Weekly Forex Currency Review 14-01-2011

The Euro has rallied strongly from initial 2011 losses. A key feature during the course of the next few months is likely to be a lack of confidence in all the G3 currencies as the economies face very important structural vulnerabilities. There are likely to be frequent swings in sentiment as markets look at relative economic outlooks with a lack of conviction an important feature.           

 Key events for the forthcoming week

Market analysis

Dollar: 

The latest economic data releases have not strengthened confidence in the US economy and this will curb yield support, especially after the disappointing payroll data, but there will still be expectations of improving conditions during the year which will limit dollar selling pressure. There will be further unease over the medium-term fundamental outlook with the budget deficit likely to be an important factor over the next few weeks. The degree of defensive dollar demand will also be very important and the US currency will have much less scope to advance if there is a sustained improvement in Euro-zone confidence.   

The dollar initially weakened following the weaker than expected employment data last Friday, but regained ground against the Euro with the single currency retreating to a low below 1.29.

There was a 103,000 increase in payrolls for December compared with expectations of around 150,000 and unofficial hopes for a much stronger figure. The unemployment rate fell to 9.4% from 9.7% with some withdrawal from the workforce.

The latest readings for consumer confidence show that there has been a significant improvement in confidence at the beginning of 2011 which helped support confidence to some extent. There were few major US growth readings during the remainder of the week which dampened movement in US yields.

The latest US jobless claims data was weaker than expected with an increase to a 10-week high of 445,000 in the latest week. There is still the threat of distortions caused by the year-end period, but there will still be some disappointment over the data.

The Beige Book was broadly in line with recent expectations. Economic conditions were reported to be stronger, but there were still important areas of concern. Regional Fed President Fisher stated that, barring surprises, the central bank was likely to complete the quantitative easing programme. 

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The Euro-zone structural vulnerabilities will continue to be an extremely important focus during the first quarter of 2011. There has been some easing of immediate fears which will also eased selling pressure on the Euro, but it will still be very difficult to secure a sustained improvement in confidence. Similarly, although warnings over the possibility of interest rate increases will tend to provide near-term Euro support, there will also be fears that any rise in rates would trigger further stresses within the weaker economies.  The Euro will, therefore, still face strong barrier to sustained gains.

The Euro remained under heavy pressure initially, but there was a very sharp reversal later in the week as the Euro advanced to 2011 highs near 1.3450 against the dollar.

The debt situation remained an important focus and there was some initial relief over the latest Portuguese debt-auction results, although the outcome was still mixed. The latest debt auction for Spain was also relatively well received and, although the amounts involved were relatively small, there was relief that market tensions did subside slightly.

There was a renewed pledge of support for the Euro by German Chancellor Merkel who stated that everything would be done to protect the currency. There will also be further speculation over an expansion of the EU support fund and more favourable loan terms. There will, however, be strong internal opposition to further support and this is an extremely important factor within Germany given the number of state elections due in 2011.

As expected, the ECB left interest rates on hold at 1.00% following the latest council meeting. The comments from ECB President Trichet were more surprising as he stated that short-term inflation risks had increased. He also stated that prices needed to be monitored very closely following the recent increase in inflation which is the ECB’s normal coded message that it will consider an increase in interest rates.

The Euro gained strong support from the comments, but there will also be concerns that any increase in borrowing costs would intensify strains within the Euro area and further weaken peripheral economies. IMF officials also warned that there were still major structural risks within the Euro area.

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Overall confidence in the Japanese economy will remain weak which will continue to limit the scope for yen support. There will also be growing fears over longer-term structural outflows from Japanese bond markets which will also tend to be a negative yen factor, especially when global risk appetite improves. There will still be an important lack of confidence in the Euro-zone and US economies and this should limit selling pressure on the Japanese currency. Exporters will also look to sell dollars on any notable rally and yen losses are, therefore, still likely to be measured.

The dollar was blocked in the 83.50 area against the yen during the week and retreated to around 82.50. The Japanese currency failed to make much headway on the crosses with the Euro gaining strong support.

Domestically, the economic data was weaker than expected with a 3.0% November decline in machinery orders compared with expectations of a monthly increase. Overall confidence in the growth outlook remains weak and this will continue to be a negative factor for the Japanese currency. 

Overall confidence in the Japanese fundamentals will also remain weak and there will be a growing risk of structural outflows from the bond market which will tend to undermine the yen, especially if there is Chinese selling. Risk appetite was generally solid which lessened defensive demand for the currency.

Sterling:

The Bank of England policies will be a very important focus and disagreement are liable to intensify. There will be pressure for a tighter policy to curb inflation, but there will also still be demands to maintain a highly-expansionary monetary policy to help support the growth outlook. 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 G3 economies. Volatility is likely to remain a key feature in the short term.   

Sterling found support on dips to the 1.54 area against the dollar early in the week and then rallied consistently to a high near 1.5880 as Sterling tracked Euro gains. The UK currency was unable to keep pace with the Euro and weakened to near 0.85 from highs just beyond 0.83.

The latest BRC shop-price inflation index reported a figure of 2.1% for December from 2.0% previously and inflation fears will remain an important short-term focus, especially as tax increases will put significant upward pressure on prices.

The Bank of England left interest rates on hold at 0.50% for the 22^nd consecutive month. There was no statement by the bank following the announcement and the vote split will not be known for another two weeks. There will be speculation that the bank will move towards a tighter policy, especially after the comments from ECB President Trichet, and this will tend to offer some degree of Sterling support.

There will still be major doubts over the economic outlook with unease over the housing sector due to persistent shortage of finance and fears that consumer spending will weaken as tax increases take effect.

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Franc trends will remain heavily influenced by developments surrounding risk appetite and the Euro-zone. There will be a sharp decline in defensive franc demand if there is a sustained improvement in Euro-zone confidence. There will also be pressure on the National Bank to intervene and reverse recent franc strength as domestic alarm over the economic impact increases. The franc will still be the ultimate safe-haven currency and will gain important support at times with volatility likely to remain a key feature.

The franc advanced to highs beyond 1.25 against the Euro early in the week, but then lost ground sharply. The Euro maintained a very strong tone with a renewed surge to a 1-month high near 1.2950 on Friday.

There was broad Euro support following Trichet’s comments and there was also a reduction in defensive Swiss franc demand as Euro-zone debt fears eased. The dollar was unable to make a break above 0.9750 against the Swiss currency as cross-related moves tended to dominate.

There was further speculation that the National Bank would intervene to weaken the currency, especially after warnings over the damaging impact of franc strength from SNB member Jordan.

Australian dollar:

The Australian dollar was subjected to considerable selling pressure during the first half of the week with 1-month lows near 0.98 against the US currency.

The US dollar was generally strong and there were increased fears over the impact of severe flooding, especially as there will be damage to key export industries.

Underlying confidence in the economy has also been damaged by a series of weaker PMI readings and the latest employment increase was also lower than expected, although unemployment did fall over the month. There was a recovery back to parity as the US dollar was subjected to renewed selling pressure.

Australian dollar volatility is liable to remain relatively high given the potential for sharp fluctuations in domestic and international sentiment. Persistent doubts over the domestic economy will limit the scope for renewed gains.

Canadian dollar:

The Canadian dollar has maintained a strong tone against the US currency during the week and advanced to 30-month highs near 0.9850 before a retreat back to the 0.9930 area with the Canadian currency volatile on the crosses.

The currency was boosted by solid risk appetite while oil prices were also strong which provided important support for the currency. Gold prices tended to edge lower later in the week which undermined demand for the Canadian dollar to some extent

Domestically, there was also speculation that the Bank of Canada would increase interest rates during the first quarter of 2011 which boosted confidence in the local currency.

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.

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The rupee secured marginal gains for the week, but it failed to hold its best levels and the currency generally underperformed as it settled near 45.30 against the US dollar.

There was further evidence of capital outflows from the stock market which had a negative impact as there were greater concerns over domestic fundamentals.

The latest industrial production data was weaker than expected and there were also fears that interest rates would need to increase further to combat a growing inflation threat.

The rupee should prove to be broadly resilient given a lack of enthusiasm for the dollar, but there is scope for some depreciation on concerns over the domestic fundamentals, especially if inflation rises further.  

Hong Kong dollar:

The Hong Kong dollar was unable to strengthen through 7.77 against the US dollar and consolidated close to 7.7750 as ranges were generally narrower during the week.

The currency gained support from generally solid risk appetite and a decline in US yields. There was still uncertainty over Chinese policy trends which curbed any capital inflows.

The Hong Kong dollar will gain ground when international risk appetite improves, but uncertainty over Chinese economic policies will tend to deter strong capital inflows.

Chinese yuan:

There was a significant divergence between the official yuan fixing and the market rate during the week as there was a slight weakening in the spot rate despite a series of stronger fixings by the central bank with a record high fix beyond 6.60 on Friday.

There were strong expectations that the central bank was attempting to push the yuan stronger ahead of the US-Chinese Presidential meetings due next week, especially given that there are still very important tensions surrounding the yuan’s value

There were further concerns over the domestic inflation outlook and there was speculation that there would be a further near-term increase in interest rates to control price increases.

The political and economic demands still suggest that the yuan will gradually strengthen against the dollar during the course of 2011, at least during the first half of the year.

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