Weekly Forex Currency Review 24-06-2011

The Euro-zone debt crisis and sovereign-debt default risk will continue to have a very important short-term market impact. Even if austerity measures are approved by the Greek parliament, there will be fears that a rescue package will not solve the underlying difficulties and there will be further strong default fears for the medium term.  Underlying global risk appetite is liable to be weaker given unease over global growth conditions.  

Key events for the forthcoming week

Market analysis

Dollar: 

There will be further concerns over the US economic outlook after a run of generally weak releases and trends over the next few weeks will be extremely important for sentiment. The Federal Reserve will maintain interest rates at very low levels over the next few months and if there is evidence of renewed deterioration then there will be the possibility of additional quantitative measures. The US debt profile and political battle surrounding the debt ceiling will tend to undermine confidence in the near term while a deal would provide some limited relief. There is still scope for support from on defensive grounds, especially as underlying risk appetite is liable to be weaker.  

The dollar found support on dips to beyond 1.44 against the Euro during the week and advanced strongly to highs near 1.4150. Increased Euro-zone fears were compounded by a sharp fall in commodity prices as the IEA announced that it would release strategic oil stocks into the market with risk appetite generally weak.

There were no surprises from the FOMC meeting with interest rates left on hold at 0.00 - 0.25% range. There was a downgrading of growth forecasts with the forecast expansion for 2011 cut to a 2.7 - 2.9% range from 3.1 - 3.3% previously.  The Fed expressed some concerns over price increases, but it expected that inflation was expected to fall to or below the level consistent with full employment and inflation in the medium term. The Federal Reserve stated that interest rates would be held at low levels for an extended period and the inflation comments suggested that further quantitative easing could still be considered in the medium term.

Fed Chairman Bernanke declined to make any direct references to further quantitative easing and the main message was that there was a high degree of uncertainty over the situation. The dollar gained some support on relief that there was no mention of further quantitative easing at this time.

Jobless claims rose to 429,000 in the latest week from 420,000 previously while the new home sales data was slightly stronger than expected. There was no significant impact on interest rate expectations with markets still expecting the Fed to retain very low interest rates. There was a breakdown in congressional talks over raising the US debt ceiling and there will be a further lack of confidence in the US fundamentals.

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The Euro-zone structural difficulties will remain an extremely important short-term focus as the Euro-zone and IMF maintain their efforts to prevent a debt default.  Approval of austerity measures by the Greek government which would secure fresh support would boost immediate sentiment, although confidence is liable to subside again quickly given that default remains highly likely in the medium term. Failure to approve austerity measures would also trigger sharp initial Euro losses.  Even though the Euro will gain some support on yield grounds, the net risk profile continues to suggest that the currency will depreciate in the medium term.

The Euro rallied at times, but was also subjected to heavy selling pressure, especially after ECB President Trichet warned over financing conditions within the Euro area. From a longer-term perspective there were further warnings over the Euro outlook, especially with little confidence that the Greek government will be able to deliver on austerity measures. There was further negative media rhetoric surrounding the underlying Euro outlook and Fitch warned that even a voluntary debt rollover would be considered a default.

The Greek parliamentary no-confidence vote was in line with expectations with the government winning by 155-143. Late in the week, the EU and IMF announced that they had reached agreement with the Greek government over a five-year austerity package. Approval of the package would secure a new EUR120bn rescue package for Greece which would prevent an immediate debt default.

There will now be another vote on austerity measures next week with approval critical if Greece is to secure the fresh Euro-zone backing and additional rescue package. The Euro rallied, but there was still a high degree of caution. The government will need to secure parliamentary approval for the measures on Tuesday and agreement is far from guaranteed, especially with the opposition party failing to back tax increases.

Even if a near-term agreement can be reached there will be fears that Greece will still default in the medium term. In the meantime, there will be fears over further underlying capital flight, especially with further weakness in the banking sector.

As far as the economic data is concerned, the German IFO index weakened to -9 for June from 3.1 previously and the PMI manufacturing index was at an 18-month low, maintaining expectations of a significant slowdown in the economy which would also make it even more difficult for peripheral economies to secure growth.

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There will be some optimism over a very slow improvement in the economy as production looks to stage a rebound. Underlying confidence will remain very fragile and there will be huge concerns over the debt profile, especially as there are severe political divisions. The yen will gain defensive support when risk appetite deteriorates and there will also be the potential for long-term capital repatriation which would underpin the yen, especially if European bond holdings are scaled back further in expectation of a medium-term Greek default.  

The dollar found support close to 80 against the dollar and advanced to a high just above 80.70 against the yen on Friday, but was unable to extend the gains.  Losses for the US currency were curbed by expectations of strong-buying support close to the 80 level. The yen continued to gain defensive support on the crosses and it pushed to the highest level since March against Sterling with a slide to below 129.0.

There were a flurry of comments from Chinese research institutes suggesting that domestic inflationary pressure had peaked and this tended to improve risk conditions in Asia on Friday with reduced expectations of a near-term increase in interest rates. This lessened immediate demand for the Japanese currency.  

The latest Chinese PMI manufacturing index retreated to 50.1 for June from 51.6 which will maintain expectations of a sharp slowdown in the Chinese economy and provide some defensive yen support on expectations of a wider slowdown.

Finance Minister Noda stated that he was prepared to take bold action in the currency markets if necessary and there was caution over yen buying close to the 80 level given the possible intervention threat.

Sterling:

Confidence in the economy will remain weak with further concerns over the outlook for consumer spending. Although inflation is continuing to run substantially above target, the Bank of England will not be in a position to raise interest rates significantly and real yields will remain very unattractive which will limit Sterling support. There will be doubts over the government’s fiscal policies. There will also be further unease over the banking sector, especially if there is the threat of losses from Europe. In this context, the UK currency will find it difficult to gain strong defensive support from difficulties within the Euro-zone and the net trend is liable to be for further depreciation against the dollar.

The headline government borrowing data for May was slightly better than expected at GBP15.2bn for the month from GBP7.7bn previously, although the underlying data, excluding financial interventions, was slightly higher compared with last year.

Bank of England MPC member Fisher stated his concerns over the growth outlook and also stated that further quantitative easing was possible if there was a sustained threat of deflation within the economy.

There was no surprise on the interest rate vote split in the Bank of England minutes with a 7-2 decision to hold rates at 0.50% at the June MPC meeting. The bank was generally gloomy over the economic outlook, warning that the weakness in demand was liable to last longer than expected. There were also references that several members considered the possibility of further quantitative easing if downside risks to the medium-term outlook materialised.

The minutes reinforced expectations that interest rates would remain at extremely low levels and there were also further fears surrounding the banking sector which sapped Sterling support. The UK currency weakened to 3-month lows below 1.60 against the dollar and also weakened to test support near 0.8950 against the Euro.

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The Swiss currency will remain the ultimate safe-haven currency, especially with strong expectations that Greece will default in the medium term. Even if there is a successful rescue package, there will be fears that underlying tensions will return quickly. There will fears that the ECB position will be compromised and that the Euro-zone banking sector will weaken further which will tend to trigger further capital flows into the Swiss currency. The franc should retain a strong net tone, but there will be sharp retreats at times, especially as it remains substantially over-valued on a fundamental view.  

The dollar was unable to make any sustained impression on the franc during the week and it dipped to test support near 0.8380 in very choppy trading conditions.  The Swiss currency advanced very sharply to fresh record highs beyond 1.19 against the Euro as Euro-zone confidence deteriorated.

Although the Euro rallied following the announcement of a Greek support package agreement, it was unable to move back above the 1.20 level which suggests that there is still important defensive demand for the franc.  Fear is liable to be the dominant influence for now as underlying confidence remains extremely fragile. Volatile trading will remain a key threat in the short-term.

There was a decline in the Swiss ZEW business confidence index to -24.3 for June from -11.5 the previous month which triggered some concerns that the strong franc is starting to have a more damaging impact.

Australian dollar:

The Australian dollar continued to trade erratically during the week, although with a slightly narrower range than that seen over the previous period as it hit selling pressure above 1.0650 against the US dollar before testing support below 1.0450.

Risk conditions were fragile which lessened demand for the Australian currency and there was also a decline in commodity prices which had a negative impact as unease over the global economy increased. There was some relief late in the week on speculation that China would be more cautious over raising interest rates again.

Domestically, the Reserve Bank minutes from June indicated that a further increase in interest rates was still likely over the next few months, but that there was no urgency surrounding the situation.

The underlying domestic and international risk profile leaves will leave the Australian dollar vulnerable to further selling pressure despite further yield support.

Canadian dollar:

The Canadian dollar found support close to 0.9850 against the US dollar during the week and the general tone was resilient even though it was blocked close to 0.97.

There was a cautious tone towards risk appetite which curbed demand for the Canadian dollar and there was also strong selling pressure during Thursday when oil prices were subjected to sharp selling pressure.

The Canadian dollar is liable to weaken given unease over the global growth and risk environment, especially as commodity prices will be vulnerable to net losses.

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The rupee had a slightly weaker tone for much of the week, although ranges were relatively narrow with the currency consolidating close to 45 against the US currency.

The rupee was undermined by a deterioration in risk appetite as global equity markets came under pressure and there were fresh stresses within the Euro area. The local bourse did prove to be resilient which also lessened selling pressure on the rupee.

Although the rupee should be able to remain resilient on hopes for capital inflows, it will be difficult to make gains given the weaker international risk environment.

Hong Kong dollar:

The Hong Kong dollar found support close to 7.7950 against the dollar and secured a slightly firmer tone with a move towards 7.7880. Given the volatility seen in other markets, Hong Kong dollar moves were relatively mild.

The local currency was unsettled by further stresses within Chinese money markets and unease over the risk of capital outflows.

The Hong Kong dollar will be vulnerable if risk appetite deteriorates further and higher volatility is likely to remain the dominant market feature in the short-term.

Chinese yuan:

The yuan was confined to relatively narrow ranges with consolidation around 6.472 which still represented a generally solid tone late, especially late in the week given that the US currency advanced against the Euro.

There were conflicting reports on monetary policy as warnings over the risk of a further increase in inflation were offset by some domestic speculation that China would look to move away from any further monetary tightening.

Slow yuan appreciation remains likely for now, although there will be a growing threat of instability as capital flows intensify and economic uncertainties increase.