Weekly Forex Currency Review 28-03-2014

The ECB will be an important short-term focus with unease surrounding deflationary forces within the Euro-zone. There will be speculation over a more aggressive move to policies such as quantitative easing, although it will still be difficult to secure majority support for such a move at April’s meeting. The Chinese economy is also likely to be a key market focus given the impending and serious threat of a severe credit crunch and speculation over a more aggressive policy response by the government.

Key events for the forthcoming week

Market analysis

Dollar:

There has been no major change in the underlying tone of US economic indicators. The most positive aspect has again tended to be low readings for jobless claims which suggests solid underlying labour-market conditions. Medium-term yield have remained at higher levels and the Fed tapering process should remain intact in the short-term, but the dollar has still found it difficult to gain sustained traction. There will be a further near-term improvement in structural fundamentals which should also provide underlying US support.
 
The dollar found significant support against the Euro during the week while losing ground elsewhere, notably against commodity currencies with net losses as a whole.

The US Markit flash PMI manufacturing index at 55.5 for March from 57.1 previously. The headline US durable goods data was stronger than expected with an increase of 2.2% for February, but the core release was slightly disappointing at 0.2% and the dollar failed to gain any traction following the release with little evidence of any surge in capital spending at this stage.

Final US GDP data for the fourth quarter was marginally weaker than expected with  a figure of 2.6% from 2.4% previously while the jobless claims data was significantly stronger than expected with a decline to 311,000 in the latest week from a revised 321,000 previously and this was the lowest figure since November which maintained underlying optimism surrounding recent labour-market trends. There was an increase in consumer confidence to 82.3 for March from a revised 78.3 the previous month which was the highest figure since early 2008, while there was a stronger than expected reading for house-price inflation.

Philadelphia Fed President Plosser maintaining his traditional hawkish tone with comments that short-term interest rates could reach 3% by the end of 2016.  There were slightly hawkish comments from regional Fed President Bullard who stated that he was looking for a rate hike early in 2015. Yield spreads continued to move in the dollar’s favour, but the US currency again struggled to gain any significant traction

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The Euro-zone economic outlook will continue to come under close scrutiny in the short-term. There will be further concerns surrounding deflationary pressures together with unease surrounding the very weak rate of money supply and lending growth. There will be additional pressure on the ECB and increased speculation that over a shift towards more aggressive monetary policies, especially following recent Weidmann comments. The Euro will continue to gain important short-term structural support, but the foundations are liable to be increasingly brittle, especially if growth conditions deteriorate.  

The Euro retreated during the week as the monetary policy debate grabbed attention, eventually falling to just above 1.37 against the dollar.

The Euro was boosted initially by much stronger than expected French PMI data with the composite index finally moving back above the 50 level and registering a 31-month high. Momentum was reversed quickly by weaker than expected German data.

For the Euro-zone, there was a further decline in inflationary pressures with input and output costs at the lowest level since the second quarter of 2013.There were generally downbeat comments from the Bank of Finland over growth prospects and comments that ECB interest rates were likely to stay low for a longer period.

There were potentially significant comments from Bundesbank head Weidmann who stated that any further strengthening in the Euro could be combated by a move to negative deposit rates. He also stated that quantitative easing could not be ruled out completely. Although the underlying tone was still very cautious, there was speculation over a potential shift in Bundesbank thinking which could also have an important wider impact on ECB policy.

The Euro was pushed lower again by reported comments from ECB member Makuch who stated that several members were open to quantitative easing if necessary and prepared to take action. ECB President Draghi reiterated that the bank would take all necessary measures to combat deflation if required. Overall, there was increased speculation that the ECB was prepared to take more aggressive action.

The latest Euro-zone money-supply data remain weak with annual growth held at 1.3% for February while there was a 2.2% decline in loans to the private sector. The data reinforced concerns surrounding weak economic conditions and disinflation. Spanish inflation was also negative for March at -0.2%.

Former ECB Bini-Smaghi stated that the central bank should engage in quantitative easing and there will be further speculation over moves at next week’s meeting. At this stage, only a very small number of analysts are expecting a rate cut.

Yen:

Capital-account trends will be watched closely in the short-term and there is the possibility of some year-end repatriation. The yen will also gain some degree of support when risk appetite deteriorates, especially if Chinese economic prospects deteriorate further. The dollar will still gain underlying support on yield grounds and the gradual ending of Fed bond purchases should also provide underlying dollar support. Bank of Japan policies will remain under close scrutiny, especially with April’s sales-tax introduction liable to trigger a sharp downturn in spending and the economy as a whole.

The dollar found support below the 102 level against the yen during the week, but rallies quickly faded and the US currency was unable to gain sustained support

There was further speculation that the Bank of Japan could engage in further quantitative easing within the next few months, especially with the economy liable to slow sharply. There was a slightly higher reading for Tokyo consumer inflation and the unemployment data was better than expected at 3.6%. In contrast, there was a much weaker than expected release for household spending which will increase unease surrounding consumer demand trends.

There was further speculation over Chinese measures to support the economy with the dollar again consolidating just above the 102 level with some speculation over year-end repatriation flows. There was no escalation of tensions surrounding the Ukraine situation even with important underlying stresses.

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The UK economy will continue to grow solidly in the short-term with the very strong retail sales figure likely to trigger a further boost to near-term confidence. Demand is still liable to fade and the Bank of England is likely to take a very cautious stance, especially with evidence that inflationary pressure is easing, at least in the short-term. Sterling is unlikely to gain additional yield support and there will also be very important balance of payments vulnerability which will expose the currency to downside pressures.

Sterling was able to regain ground against the dollar during the week with a move above 1.66 and also moved away from 2014 lows against the Euro.
 
The headline UK inflation data was in line with expectations with a decline in the annual rate to fresh four-year lows of 1.7% from 1.9% the previous month while core data was slightly stronger than expected. As far as second-tier data is concerned, there were weaker readings for producer prices which suggested forthcoming consumer inflation data would be weak. The annual house-price index gain was stronger than expected at 6.8% which maintained concerns surrounding potential over-heating.

There were comments from Bank of England MPC member Weale that the economy was looking better and that interest rates could not stay at 0.5% indefinitely.  Weale has been one of the more hawkish MPC members and, although there was nothing particularly new in the comments, the remarks did help push Sterling higher.

There were further warnings surrounding the housing sector from the Bank of England Financial Stability Committee with concerns over over-heating in the London area despite generally more subdued conditions elsewhere in the country.

There was a much stronger than expected retail sales report with a 1.7% jump in volumes for March compared with expectations of a 0.5% gain. The data will revive speculation that the Bank of England will be forced into an early policy tightening.

Swiss franc:

There will continue to be mixed short-term influences on the franc. The currency will gain some support when risk appetite deteriorates and also on speculation over a more aggressive ECB policy, but underlying demand for the Swiss currency has tended to fade in line with a slide in gold prices. The National Bank will continue to defend the minimum franc level aggressively in the short-term if necessary and will continue to intervene aggressively if required. For now, markets remain convinced that the Euro minimum level will be sustained.

The Swiss currency lost some ground against the Euro and dollar during the week as immediate defensive demand for the Swiss currency eased. From a longer-term perspective, the IMF called for the National Bank to consider negative interest rates if there was sustained pressure on the 1.20 minimum level. Alternate bank member Moser stated that the bank was ready to take further steps if necessary.

The franc was unable to gain any traction against the Euro despite speculation over a more aggressive set of policies from the ECB to counter increased unease over deflationary pressures with an overall decline in demand for defensive assets.

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The Australian dollar was able to resist downward pressure during the week and gradually pushed higher to a four-month peak just below the 0.9300 level. Although there were still important concerns surrounding the Chinese economy and downward pressure on industrial commodity prices, the local currency was more resilient.

Reserve Bank  Governor Stevens effectively stated that monetary policy was on hold for now and expressed some optimism over a rebalancing of the economy away from mining dependency. He continued to back a weaker currency in the longer term, while being uncertain how to get there.

The Australian dollar will gain some support for hopes surrounding a domestic recovery, but global conditions are liable to limit any further recovery.

Canadian dollar:

The Canadian dollar strengthened at the end of last week following stronger than expected data for consumer prices and retail sales. These releases eased immediate concerns surrounding the economy and also dampened expectations that the Bank of Canada could consider a looser monetary policy. The Canadian currency was able to rally significantly, especially with a covering of speculative short positions. In this environment, USD/USD weakened to near the 1.10 level.

The Canadian dollar will continue to have the scope for gains from over-sold conditions with a slight shift in monetary policy expectations, but only limited gains.

Indian rupee:

The rupee maintained a solid tone for much of the week and pushed to 8-month highs close to 60.0 against the US currency. Emerging-market currencies managed to hold firm and there was further evidence of capital inflows to domestic equities.

The rupee drifted lower later in the week with an increase in dollar demand by oil importers ahead of the month-end. The currency consolidated near 60.30 with optimism over the forthcoming election helping to stem potential selling pressure.

Confidence surrounding the domestic fundamentals will provide important rupee protection even with little scope for gains given the underlying global tensions.

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 The Hong Kong dollar secured a firmer tone during the week, consistently holding stronger than the 7.76 level against the US dollar. Despite important underlying concerns, there was a more measured tone surrounding China’s credit vulnerability and potential exposure for the Hong Kong banking sector which also helped stabilise the local currency. The yuan was also able to resist substantial losses during the week.
 
Even if confidence improves slightly foe now, underlying concerns surrounding lending trends and underlying exposure to the mainland economy will persist.

Chinese yuan:

The yuan was unable to recoup significant recent losses against the dollar, but there was a more stable tone with no heavy losses for the week as it stabilised around 6.21. The PBOC was content with a softer tone without letting the currency retreat sharply.

There were further concerns surrounding the economy with the HSBC PMI manufacturing index at an eight-month low and staying below the pivotal 50 level. Credit fears persisted, but were partially offset by increased speculation that the government would sanction a further stimulus.  

Yuan volatility is likely to remain substantially higher in the short-term with underlying concerns surrounding the credit outlook limiting any potential recovery.

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