Weekly Forex Currency Review 13-05-2011

Overall strategy: Market volatility is likely to remain an important short-term feature, especially with sharp movements in commodity prices spilling-over into other asset classes. The Euro-zone sovereign debt position will also be seen as more urgent as Greek conditions continue to deteriorate which will increase the threat of further Euro-related volatility.   

 Key events for the forthcoming week

 Market analysis

Dollar: 

The dollar will continue to gain support when there is a deterioration in risk appetite and any further downward pressure on commodities would also benefit the US currency. There will be expectations of solid near-term growth and the Federal Reserve is likely to end quantitative easing in June, but it will maintain a very loose monetary policy which will limit US currency support.  There will also be a lack of confidence in the medium-term fundamentals as the debt ceiling comes into focus.  The dollar will find it hard to make strong gains, but some further recovery is achievable give unease over the Euro-zone outlook.

The dollar made further net gains over the week with renewed selling pressure on commodities, underpinning defensive demand for the US currency and triggering an unwinding of speculative selling with the trade-weighted index moving away from 3-year lows.

As far as the economic data is concerned, US initial jobless claims declined to 434,000 in the latest week from a revised 478,000 previously while there was a modest slowdown in the rate of retail sales growth with a gain of 0.5% for April following a 0.9% increase previously. Regional Fed President Plosser repeated his calls for a modest tightening of Federal Reserve policy, but the overall market impact was limited with markets looking for any additional remarks from core Fed members before there is a substantial shift in market sentiment.

There was renewed selling pressure on commodities during the week with oil prices retreating sharply while there was renewed selling pressure on metals prices. These declines triggered fresh defensive demand for the US dollar as there was also pressure for a reduction in short dollar positions which had been used to fund carry trades.

The US trade deficit was higher than expected at US$48.2bn for March despite a strong export performance which will maintain unease over medium-term dollar valuations.

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The Euro-zone structural difficulties will remain an extremely important short-term focus, especially as sovereign-debt risk has continued to increase. It will be extremely difficult to find an economic solution for Greece and other heavily-indebted economies which is also acceptable politically. The Euro will also be subjected to heavy selling pressure if there is intensification of the contagion threat.  The ECB will dampen market expectations of a dovish tone which will provide Euro support at times, but the currency will find it difficult to sustain any significant advance.

The Euro fell over the week as it failed to find relief from structural vulnerabilities and hit a 5-week low below 1.4150 against the dollar before some correction.

Ratings agency Standard & Poor’s downgraded Greece’s rating to B from BB- while Moody’s warned over the probability of further substantial cuts within the next few weeks. Markets know the situation surrounding Greek debt is unsustainable and there have been greater fears that political solutions  to tackle the economic crisis will not be sufficient or enacted quickly enough to stabilise the situation. There were increased fears over a disorderly debt default or a Greek withdrawal from the Euro which would cause major stresses within the Euro-zone banking sector.

European officials will be under strong pressure to find a workable solution ahead of a planned May 16^th Euro-group meeting. There were media reports that there would be an additional EUR60bn support package for Greece, but these reports were denied by the Greek government. There were also reports from within the German government that Greece may not qualify for the next loan tranche under the existing agreement given doubts over progress surrounding fiscal adjustment. 

Uncertainty will remain a key feature and is also liable to trigger further volatility, especially given the potential contagion risk surrounding other Euro members. There was some hawkish rhetoric by ECB members with comments that markets had mis-interpreted President Trichet’s remarks at last week’s press conference.

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From a longer-term perspective, overall confidence in the economy and government-debt situation will remain extremely fragile as the situation remains perilous.  The Bank of Japan will maintain an extremely loose monetary policy to support demand which will hurt the yen. Global risk considerations will also remain important and the yen will gain support when there is a sharp deterioration in confidence and heavy stock-market falls. Nevertheless, the yen will find it difficult to sustain gains given underlying vulnerability.

The dollar and yen gained support from a fresh deterioration in risk appetite and a move into more defensive currencies as commodities came under fresh selling pressure. The dollar was blocked in the 81.30 area and had a slightly weaker tone even though it did find support close to 80.50 in choppy trading conditions.

The latest Japanese current account data recorded a sharp decline in the surplus to JPY240bn for March from JPY723bn previously as exports declined. The underlying balance of payments position will remain weaker in the near term and this will tend to undermine the yen.

The yen also continued to gain support from vulnerability in global equity markets and weakness in commodity prices with further pressure for a reduction in commodity-related carry trades funded through the Japanese currency.

There was still a lack of confidence in the Japanese fundamentals which limited yen buying with expectations that the Bank of Japan would need to maintain a highly-expansionary monetary policy at next week’s policy meeting. The dollar maintained a more fragile tone in Asia on Friday with a retreat to near 80.50.

Sterling:

The Bank of England is looking for an opportunity to increase interest rates to curb inflationary pressure, but there will be further major concerns over the growth outlook as spending remains under pressure and there will also be fears that the banking sector will not be strong enough to cope with higher borrowing costs.  In this environment, underlying confidence in the economy and Sterling is likely to be weak.  There will still be an important element of protection from weak fundamentals in other key economies, but Sterling will find it difficult to make much headway.

As expected, GDP growth forecasts were downgraded in the Bank of England quarterly inflation report and the bank also warned over the outlook for consumer spending as real incomes continued to decline.  The bank, also raised its inflation forecasts with the headline rate set to rise to over 5.0% as energy costs rise.

In his press conference following the report, Bank Governor King warned that interest rates would eventually need to rise and the inflation report was consistent with rates rising slightly in the third quarter of 2011. King, however, also warned that weakness within the banking sector would lessen the scope for higher rates and there were very important concerns surrounding the economy.

The report provided immediate support for Sterling on a revision to interest rate expectations, but the currency will find it more difficult to gain sustained support given the downbeat assessment. From a peak above 1.65 against the dollar, the currency retreated to lows below 1.6250 and failed to sustain gains beyond 0.87 against the Euro.

The RICS house-price index improved slightly to -21% for April from -23% previously which was a 10-month high for the index even though it remained in negative territory. Underlying confidence in the housing sector remained fragile, especially with the Halifax house-price index dropping 1.4% for April.

Economic data later in the week did not provide any support with a weaker than expected 0.3% increase in industrial production for March following a 1.2% decline the previous month. The latest monthly NIESR GDP data also recorded weaker than expected growth of 0.3% for April from a downwardly-revised 0.5% previously which does not suggest that the economy has been able to gain any momentum.

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International considerations will continue to dominate in the short-term. The Swiss currency will remain the ultimate safe-haven currency, especially with all major alternatives suffering from a lack of confidence and central bank quantitative easing. These fears will trigger underlying flows into the franc, particularly when fears over the Euro intensify.  The franc will also gain support when risk appetite deteriorates, but the currency remains over-valued and there will be reduced pressure for higher interest rates following the weaker than expected inflation data.

The dollar secured a net advance against the franc with a high close to 0.89 even though the US currency was hampered by a firm franc tone on the major crosses.

There was further pressure for a reduction in speculative commodity positions which provided support for the Swiss franc. Swiss consumer prices rose 0.1% in April compared with expectations of a 0.5% increase which lessened immediate pressure for a National Bank interest rate increase and weakened the Swiss currency.

Fears over the Euro-zone sovereign-debt situation will continue to underpin the Euro in the short-term. The European banking sector will also be watched closely and fresh stresses may have a mixed franc impact given that there are substantial debts carried in the National Bank’s bad-loan vehicle.

Australian dollar:

The Australian dollar was again subjected to volatile trading during week with a peak above 1.0850 against the US dollar before a slide to the 1.0560 area. Risk conditions continued to have a very important impact on the Australian currency and it was subjected to renewed selling pressure when commodity prices fell sharply.

Domestically, the Reserve Bank maintained a firm tone in its monetary assessment, but the latest economic data was weaker than expected with a sharp decline in employment of over 20,000 with a bigger decline in full-time employment

There will continue to be strong-buying support for the Australian dollar on retreats, but the net trend is liable to be for a further correction weaker against the US dollar.

Canadian dollar:

The Canadian dollar hit tough resistance close to 0.95 against the US currency early in the week and then retreated sharply with lows near 0.97. Trends in commodity prices remained the dominant influence with a renewed sell-off in oil and precious metals putting downward pressure on the Canadian dollar.

The domestic data did not have a major impact with a slightly stronger than expected reading for the trade surplus offset by a weaker reading for housing starts. Underlying confidence in the fundamentals remained strong.

The Canadian dollar is liable to drift weaker given that it remains over-valued and there will again be sharper losses if commodity prices decline again.

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The rupee had a weaker tone for the week as a whole and despite interim recoveries, there was a decline to 7-week lows as it touched the 45 level against the US dollar.

Risk conditions remained very important and the rupee was unsettled by a weaker tone in regional equity markets with the local bourse subjected to considerable selling pressure over the week as a whole.

The rupee was also undermined by a general recovery in the US currency while the impact of lower oil prices will not be seen in the short-term.

The rupee should be able to avoid heavy losses even though it will be difficult for the currency to make strong headway while risk appetite remains weaker.

Hong Kong dollar:

The Hong Kong dollar was unable to secure a renewed advance during the week and retreated towards the 7.7750 area against the US dollar.

The Hong Kong currency was undermined by a general tone of risk aversion and weaker regional stock markets, although it still proved to be broadly resilient give expectations of strong IPO-related capital inflows.

Longer-term revaluation speculation and expectations of a stronger Chinese yuan should protect the Hong Kong dollar from strong selling pressure.

Chinese yuan:

The yuan strengthened only marginally against the US dollar for the week as a whole with the spot rate not advancing much beyond the 6.50 level. The Chinese currency did, however, strengthen in trade-weighted terms given the Euro’s weakness.

The latest inflation rate was slightly higher than expected at 5.3% for April and the central bank tightened minimum reserve requirements again as a further tightening of policy. There was a further debate surrounding interest rates with expectations that there would need to be further increases to curb inflation.

The US-China bilateral talks did not have a major impact with some cooling of the recent rhetoric calling for a faster pace of yuan appreciation.

There is the potential for further short-term yuan appreciation, although any serious doubts over Chinese growth trends could spark a sharp reversal late in 2011.