp fall in the services sector index to 46.9 for the month from 48.9 previously. The German manufacturing data was also disappointing which raised fresh concerns over the Euro-zone growth outlook.

Yen:   

The dollar will look to secure near-term yield support on yield grounds. There has continued to be a net deterioration in the balance of payments position, illustrated by another very weak trade report for January. This will continue to weaken the yen’s underlying support with expectations of medium-term depreciation. The currency will also be vulnerable if there is evidence that the Bank of Japan will push for additional quantitative easing, but the bank is liable to hold steady for now and there will still be some net yen protection if there is fresh deterioration in risk appetite.

The dollar proved resilient at lower levels below 102 against the yen while finding it difficult to make significant headway as the yen proved resilient.

As expected, the Bank of Japan held the amount of quantitative easing steady at the latest policy meeting. The bank did, however, expand a policy of providing cheap financing to the corporate sector with the amount expanded to JPY7trn from JPY3.5trn. The move put immediate downward pressure on the yen and selling was compounded by a sharp rise in the Nikkei index which increased by close to 3%.

There was still a generally cautious tone surrounding risk appetite which limited more decisive support for the US currency. This defensive tone was sustained during the Asian trading session on Thursday following a weaker than expected reading for the Chinese HSBC PMI index. The flash reading dipped to 48.3 for February from 49.5 previously which was a 7-month low for the index and triggered a further deterioration in global risk conditions.

The latest Japanese trade data was weaker than expected with an adjusted JPY1.82trn deficit for January which will maintain major unease surrounding longer-term Japanese fundamentals.

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Sterling will continue to gain short-term support on growth and yield expectations. There will be doubts whether the Bank of England can resist monetary tightening over the next 12 months which will provide near-term support. The situation will change rapidly if there are signs that growth conditions are weakening again with a sharp outflow of funds. The UK currency will also be vulnerable to underlying selling pressure given longer-term balance of payments vulnerability.

Sterling maintained a firm tone, but did retreat from five-year highs on a trade-weighted basis and dipped from four-year highs above 1.68 against the dollar.

The latest headline UK consumer inflation data was slightly weaker than expected with a decline in the annual rate to 1.9% for January from 2.0% previously, the first time the rate has been below 2.0% for close to five years.

The labour-market data had been highly-anticipated ahead of the release. There was a further significant decline in the unemployment claimant count by over 25,000 for the month and the number has fallen every month since November 2012. In contrast, there was an unexpected increase in the ILO unemployment rate to 7.2% from 7.1% previously compared with expectations of no change.

The ILO rate had a significant impact on short-term market sentiment given the 7% Bank of England threshold and the data dampened tightening expectations to some extent as it potentially gives the bank more flexibility.

The MPC minutes were broadly in line with expectations and Governor Carney did not call a vote on revised forward guidance which suggests no major splits within the MPC at this stage. Sterling spiked lower following the data with a retreat to below 1.6650 against the dollar while the Euro moved above 0.8250.

There were relatively hawkish comments from MPC member Weale. He stated that an earlier raise in interest rates couldn’t be ruled out which triggered a fresh rise in gilt yields and pushed Sterling higher before fading again on expectations of wider MPC resistance to any tightening. Retail sales fell 1.5% in January, correcting from huge-gains seen in December.

Swiss franc:

The Swiss currency will gain support if emerging-market sentiment deteriorates again.  There will also be underlying support if there is evidence of fresh deterioration in the Euro-zone economic outlook. The National Bank will remain concerned surrounding inflation within the property sector, but the measures of wholesale and consumer inflation have remained very low for now.  Overall, the central bank will maintain the minimum Euro level in the short-term.

The franc strengthened against the Euro with a fresh test of the 1.22 area and maintained a firm tone against the dollar below 0.90 as risk appetite faded.

There was a generally firmer Swiss tone on the crosses as the Euro retreated to test support below the 1.22 level. There was some deterioration in underlying risk appetite which underpinned demand for the Swiss currency with fresh doubts surrounding the Chinese outlook and unease surrounding global growth prospects.

Domestically, there was a decline in the ZEW business expectations index which suggests that demand may be faltering in the economy, but international considerations will tend to dominate for now.

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The Australian dollar was unable to make further headway during the week and hit selling pressure on approach to the 0.91 area against the US dollar. There were fresh concerns surrounding the Chinese economic outlook following a weaker PMI release and there was also weakness in key commodity prices which damaged the currency.  

The Reserve Bank minutes were broadly in line with expectations with the central bank looking to maintain a steady policy for now and resist further cuts in interest rates. There were no major data releases during the week.

The Australian dollar will be vulnerable to fresh selling if there is evidence of substantial deterioration in the Chinese outlook and commodity-price weakness.
 
Canadian dollar:

The Canadian dollar was able to strengthen over the first half of the week and moved towards the 1.09 area against the US currency. There was a sharp reversal over the second half with the dollar moving  to highs above 1.11.

There was a weaker reading for Canada’s capital account with capital outflows which increased concerns surrounding weaker investor sentiment. There was also fresh concern surrounding the outlook for commodity prices which damaged the currency and the wholesales data was also much weaker than expected.
 
The commodity prices trends are likely to have an underlying negative impact on the Canadian dollar and there will be further concerns over weaker investment inflows.

Indian rupee:

The rupee was more vulnerable during the week and retreated to test the 62.50 area against the US currency. There were fresh concerns surrounding wider emerging markets which had a negative impact on the currency, especially with concerns that Indian growth prospects would be damaged. There were also IMF calls for the government and central bank to make a response to the ongoing tapering concerns.

Equity markets weakened significantly during the week with four consecutive daily losses which raised concerns over potential longer-term structural outflows.

Wider emerging-market trends will have an important impact and underlying trends are liable to undermine the rupee, especially if growth indicators deteriorate.

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The Hong Kong dollar was confined to much narrower ranges during the week with consolidation around 7.7550 against the US currency. Here was a weaker trend for the Chinese yuan which helped curb any pressure for further local-currency appreciation.

Appreciation pressure on the Hong Kong dollar will ease if the Chinese yuan continues to weaken and selling will be a feature if emerging-market stresses increase.
 
Chinese yuan:

The yuan weakened consistently during the week and dipped to lows near 6.09 against the US dollar on Friday with the weakest decline for three years as the PBOC looked to guide the currency weaker.

There was speculation that the central bank was looking to resist appreciation, but there were also some concerns over the underlying capital-account fundamentals. There was a weaker reading for the HSBC flash PMI reading which declined to a 7-month low of 48.3 which increased concerns surrounding the Chinese outlook.

The economic outlook will be watched very closely and there is scope for further yuan selling if there is evidence of sustained deterioration in growth conditions.

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