Weekly Forex Currency Review 07-01-2011

Liquidity levels will return to normal and investor allocations at the start of the year will be extremely important for market direction. The strength of US demand and the extent of Euro-zone stresses will be key areas of focus in the short term with the Euro vulnerable to further losses if yield spreads continue to widen.           

 Key events for the forthcoming week

Market analysis

Dollar: 

There has been a significant shift in expectations surrounding the US economy over the past two weeks with greater confidence over the growth outlook following a string of generally favourable data releases. The US currency will continue to gain some support from higher yields, but will be limited by the fact that the Federal Reserve will maintain a highly-expansionary monetary policy. There will also be fears surrounding the US fundamentals, particularly if there are tensions surrounding the debt ceiling. The dollar will gain defensive support at times, especially if there is an unwinding of global carry trades.   

The dollar weakened during the last few sessions of 2010, but then rebounded in the first week of 2011 and pushed to a four-month high against the Euro.

The US economic data was the catalyst behind the sharp move with a much stronger than expected ADP employment report. There was an estimated 297,000 increase in private payrolls for December following a revised 92,000 increase the previous month. There will be some concerns that seasonal distortions may have had an important impact given that other data has not been as strong. Nevertheless, the data pushed bond yields sharply higher which also boosted the dollar.

The headline ISM report was also stronger than expected with a rise to 57.1 for December from 55.0 previously which will maintain expectations of stronger growth conditions. The employment index was, however, only just above the 50 benchmark and was not consistent with the ADP report.

US jobless claims rose to 409,000 in the latest week from 391,000 previously, but the underlying trend remains encouraging.

The FOMC minutes from January revealed that there was greater confidence in the economy. Fed members were still not willing to consider changes to the quantitative easing programme and there were comments suggesting that a substantial economic improvement would be needed before any adjustment would be considered. The overall dovish Fed stance will tend to dampen dollar enthusiasm.

Click Here

The Euro-zone structural vulnerabilities will remain an extremely important focus during the first quarter of 2011. It will be very difficult to secure a sustained improvement in market conditions as medium-term fears surrounding the Euro area will persist, especially with funding pressures likely to increase over the next few weeks. There will also be persistent speculation surrounding the Euro’s medium-term future. The ECB will find it very difficult to exit from special liquidity measures which makes a sustained Euro recovery unlikely and volatility is likely to remain high.

The Euro was unable to sustain gains seen between the Christmas and New Year period and it has been subjected to renewed selling pressure both against the dollar and on the major crosses.

The Euro is still being undermined by fears surrounding the structural outlook with fears that market pressures will intensify over the next few weeks with Portugal potentially needing an EU support package.
Although the German data has remained strong, there are major doubts surrounding the Euro-zone economy as a whole and a weak retail sales reading reinforced the fears that budget tightening would undermine growth and keep peripheral countries in recession.

There was also a renewed widening in yield spreads during Thursday which also had an important negative impact on the Euro, especially with unease over the heavy debt issuance which is scheduled for next week.

But for too long people have been missing out on the easy profits on the foreign exchange (or forex) market.
Until Now...  Click Here.

The yen will tend to lose support when global risk appetite improves with potential outflows to fund carry trades. There will still be caution over aggressive capital outflows from Japan, especially given a lack of  confidence in the Euro-zone and US economies. Overall confidence in the Japanese economy will remain weak and there will certainly be no resistance to a weaker Japanese currency from the Finance Ministry. Without substantial capital outflows, the yen should still be able to resist to heavy selling pressure even with a weaker tone likely.

The dollar edged higher to the 82.20 area ahead of the New York open on Wednesday and then advanced strongly following the US ADP release. There was a strong rise in US bond yields which had a direct impact in boosting the dollar against the yen.

Risk appetite was also generally firmer following the economic releases and this continued to dampen defensive demand for the Japanese currency with investors taking a more positive stance towards global growth and carry trades. The dollar secured its biggest daily advance for three months with a rise to a peak near 83.60 before consolidation.

The latest capital-account data indicated there were net outflows from Japan in the latest week and the yen will tend to lose ground when risk appetite improves. There will still be caution over the US and Euro-zone fundamentals which will tend to limit selling pressure on the Japanese currency.

Sterling:

There will be expectations of a sharp economic slowdown as tax increases take effect. The growth and inflation balance will remain extremely important, especially as tax increases will also raise the inflation rate. The Bank of England policies will be under close focus with pressure to maintain a highly-expansionary monetary policy despite the inflation fears. If confidence in the central bank deteriorates, Sterling could come under heavy selling pressure. There should still be some degree of protection from a lack of confidence in the Euro-zone and US outlook. High volatility is likely to remain a key feature.   

Sterling remained generally volatile during the week and there were net losses against the dollar, but it strengthened to 4-week highs near 0.84 against the Euro.

The UK PMI manufacturing data was stronger than expected at a 16-year high of 58.3 for December from a revised 57.5 the previous month. Within the data, there was also a record high reading for the inflation component.

Inflation expectations and the impact on the Bank of England will be an extremely important market element in the short term. The consumer inflation rate is already more than 1% above the 2% government target and higher indirect taxes will put further upward pressure on consumer inflation.

Sterling may gain some support from expectations that the Bank of England will need to move closer to monetary tightening, but this confidence could prove to be extremely fragile with Sterling vulnerable to heavy selling if the market perceives that inflation control has been lost.

There was a decline in the construction PMI index to below 50 for December. There were adverse weather conditions during the month which lessened the potential market impact of this release.

The UK services-sector index was also sharply weaker than expected with a decline to 49.7 for December from 53.0 the previous month. There will be concerns over the underlying stresses within the sector, especially with new-business conditions weak. The data will tend to undermine confidence in the economy, especially with persistent doubts surrounding the housing sector.

The UK currency will still tend to gain protection from serious stresses within the Euro-zone, but the situation will reverse rapidly if there are renewed stresses in the domestic banking sector.

DO YOU OWN THE RIGHT STOCKS?

Analyze Your Stocks FREE! – Click Here

The heavy year-end capital flows into the Swiss currency have now been reversed, but there will still be underlying flows into the franc given a lack of confidence in the Euro-zone economy.  There is also still a possibility of much more substantial capital flight into the Swiss currency if Euro-zone tensions intensify. The National Bank will maintain a steady policy in the short term and will be under pressure to resist interest rate increases given the deflationary impact of a strong franc.

The franc strengthened to record highs against the dollar and Euro late in 2010, butt hen weakened sharply during the first few trading days of this year with the dollar pushing to a high above 0.97 from lows near 0.93.

The franc had advanced strongly in the run-up to the year-end and there has been an important element of unwinding these trades as volatility remained high.

The franc will still tend to attract defensive support given a fundamental lack of confidence in the Euro-zone.

Swiss consumer prices were unchanged for December with a 0.5% annual increase which will tend to ease deflation fears slightly and ease demands for a weaker franc.

Australian dollar:

The Australian dollar strengthened sharply late in 2010 with a fresh 28-year peak above 1.02 against the US dollar as commodity prices remained strong. The currency was unable to sustain the advance and weakened steadily during the first week of 2011 with a move back to below parity.

There was a generally firmer US dollar trend which curbed support for the Australian dollar.  The domestic data was weaker than expected with the manufacturing and services-sector PMI indices both below the pivotal 50 level while there were increased fears that flood damage would undermine the economy.

Australian dollar volatility is liable to remain relatively high given the potential for sharp fluctuations in domestic and international sentiment. Buying support on dips will tend to slow and further currency decline.

Canadian dollar:

The Canadian dollar strengthened to highs beyond 0.9950 against the dollar late in 2010 and resisted substantial weakening in the new year.

The Canadian currency gained support from a rise in oil prices to fresh 2-year highs while there was also optimism over the global growth outlook which supported the currency. The PMI index was weaker than expected with a decline to 50.0 for December from 57.5 previously, but the series is not seasonally-adjusted and is volatile on a monthly view.

It will remain difficult for the Canadian dollar to sustain move beyond parity even if optimism over the growth outlook maintains a strong tone in the short term.

Our "Value Packed" online trading seminar will show you how you can.

Click Here To Find Out More

After strengthening late in 2010, the rupee was generally on the defensive in the first week of 2011 and dipped to three-week lows near 45.35 against the US currency. The main factor behind the move was a stronger US dollar as the Euro weakened sharply.

The local stock-market was generally subdued which limited potential capital inflows into the rupee and there was caution over the 2011 outlook for interest rates given fears that inflation was set to rise.

The rupee should prove to be broadly resilient in the near term even with uncertainty over monetary policy discouraging strong capital inflows.  

Hong Kong dollar:

The Hong Kong dollar again found support on dips beyond 7.78 against the US dollar and advanced to highs near 7.767 before consolidating near the middle of this range. A firmer US currency and rise in US yields tended to have some negative impact on the Hong Kong dollar.

There was, however, a general improvement in risk appetite which helped underpin the currency. Uncertainty over China’s 2011 monetary policy tended to stifle wider capital inflows and curb currency gains.

The Hong Kong dollar will gain ground when international risk appetite improves, but uncertainty over Chinese economic policies will tend to stifle gains.

Chinese yuan:

The yuan advanced strongly late in 2010 as a firm tone for the local currency was compounded by a weaker US dollar and the yuan advanced to a record post-float high close to 6.59 against the US currency.

There was a partial reversal in the first week of 2011 with the yuan retreating to near 6.63, but it did advance against the Euro.

The Chinese manufacturing PMI data was slightly weaker for January which increased speculation that the economy might be at a peak, but inflation fears remained an important influence amid expectations that further monetary tightening would be required. Signs of firmer US growth helped lessen potential currency tensions to some extent.

There will be persistent expectations that yuan appreciation will be sustained in the first half of 2011, especially with the central bank still having to combat inflation.

Click Here to learn more