Weekly Forex Currency Review 23-12-2010

Liquidity levels will remain lower in the short-term during the Christmas and New Year period. This may confine major currencies to narrow ranges, although volatility and erratic trading conditions will continue to be an important threat, especially as there will be important year-end positioning flows.  There is likely to be a pessimistic stance towards the Euro’s early 2011 outlook.          

Key events for the forthcoming week

Market analysis

Dollar:

There is likely to be some further market optimism surrounding the 2011 US growth outlook and there will be some dollar support on yield grounds. This support is still likely to be limited unless there is evidence that the Federal Reserve will scale back its quantitative easing programme. There will also still be an important lack of confidence in the US fundamentals which will continue to limit US currency support.  If confidence in the global economy can be sustained, the dollar will be vulnerable as a carry currency while any tightening of global liquidity would be important in boosting defensive demand. Overall, the dollar will find it difficult to make much headway.   

The dollar maintained a firm tone against the Euro and Sterling over the week, but the overall performance was very mixed as it lost ground against commodity currencies and also retreated to near-record lows against the Swiss franc.

The US existing home sales data was slightly weaker than expected, but there was still an increase to an annual rate of 4.68mn for November from 4.43mn previously and there was a reported monthly increase in house prices. The dollar will gain some support from optimism over a firmer growth trend, but the US currency is still struggling on a trade-weighted basis as there has been a further flow of funds into alternative investment areas such as commodities.

The US Federal Reserve announced that its dollar swaps liquidity programme would be extended until August 2011. Although amounts in the tenders have been low, the extension will fuel market fears that banking-sector tensions are rising again. The dollar will tend to gain ground if European banks find it difficult to secure US funding in the open market.

Overall confidence in the US growth outlook remained slightly stronger and Regional Fed President Bullard stated that the Fed’s quantitative easing programme could be adjusted during the course of 2011 which provided tentative dollar support.

Click Here

The Euro-zone structural vulnerabilities will remain an extremely important focus over the next few weeks at least. There will be further speculation that Portugal will require EU support early in 2011 as market access may prove to be extremely limited. From a medium-term perspective, the Euro will be much more vulnerable if the focus becomes more intense on core countries such as France, Spain and Belgium. There will also be persistent fears that ECB independence and credibility will be compromised which will undermine the Euro.  Support from China will cushion selling pressure to some extent.

The Euro remained on the defensive during the week and tested 3-month lows against the US dollar, although there was significant buying interest on dips, notably from Asian central banks.

The Euro selling pressure intensified following Moody’s announcement that Portugal’s credit rating was being put under review for a fresh downgrade.

There was also speculation that Greece’s ratings would be cut and a growing unease that France’s AAA rating could also be in jeopardy. Markets are expecting that Portugal will require EU support during the first quarter of 2011 and there are also important tensions surrounding the ECB as it remains unhappy over the Irish bailout implications.

Despite reports of Chinese buying, there was further speculation that Portugal would require EU support due to difficulties in raising funds through capital markets. From a medium-term perspective, there will also be a high degree of unease that market attention is starting to focus more on core economies such as France and Belgium. There has been greater speculation that these countries will be subjected to credit-rating downgrades in 2011 and such action would have potentially very serious implications for the Euro.

Find out more, Click Here.

Underlying confidence in the Japanese economy will subdued at best and there will be further pressure any yen gains to be resisted in order to underpin the competitive sector, especially in view of pessimism over the near-term growth outlook. The yen will tend to lose ground if there is a sustained improvement in risk appetite. There will still be caution over aggressive capital outflows from Japan, especially given a lack of  confidence in the Euro-zone and US economies The Japanese currency should, therefore, be able to resist heavy selling pressure.

The dollar was on the defensive against the yen over the second half of the week and the yen was also resilient on the crosses with the Euro sliding to below 109.

The seasonally-adjusted Japanese trade surplus fell to JPY0.43trn for November from JPY0.58trn previously and there will be further concerns over export competitiveness which maintain pressure for yen gains to be resisted, especially with pessimism over the fourth-quarter GDP data.

The dollar rose briefly following the US economic data on Wednesday, but was unable to make any significant progress. There will be the scope for further capital repatriation ahead of the year-end period which will tend to put upward pressure on the yen and there will be the risk of erratic trading.

There has been further interest in commodity currencies which should tend to curb yen support, especially if there is a sustained improvement in risk appetite. The Finance Ministry will also be uneasy over yen strength and there is scope for further semi-official dollar buying over the next few days. The US currency still remained on the defensive in Asia on Thursday with Japanese markets closed for a holiday and there was a fresh decline to lows below 83.00.

As expected, the Bank of Japan left interest rates on hold in the 0.00 – 0.10% range at the latest policy meeting and there were no fresh policy announcements. The central bank downgraded its growth expectations

Sterling:

There will be expectations of a sharp economic slowdown during the first quarter of 2011 as tax increases take effect.  Markets are more concerned now over the inflation outlook which will put the Bank of England policies under intense focus. Overall, despite the bank’s own inflation concerns, there will be a high degree of scepticism whether the central bank will be in a position to tighten and credibility is liable to deteriorate further.  It remains the case that only a small shift in sentiment could leave Sterling vulnerable to heavy selling pressure given the growth and debt dynamics.

Sterling had a significantly weaker tone during the week and retreated to 3-month low below 1.54 against the US dollar while it was also unable to make any headway against the Euro. Underlying confidence in the economy has also weakened with expectations that growth will slow sharply and there have also been fresh concerns over the banking sector.

Third-quarter GDP figure was revised to 0.7% from 0.8% while the second-quarter estimate was also revised down.  Direct damage from the data should have been limited, but fears over the 2011 outlook also increased which had a negative Sterling impact. The other data was also weaker than expected with the third-quarter current account deficit rising to GBP9.6bn.

The latest mortgage lending data remained weak and there will be expectations of further housing-sector weakness in 2011 which will tend to undermine Sterling support.

The Bank of England December MPC minutes revealed the same vote split as the previous 2 meetings with Sentence calling for higher interest rates while Posen wanted to expand quantitative easing. Within the minutes as a whole, there were increased concerns over inflation and this will lead to some speculation over a near-term move to tighten policy. There was still a high degree of scepticism whether the bank will be in a position to increase rates which undermined Sterling.

The latest monthly government borrowing requirement of GBP22.8bn was sharply higher than expected and was also a record deficit for the month with the cumulative position now little changed from last year. The higher than expected shortfall will increase reservations over the UK structural outlook and will increase the risk of contagion surrounding debt levels.

DO YOU OWN THE RIGHT STOCKS?

Analyze Your Stocks FREE! – Click Here

International developments will remain extremely important in the short-term and the franc will maintain defensive support given the sustained deterioration in Euro-zone confidence. There is also still the possibility of much more substantial capital flight into the Swiss currency if Euro-zone tensions intensify. The National Bank will certainly be uneasy over franc strength, especially given the pace of recent appreciation and there will be pressure for intervention to curb further rapid gains.

The Swiss currency maintained an extremely strong tone on the crosses during the week and advanced to a series of record highs beyond 1.25 against the Euro. The dollar was also under strong pressure and retreated to lows near 0.95. The franc has found it relatively easy to break Euro support levels which suggests that underlying investment flows into the currency are very strong or that there has been heavy speculative buying.

The latest trade data recorded an export decline of 3.4% for November and, although the underlying trade performance remained robust, there will be increased domestic unease over the impact of further franc strength with increased pressure for National Bank action.

Australian dollar:

The Australian dollar proved resilient during the week and made a fresh challenge on parity against the US dollar with a move above this pivotal level to challenge December highs late in the week.

There were year-end pressures to hold the Australian dollar and it also gained support from the high level of commodity prices as funds continued to look for attractive alternatives beyond the US dollar and Euro.

The Reserve Bank maintained a generally hawkish tone, but there were also reservations over the domestic economy which curbed aggressive currency buying.

Australian dollar volatility is liable to remain relatively high given the potential for sharp fluctuations in domestic and international sentiment. It may again prove difficult to sustain a move above parity against the US dollar.

Canadian dollar:

The Canadian dollar was unable to make an attack on resistance levels close to parity against the US currency, but there was solid support on a retreat to beyond 1.02.

The domestic data was weaker than expected with lower than expected reading for consumer inflation. In contrast, the international trends were generally supportive as there was a rally in oil prices to a two-year high which supported the currency.

It will remain difficult for the Canadian dollar to sustain any move beyond parity especially if there further market concerns over domestic and global debt levels.

Our "Value Packed" online trading seminar will show you how you can.

Click Here To Find Out More

The rupee had a generally firm tone over the week as a whole, although market movements were generally subdued as liquidity was generally low.

There was evidence of dollar sales during the week which underpinned the Indian currency. There were net equity outflows for December as a whole, but there was no evidence of heavy selling which limited any pressure on the currency.

The rupee should prove to be broadly resilient in the near term and the most likely outcome is for a period of range trading with capital inflows providing some support.  

Hong Kong dollar:

The Hong Kong dollar found support on dips towards 7.78 against the US dollar, but was again unable to strengthen back through 7.77. US Treasury bond yields remaining higher which limited buying support for the Hong Kong currency.

There was caution over the Hong Kong equity and property markets with no evidence of substantial capital inflows despite caution over the Chinese securities markets.

The Hong Kong dollar appears to be struggling to resist capital outflows, butt he medium-term dynamics should curb significant selling on the currency.

Chinese yuan:

The yuan maintained a generally firm tone over the week as a whole and advanced to a high around 6.647 against the US currency even though the Euro was generally weak.

Inflation remained an important focus during the week and there was increased speculation that the Chinese authorities were looking to encourage a firmer domestic currency to help contain inflation pressures.

The authorities will see yuan appreciation as a useful tool in tackling inflation, but there will still be resistance to more than slow appreciation.

Click Here to learn more