Weekly Forex Currency Review 03-12-2010

The Euro-zone stresses will continue to be a very important market focus and volatility levels are liable to remain higher as longer-term uncertainties will remain extremely important. Friction over global currency policies has eased for now, but the underlying issues will remain very important and potential tensions will remain an important factor.            

Key events for the forthcoming week

Dollar:

The latest US economic data releases have been mixed, but there has been further tentative evidence of firmer conditions which will provide some degree of dollar support on hopes for investment inflows and higher yields. Underlying confidence in US fundamentals will still be very fragile which will limit buying support. International conditions will continue to be watched very closely and there will certainly be defensive dollar demand at times, especially if Euro fears intensify again and there is a further increase in Libor rates. It remains the case that the dollar will be dependent on weakness elsewhere to advance strongly.

The dollar gained important defensive support at times during the week when the Euro came under pressure and risk appetite deteriorated with peak beyond 1.30. The dollar still found it difficult to gain strong support and retreated from its best levels against European currencies.

The US ISM manufacturing index was close to expectations with a figure of  56.6 for November from 56.9 previously. The latest ADP employment report was also firmer than expected with a private-sector employment increase of 93,000 for November from a revised 82,000 in October.

The jobless claims data was slightly weaker than expected with an increase to 436,000 from a revised 410,000 the previous week. In contrast, there was a strong 10.0% increase in pending home sales.

There was an increase in consumer confidence to 54.1 from a revised 49.9 the previous month while the Chicago PMI index rose to the highest level since May. There were no indications during the week of a reassessment of policy by the Federal Reserve as the Beige Book indicated a slow improvement in conditions.

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The Euro-zone structural vulnerabilities will remain an extremely important focus in the short-term. The support packages will provide some degree of short-term relief, especially if there is further bond buying of European bonds by the ECB.  It will be much more difficult to secure a sustained improvement in confidence given the underlying vulnerabilities and there will be further speculation that there will be a break-up of the Euro in the medium term. There will also be pressure for the ECB to sustain a higher rate of bond buying which will certainly limit Euro support.

Following the EUR85bn rescue package for Ireland, there was further speculation that other countries would also require support and officials were unable to restore confidence with the Euro being subjected to heavy selling pressure at times.
There was a further widening of yield spreads and credit default swaps during the first half of the week. Although again focussed on Spain and Portugal, there was also a widening of spreads for countries such as Belgium which indicates that stresses are spreading and the Euro retreated on all the major crosses.

Confidence was undermined further by a warning by Standard & Poor’s that Portugal’s credit rating was liable to be downgraded while there was also speculation that the Irish bailout package could be rejected by parliament. There was some relief that there was no action on France’s credit rating by the agencies.

In comments on Wednesday, ECB Chairman Trichet suggested that the ECB might provide additional support for the Euro. There was strong market speculation that the bank would announce a major bond-buying programme on Thursday. There were also expectations that the bank would announce that extraordinary liquidity measures will not be removed in the short-term. There was also speculation that there would be additional funds for the European support fund with an increase in IMF funding.

As expected, the ECB left interest rates on hold at 1.00% and the main focus was on the Chairman’s press conference. Trichet announced that the special liquidity measures to support the banking sector would be extended until at least April 2011 in order to combat liquidity difficulties, broadly in line with market expectations.

There was no mention that the bank would buy additional bonds and this lack of action undermined the Euro. Despite a lack of comment on additional bond buying, there was evidence of strong-buying of peripheral bonds by the central bank. The buying helped narrow yield spreads and also stabilised risk appetite which pushed the Euro to a high around 1.3240.

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The Korean situation will continue to be watched closely and the Japanese currency will lose support if there is any further military action. Domestically, confidence in the Japanese economy will remain fragile and there will be pressure for currency gains to be resisted. The yen will also lose support if there is a sustained improvement in risk appetite. Given a lack of confidence in the US and Euro-zone economies, substantial capital outflows from the yen still look unlikely which will provide important protection.

The yen weakened to 7-week lows near 84.50 against the dollar during the week, but was able to regain ground later in the week as there was still a reluctance to sell the Japanese currency.

The US currency gained support from higher Treasury yields following the batch of favourable economic data and an easing of risk aversion also curbed defensive demand for the Japanese currency.

The Chinese PMI data was slightly stronger than expected which supported near-term hopes over the Asian economic outlook, but there were also fears that the Chinese authorities would tighten monetary policy further which curbed risk appetite.

The domestic data provided no yen support with industrial production weakening for the fifth successive month while there was a small increase in unemployment and the PMI index remained below the 50 level.

Sterling:

International considerations will remain important in the short-term and any easing of contagion fears would tend to limit Sterling support against the Euro. The European banking sector will remain an important focus and Sterling will tend to be subjected to selling pressure if fears over the UK banking sector return. Domestically, there will also be expectations of a sharp slowdown in demand at the beginning of 2011. The Bank of England is likely to maintain a broadly neutral position in the near term which should help cushion Sterling from strong selling pressure.

Sterling was dominated by international considerations during the week as the domestic data was firmly of secondary importance with Sterling generally having a slightly softer tone. The UK currency dipped to test support below 1.55 against the dollar while the Euro found support below 0.84.

The latest CIPS manufacturing-sector report was stronger than expected with a rise to a 16-year high of 58.0 according to the latest survey which boosted optimism in the manufacturing sector. There was a slightly stronger than expected PMI index reading for the construction sector.

There was some reversal in capital outflows from the Euro which dampened immediate demand for Sterling and there were also fears that the dominant services sector would face much tougher conditions which will limit currency support.

There will still be unease over the domestic economy with expectations of a renewed and potentially sharp slowdown early in 2011 as tax increases come into effect. The latest Nationwide house-price data recorded a further decline in prices for November and overall consumer spending has been subdued.

An easing of Euro-zone tensions will tend to lessen any defensive demand for Sterling and this will tend to have a negative impact on the UK currency. The domestic influences will tend to return to prominence over the forthcoming week with the Bank of England MPC meeting on Thursday.

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International developments are liable to remain dominant in the short-term and the franc will maintain defensive support on a lack of confidence in the Euro-zone. There is also a possibility of much more substantial capital flight away from the Euro into the franc if the ECB is unable to restore confidence. The National Bank is likely to remain vigilant over the possible threat of deflation. There is, therefore, the possibility of renewed intervention if franc gains appear on the point of accelerating.

The franc maintained a firm tone against the Euro over the week as a whole and tested Euro support below 1.30 as Euro selling intensified, but the franc did weaken from its best levels as the sense of panic surrounding the Euro-zone eased.

With the franc robust on the crosses, the dollar struggled to make much headway and hit resistance above 1.0050. The Swiss currency continued to gain defensive support from a the contagion threat within the Euro-zone.

Domestically, consumer prices rose 0.2% in November which was slightly higher than expected and did not inflame immediate deflation fears

Australian dollar:

The Australian dollar was again prone to choppy trading conditions during the week and dipped sharply in the middle of the week with a low below 0.9580 against the US dollar. International risk appetite was weaker with persistent contagion fears surrounding the Euro-zone which discouraged wider flows into high-yield currencies.

The domestic data was generally weaker than expected with a 0.2% GDP increase for the third quarter while retail sales dipped sharply for November and the manufacturing PMI index also retreated to significantly below 50 in the latest survey.

Risk appetite improved later in the week and there was still underlying demand for alternative asset classes and the Australian currency rallied back to the 0.9750 area against the US currency.  

Australian dollar volatility is liable to remain high in the short-term, especially with sharp fluctuations in sentiment. Doubts over the domestic economy combined with underlying risk aversion will tend to limit Australian dollar support.

Canadian dollar:

The Canadian dollar again found support close to 1.0250 against the US currency during the week and secured a generally firmer tone with solid gains towards parity later in the week.

The domestic data was generally disappointing with a weaker than expected GDP release for the latest quarter. The Canadian currency gained support later in the week from an improvement in risk appetite and higher crude oil prices.

There will be underlying confidence in the domestic fundamentals which should limit selling pressure on the Canadian dollar, but it will be difficult for the currency to extend gains much beyond parity.

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The rupee remained generally on the defensive for much of the week and retreated to 10-week lows beyond 46.0 against the US dollar.

Global risk conditions remained important and there was an important lack of confidence which dampened demand for the Indian currency.

There was a stabilisation in conditions later in the week which helped underpin the rupee and there was also evidence of exporter dollar selling which helped support the Indian currency.

The rupee should be able to resist further heavy losses, although it will be difficult to advance far in the very short -term given unease over global conditions.  

Hong Kong dollar:

The Hong Kong dollar maintained a generally weaker tone during the past seven days and dipped to test support near 7.77 before finding support.

The international risk conditions were generally fragile which dampened demand for the Hong Kong currency, especially as there was some tightening in global liquidity.

The Hong Kong dollar will lose ground when risk appetite deteriorates, but heavy selling pressure from current levels should be resisted given the fundamentals.

Chinese yuan:

The yuan was confined to relatively narrow ranges during the week and had a slightly weaker tone with a retreat to the 6.66 area against the US currency as the performance remained correlated with the dollar’s underlying performance.

The domestic data provided relief with solid readings for the latest PMI data which will tend to lessen fears over export competitiveness.

There was further speculation that the central bank would need to tighten monetary policy further to help stem inflation pressure, but there were also promises that lending levels would be sustained.

There will be continuing expectations of further yuan appreciation in the medium term. The central bank may find it increasingly difficult to maintain narrow trading ranges over the next few weeks.

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