Weekly Forex Currency Review 12-11-2010

There will be further intense debate surrounding the global economy together with government and central bank policy responses. Any evidence of weaker growth conditions would reinforce potential pressure for weaker currencies to maintain a competitive advantage. Weaker growth conditions would also reinforce Euro-zone structural concerns.              

Key events for the forthcoming week

Dollar:

There has been some tentative signs of improvement in the US economy and Treasury yields have risen which will give some support to the dollar. There will still be an underlying lack of confidence in the fundamentals and the Federal Reserve decision to boost quantitative easing will also still tend to be a negative factor for the currency. There will also be expectations that the US will be satisfied with a weaker US currency. In this environment, there will need to be a stream of stronger data to boost confidence in the US currency. The dollar could still gain some important protection from weakness in the Euro-zone and deteriorating risk appetite will also provide some support at times.
The dollar secured a further significant recovery against the Euro during the week with highs near 1.36. The performance against other major currencies was certainly much less convincing, but sentiment did improve to some extent over the second half of the week with an advance on a trade-weighted basis.

The US economic data caused some grounds for optimism with jobless claims declining to 435,000 in the latest week from a revised 459,000 previously. The trade deficit narrowed slightly with a rise in trade volumes providing some support to growth hopes.

There was a rise in US Treasury yields, partly related to the economic data and partly related to disappointing bond auctions. Such an outcome certainly has two-way risks for the dollar as there will be fears that international investors are losing interest, but the currency did secure net support from a rise in rates as 10-year yields rose to a 7-week high.

Regional Fed President Bullard stated that the amount of quantitative easing could be adjusted higher or lower over the next few months, but markets remained cautious over the Federal Reserve policies.
US and global currency policies remained in focus during the G20 meetings which maintained the risk of volatility, although the impact was dampened by a US market holiday on Thursday. Former Fed Chairman Greenspan stated that the US was pursuing a policy of dollar devaluation. This was denied by Treasury Secretary Geithner who said it would not push for competitive devaluation.

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The Euro-zone growth data has been slightly disappointing, although this has primarily been from relatively old data. Attention has focussed firmly on the structural vulnerabilities and the deterioration in conditions surrounding the peripheral bond markets will undermine Euro sentiment with particular fears surrounding Ireland. There will also be speculation that the ECB will find it much more difficult to withdraw excess liquidity and there remains the possibility that confidence will deteriorate more substantially which could expose the Euro to heavy selling pressure.

The Euro came under renewed selling pressure during the week as structural vulnerabilities were again a key market focus. The Euro dipped to a 6-week low against the dollar and also suffered sharp losses on the major crosses.
The ECB confirmed that it had bought around EUR700mn in Euro-zone bonds as investor confidence continued to deteriorate. From a medium-term perspective, there were increased fears that new debt-crisis mechanisms would make it more difficult for the ECB to intervene and there were also increased fears that plans for private-sector involvement in bailout plans would further discourage bond inflows.

Tensions within Euro-zone bond markets remained a serious market feature as confidence in Ireland continued to deteriorate. There was a further widening in yield spreads to record highs as benchmark yields rose to 9.2% and there was also increased speculation that Ireland would need some form of multilateral rescue from the IMF within the next few months.

There was a significant contagion effect with reduced confidence in countries such as Portugal and Spain while there were also fears over long-term sovereign ratings implications. The latest GDP growth data will be watched closely on Friday and any evidence that growth was faltering would have a further negative Euro impact. There was evidence of distress selling with funds unable or unwilling to meet the new margin requirements.

Yen:

There will be continuing pressure on the Bank of Japan to maintain a highly expansionary and unorthodox monetary policy to combat deflation and this will tend to limit yen support. The G20 currency policies will be watched closely and the Japanese currency is more likely to weaken if tensions generally ease. There has been some evidence of capital outflows, but heavy selling pressure on the Japanese currency is still unlikely given a lack of confidence in the dollar and Euro which will curb capital outflows.

The yen was more on the defensive against the US currency while the performance on the crosses was more mixed.
 
After a hesitant start, the dollar secured further support in the middle of the week. There was a fresh attack on resistance levels near 82 against the Japanese currency and a break of this level triggered a renewed bout of stop-loss dollar buying which propelled it to a high near 82.80.

The US currency gained some support from a rise in US yields and there was also evidence that long-term dollar bearish positions were being closed.

There were reports of substantial selling of Japanese bonds by China for the second successive month which also had a negative impact on the yen.

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Expectations of further Bank of England quantitative easing will remain lower in the short-term following the batch of generally favourable economic data. The UK currency will continue to gain some near-term support from this shift in expectations, although it is still the case that Sterling’s best form of support is likely to come from weaknesses in the main currencies. Sentiment is liable to shift rapidly given the major uncertainties over economic direction and the economy is still liable to weaken with particular fears surrounding the housing sector.  Sterling will, therefore, face greater risks within the next 2-3 months.

Sterling proved broadly resilient against the dollar during the week and there was a strong move against the Euro with the UK currency advancing to a 7-week high stronger than 0.85.

The UK economic data recorded a small increase in industrial production for September while the trade deficit narrowed to the lowest level since June at GBP8.2bn. The data still suggested that there was little momentum within the industrial sector while exports still found it difficult to make much of a positive contribution to the economy as a whole.

There was a small decline in Nationwide consumer confidence while the latest housing-sector data was weaker than expected with the RICS survey recording that 49% of agents reported lower prices in October from 36% previously.

In the quarterly report, the central bank did raise the inflation forecasts, although the median outcome was that inflation would be below the 2.0% target in two years’ time.

The bank expressed a high degree of uncertainty over the potential outcome and also stated that policy could be adjusted in either direction according to economic developments. It is clear that the bank remains very uncertain over likely policy developments, but the net impact was to dampen expectations of further near-term monetary easing which underpinned Sterling.

There were some concerns over the UK exposure to Irish banking-sector losses and any UK involvement in support measures for Ireland could also have a negative impact on Sterling sentiment.

Swiss franc:

There will be some concerns that the Swiss economy is slowing more sharply than expected which will dampen sentiment. International developments are still liable to dominate in the short-term with the franc continuing to gain defensive support. Fears over structural vulnerability in the Euro-zone and unease over a potential policy of indirect currency debasement will continue to provide important franc protection and limit the potential for sustained selling pressure.

The franc maintained a consistently strong tone against the Euro with gains to beyond 1.33 while the franc registered limited losses against the US currency.

There was a significant fourth-quarter decline in consumer confidence which will tend to reinforce unease over a potential slowdown in the Swiss economy, but international considerations tended to dominate.

The franc will continue to gain defensive support from stressed within the Euro-zone bond markets with the currency seen as an important haven from regional capital-market tensions. There will still be some caution over potential National Bank protests against currency strength which will tend to deter more speculative buying.

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The Australian dollar maintained a position above parity for much of the week, but gravity was a stronger influence and the currency was unable to sustain its position with a dip back to below parity against the US currency.

The domestic data influences were mixed, with a modest net negative impact. The main focus was on the sharp increase in unemployment to 5.4% from 5.0% previously while higher employment masked a decline in full-time jobs. Business confidence was little changed while consumer confidence declined.

Risk appetite was slightly weaker following the Chinese reserve-requirement tightening while the US currency was stronger against the Euro.

The Australian dollar will remain prone to sharp corrections weaker following the sharp gains seen over the past few weeks with greater doubts over the economy.

Canadian dollar:

The Canadian dollar maintained a firm tone over the week and tested US dollar support levels below parity on several occasions.

Underlying confidence in the economy remained solid and there was strength in oil prices which provided support. Metals prices, however, were volatile with net losses over the second half of the week which dragged the Canadian currency weaker.

There is likely to be further selling pressure stronger than parity, although the fundamentals suggest that the Canadian dollar should remain broadly firm.

Indian rupee:

The rupee was confined to narrower ranges over the week as there were offsetting market influences with consolidation near 44.30 against the US dollar.

There were renewed capital inflows, this time associated with the Power Grid share sale. The equity market still found it difficult to make much headway with sentiment weaker following the Chinese reserve requirement tightening.

There were further concerns over the competitive situation with pressure for rupee gains to be resisted as doubts over export trends increased following disappointing industrial production data.

The rupee should be able to resist heavy losses, although it will be difficult to advance far in the very short-term given adverse capital-account trends. 

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The Hong Kong dollar maintained a strong tone over the week and strengthened to test the 7.75 intervention limit.

There were further capital inflows with the trend for a stronger Chinese yuan maintaining longer-term appreciation pressure for the Hong Kong dollar.

The Hong Kong dollar should maintain a robust tone in the short-term, especially with further speculation over a medium-term breaking of the peg.

Chinese yuan:

The yuan maintained a stronger tone over the week and strengthened to a fresh post float high of 6.624 against the US dollar. The yuan gains were potentially significant as they cam when the US currency had a firmer tone against the Euro.

The central bank increased reserve requirements for the fourth time this year and there was a rise in the consumer inflation rate to a 25-month high of 4.4% which increased speculation that further tightening would be required.

There was a strong trade surplus for October and international pressure for a stronger yuan remained very high with currency issues still very important surrounding the G20 meetings. There was some evidence that Chinese officials were taking a more conciliatory tone.

There will be continuing strong expectations of further yuan appreciation in the medium term due to underlying capital inflows and international pressure. The central bank looks content to allow gradual appreciation.

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