Weekly Forex Currency Review 01-07-2011

There will be immediate relief that there has been approval for the Greek austerity package and that a Greek debt default has been avoided.  This will help underpin the Euro and boost risk appetite. The mood of confidence may not last long given important threats to the global economy, especially as there are still very important medium-term Euro-zone vulnerabilities.  

 Key events for the forthcoming week

 Date

 Market analysis

Dollar: 

There has been some tentative evidence that the US manufacturing sector could be stabilising, but overall confidence in the growth outlook will remain fragile. There will also be strong expectations that the Federal Reserve will maintain interest rates at extremely low levels which will continue to curb dollar demand. The US debt-ceiling negotiations will remain an important focus and the dollar will remain be vulnerable if there is continued brinkmanship while any agreement would provide some relief. The global outlook will also remain important and immediate defensive US demand will be curbed by the Greek austerity package approval. Doubts over the global economic outlook should still provide some degree of protection for the US currency.

The dollar secured defensive demand early in the week, but his faded as Greek fears subsided and the currency was back on the defensive in the run-up to the end of the second quarter as the Euro moved to above 1.45.

The US jobless claims data recorded a slight decline to 428,000 in the latest week from 429,000 previously which did not have a major market impact. In contrast, the Chicago PMI index was significantly stronger than expected with a gain to 61.1 from 56.6 previously. This helped maintain a more positive attitude towards risk appetite with commodity currencies securing further near-term support.

The US consumer confidence data was weaker than expected with a decline to 58.5 for June from a revised 61.7 with the dip in energy costs not having any immediate positive impact on sentiment.

There was further unease surrounding the US debt ceiling as rating agencies continued to warn over the default risk which curbed dollar support.

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There will be relief that the immediate threat of a Greek debt default has been averted following approval of the austerity package. There will also be strong expectations that the ECB will increase interest rates at the July meeting which will boost Euro yield support. There are still extremely important medium-term Euro-zone vulnerabilities given that the underlying debt and banking crisis is still liable to intensify and a Greek default is still unavoidable on a medium-term view. There is also scope for the ECB to take a more defensive attitude towards future interest rate hikes. The Euro will, therefore, find it difficult to extend gains from current levels.

EU officials continued to insist that there was no Plan B for Greece and that failure to approve the austerity package on Wednesday would block any further support for Greece and effectively trigger a debt default. The comments were also aimed at maximising pressure on the Greek government to bring potential rebels in line and secure the necessary majority. The Euro dipped to lows near 1.41 against the dollar.

Nearer the vote, there was greater market optimism over a yes vote which provided significant Euro support, especially when there was a wider improvement in international risk appetite. There were still important concerns surrounding the financial sector with reports that up to 15 Euro-zone banks could fail stress-test results

In this first vote, the austerity plan was approved by 155 votes to 138 with 1 PASOK MP rejecting the plan. There were further reports of sovereign Euro buying which continued to underpin the currency, especially with suggestions that China was buying aggressively and there was also evidence of month-end Euro buying.

As expected, the Greek parliament also approved detailed austerity package provisions and this was the final legislative barrier for the bills. There was relief that the package had been ratified and EU Finance Ministers should approve the next loan tranche for Greece this weekend. There will, therefore, be no near-term debt default for Greece which boosted the Euro and banks will also continue negotiations on terms surrounding a voluntary debt rollover.

ECB President Trichet re-iterated that the bank remained in strong vigilance mode, reinforcing expectations that there would be an interest rate increase at next week’s council meeting and the Euro gained further support on yield grounds.

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There will be some optimism over a very slow improvement in the economy as production looks to recover from the earthquake-induced shock.  The yen should be more vulnerable to selling pressure when risk appetite improves, especially as the underlying fundamentals remain precarious, but the currency is proving resilient. There will be protection from weak fundamentals elsewhere and there will also be the threat of capital repatriation as underlying confidence in the Euro area will remain weak. The yen should be able to resist heavy selling.  

The dollar found support on dips to the 80.25 area on Thursday and rallied strongly during the US session with a high near 80.85. There was a further rise in US Treasury yields which helped underpin the dollar, although it was due in part to disappointing US Treasury auctions rather than confidence in the economic outlook, although the Chicago PMI release did provide some relief.

There were expectations that there would be increased capital outflows from Japan with the launch of new investment funds. There was also a general recovery in risk appetite, but the Japanese currency was generally resilient despite the potential for speculative capital outflows.

The quarterly Tankan survey was weaker than expected with a decline to -9 from 6 previously while there was a 1.9% decline in household spending. In contrast, the unemployment data was stronger than expected with a decline to 4.5% from 4.7%.

Sterling:

Confidence in the economy will remain weak with further concerns over the outlook for consumer spending, especially with credit availability still depressed. Given economic vulnerability and weakness within the banking sector, 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 and pressure for policy reversals will increase if there is further disappointing economic data.  Any improvement in risk appetite could provide some degree of Sterling relief.

There were reports of further Bundesbank Euro/Sterling buying ahead of the month-end and there was also corporate Euro demand. This selling pushed the UK currency to a 15-month low on a trade-weighted index and beyond 0.90 against the Euro.

There was no revision to the first-quarter GDP data, in contrast to some hopes for an upward revision while the current account deficit narrowed to GBP9.4bn for the first quarter of 2011 from a revised GBP13.0bn previously.

In the Bank of England testimony on the inflation report and monetary policy there was a wide range of comments during the hearings and there will certainly be the threat that divisions will intensify over the next few months.

The underlying message was that interest rates would remain very low. MPC members were also keen to play down the possibility of any further quantitative easing with Governor King stating that further bond purchases could be seen as taking the easy option. The comments did help curb more aggressive Sterling selling.

The latest Bank of England credit-condition survey reported that consumer lending standards were set to tighten further during the third quarter which maintained fears over the consumer spending outlook, especially with lending levels already at historically low levels. There was also a renewed deterioration in consumer confidence according to the latest GfK index.

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The Swiss currency will continue to be influenced very strongly by degrees of risk appetite within global markets, especially as it remains the ultimate safe-haven currency. There will be market relief as the immediate threat of a Greek debt default has been lifted which will lessen near-term franc demand. There will still be a high degree of caution over the medium-term outlook and there will also be near-term confidence in the Swiss economy. In this environment, short-term Swiss franc losses should be contained.  

The franc maintained a strong tone early in the week as fear dominated ahead of the Greek vote and the US currency weakened to fresh record lows below 0.83.

Greek developments continued to dominate during the week and there was strong selling pressure on the franc on relief that a near-term Greek debt default had been averted. There were strong moves on the crosses as the Euro advanced rapidly with a peak around 1.2240.

The franc had gained strong support on defensive grounds and there was a sharp reversal in speculative positions as fear eased. Markets will still be cautious over the underlying outlook and volatility is liable to remain a key feature.

Robust readings for the KOF business confidence index and UBS consumer spending index helped support confidence in the Swiss economy.

Australian dollar:

The Australian dollar remained under pressure early in the week and tested 2-month lows below 1.04 against the US currency. There was solid buying support on dips and it rallied sharply to highs above 1.07 over the second half.

There was relief following Greek approval of the austerity package which boosted risk appetite and also curbed defensive US currency demand. As commodity prices rallied, the Australian dollar also gained support.

There as relief surrounding the latest PMI manufacturing survey as it rose back above the 50 level for the first time in four months.

The underlying domestic and international risk profile suggest that the Australian dollar will find it difficult to maintain support at current levels.

Canadian dollar:

The Canadian dollar remained under pressure early in the week and dipped to test support beyond 0.99 against the US dollar before reversing course. Over the second half, it rallied strongly with a peak near 0.96 as global risk appetite also improved.

Domestically, there was a stronger than expected reading for consumer prices with a 0.7% monthly increase for June and a 0.5% core increase which triggered expectations of a more aggressive Bank of Canada stance on interest rates.

The Canadian dollar could gain further near-term support on an improvement in risk appetite, but is unlikely to make strong gains from current levels.

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The rupee dipped to test 1-month lows beyond 45.10 against the dollar early in the week before recovering ground and it ended the week at 2-month highs with the US currency retreating towards the 44.50 area.

There was a significant improvement in risk appetite following the Greece austerity vote which boosted emerging-market currency demand and curbed defensive dollar demand. There were also gains for the local stock market which helped boost rupee confidence.  The currency was restrained to some extent by strong dollar demand from oil importers.

The rupee should be able to remain broadly resilient given hopes for capital inflows. It will be difficult to make significant gains given policy uncertainties.

Hong Kong dollar:

The Hong Kong dollar found support close to 7.79 against the US dollar and gradually strengthened during the week. There was an improvement in risk appetite which helped underpin the Hong Kong currency as equity markets rallied and defensive demand for the US currency fell.

There was still a high degree of uncertainty over the Chinese economic outlook which curbed Hong Kong demand to some extent with some persistent fears over a possible hard landing for the economy.

The Hong Kong dollar will gain support when risk appetite improves, but the general theme of uncertainty will limit the potential advance

Chinese yuan:

The yuan continued to edge stronger against the Chinese yuan during the week with the central bank comfortable in allowing limited gains and it consolidated near 6.466 against the US dollar.

There was further evidence of a slowdown in the manufacturing sector as the official PMI index retreated to 50.9 for June from 52.0.

There were further mixed messages on monetary policy with some calls for tightening to be stopped as inflation was being brought under control while there were also warnings that inflation was set to rise to above 6.0%.

Slow yuan appreciation remains likely for now, although there will be a growing threat of instability as fears surrounding the Chinese economy are liable to increase.