Weekly Forex Currency Review 25-02-2011

Trends in risk appetite will continue to be monitored very closely in the short-term and there is likely to be a generally more defensive tone. Central bank responses to higher energy costs will also be important. The ECB’s natural response is to tighten policy while the Fed takes a more pro-growth stance.  This contrast will tend to provide near-term Euro support, but sentiment is liable to turn frequently during the next few weeks as markets are forced to continually reassess trends.          

 Key events for the forthcoming week

 Market analysis

Dollar: 

Trends in risk appetite and geo-political risk will continue to be watched closely in the short-term. There is certainly the potential for a flow of funds out of emerging markets and a generally more cautious tone which will underpin the dollar. The US currency will also gain some degree of support from solid growth prospects.  This support will be dented by expectations that the Federal Reserve will be very slow to tighten policy and high oil prices will also be negative. Expectations that Europe will tighten first will be damaging initially, but sentiment could turn rapidly if there is evidence of a fresh Euro-zone downturn.

Risk appetite remained very fragile during the week with further concerns over the Libyan and Middle East situation. Oil prices remained an important influence as they pushed to a 30-month high above US$100 p/b and the dollar was generally unsettled by high energy costs as it failed to gain safe-haven support.

The US consumer confidence data recorded an increase to a three-year high of 70.4 for February from a revised 64.8 the previous month which will maintain optimism over near-term consumer spending trends.  In contrast, the Case-Shiller house-price index recorded a 2.4% decline in the year to December which will maintain doubts over the housing sector.

The labour-market economic data offered some encouragement with jobless claims declining to 391,000 in the latest week from 413,000 previously. Headline durable goods orders rose 2.7%, but there was a sharp decline in core orders.

Regional Fed President Evans maintained a dovish tone in comments on Tuesday as did Bullard on Thursday. In contrast to the ECB, there will be expectations that the Federal Reserve will maintain its dovish policy and keep interest rates low even if there is a further increase in energy costs.

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The Euro will gain some further near-term support from expectations of a stronger ECB line on inflation and interest rates. Overall confidence in the EU structural position will remain weak with further expectations that Portugal will require external support within the next few weeks.  Fears will certainly subside at times, but there will also be unease over the risk of a renewed downturn in growth.  The Euro will still find it difficult to gain strong support given the medium-term vulnerability and there will be further important political stresses.  Fears over the banking sector will also be an important negative Euro factor. 

The Euro continued to advance as it proved resilient to negative factors and gained support on yield grounds as it tested near 200 highs against the dollar.

The German economic data was stronger than expected as the IFO business confidence index rose to a record high of 111.2 for February from 110.6. There were also strong readings for the Euro-zone PMI manufacturing sector, although the services-sector data was less favourable. There will also be unease over the national breakdown with the risk that peripheral economies remain trapped in recession.

There was another elevated reading for bank borrowing through the ECB’s emergency lending facility and, even if this is related to a winding down of two Irish bank operations there was further unease over the European banking sector.

Comments from ECB officials were again watched very closely with Mersch commenting that there would need to be a rebalancing of monetary stance at some point. There were suggestions that there could be a consensus for a tougher language at the March council meeting and a move to tighten policy earlier than expected. 

Out-going German Bundesbank President Weber also maintained a tough tone while ECB President Trichet commented that the bank would do whatever is necessary to ensure medium-term price stability.

There will also be fears that any increase in borrowing costs would undermine the Euro-zone economy and make it even more difficult for economies to escape from recession, especially as higher energy costs will also undermine demand. The Irish election result will also be watched closely as any sign of an aggressive stance on debt restructuring by the incoming government would also have a negative Euro impact.

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Trends in risk appetite will remain very important and the yen will certainly gain support when global confidence deteriorates. Interest rate trends will also continue to be watched closely and the yen will still find it difficult to gain strong support. There will be yen backing from capital repatriation over the next few weeks ahead of the fiscal year-end and there will also be exporter selling to take advantage of any yen weakness.  From a medium-term perspective, overall confidence in the Japanese fundamentals is likely to remain weak as the rising debt burden continues to sap confidence.

The yen gained defensive support from a deterioration in risk appetite and declining global stock markets as increased fears over the Middle East situation triggered an international shift in confidence . The dollar weakened to test support below 82 for the first time since early February.

The yen will continue to gain support when risk aversion increases and there will also be increased fears over global growth prospects if energy prices continue to rise. Former top financial official Sakakibara stated that the dollar was likely to weaken to below the 80 level which had some negative impact on the US currency.

A government upgrade to its view of the economy did not have a major market impact. There was also a measured reaction to Moody’s downgrading of Japan’s credit rating to negative watch from stable with the dollar spiking higher only briefly.

There was a recorded 0.2% decline in core consumer prices in the year to January. There will be speculation that higher energy costs will boost headline prices, but underlying deflation is liable to persist.

Sterling:

Monetary policy will remain an extremely important focus and there will be expectations that the Bank of England will move to increase interest rates, possibly as soon as March.  Higher yields will offer some Sterling support, but there will also be further fears surrounding the economy, especially as any increase in interest rates would weaken confidence at a time when fiscal tightening is already undermining confidence. A combination of higher inflation and weaker growth will not support Sterling even if interest rates are increased.   Overall confidence in the UK economy will remain weak and Sterling’s best support still comes from a lack of confidence in the other major economies.

Sterling found it difficult to sustain gains during the week, failing to hold above 1.6250 against the dollar and also weakening against the Euro.

The Bank of England MPC minutes recorded a 6-3 vote for unchanged rates at the February meeting. As well as Sentence and Weale, who had voted for a hike in January, Dale voted to increase rates and Sentance was looking for a 0.50% increase to 1.00%.  The majority preferred to leave rates on hold, but there was certainly greater concern over the inflation outlook and members suggested that rates would be increased if there were signs of firmer growth. There was still a high degree of caution over the inflation and growth outlook, especially with fiscal tightening in place.

The latest government borrowing data was stronger than expected with a surplus of GBP3.7bn for January compared with a revised GBP14.5bn deficit the previous month. January is a strong month seasonally for tax receipts, but there was some relief that there was an annual improvement.

Sterling again hit resistance above the 1.62 level against the dollar during Thursday and there was heavy selling pressure during US trading which pushed it to below 1.61. The UK currency also weakened to a three-week low near 0.8575 against the Euro.  Sterling will tend to under-perform when international risk appetite deteriorates, but there will also be domestic concerns.

The latest CBI retail sales survey recorded a sharp decline to 6 for February from 37 the previous month while the prices component rose to the highest level for 20 years and consumer confidence remained weak which increased stagflation fears.

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The franc will continue to be strongly influenced by trends in risk appetite and there will certainly be support at times when risk conditions deteriorate, especially if there are renewed Euro-zone area fears. There will be further domestic concerns over the impact of franc strength and the National Bank will be in a very difficult position if there are renewed fears surrounding deflationary pressures. Even with the bank already under attack over losses from 2010’s intervention, there will be pressure to resist any renewed gains for the franc.

The franc continued to attract safe-haven support as risk appetite remained weaker. There is a lack of confidence in the major G7 currencies which is tending to amplify defensive support for the Swiss franc. The Euro weakened back to near 1.27 while the dollar weakened to an all-time low below 0.9250.

The National Bank will remain an important focus as there will be increased fears over deflation. As the franc gains ground, the bank will also record greater losses on its reserves which will increase domestic friction and criticism of the bank.

The latest trade data recorded a monthly surplus of close to GBP2.0bn and there was real-terms annual increase in exports. There is evidence of pressure in some sectors, but the data overall lessened immediate fears over the competitive position.

Australian dollar:

The Australian dollar continued to find buying support below parity against the US currency and rallied to a high near 1.0150 late in the week as the US dollar was subjected to wider selling pressure.

There was no major guidance from domestic influences and international trends tended to dominate. Sharp New Zealand dollar losses following a fresh earthquake had a negative impact as did a general deterioration in risk appetite.

Even if the currency can maintain a firm tone, reservations over domestic and global conditions will make it difficult for the  Australian dollar to reach new peaks.

Canadian dollar:

The Canadian dollar tested support levels beyond 0.99 against the US dollar during the week, but there was firm buying support on dips and it pushed back to reach 30-month highs close to 0.9810.

The retail sales data was slightly disappointing and there was speculation that the Bank of Canada would be even more cautious about increasing interest rates, particularly with reservations over Canadian dollar strength. The currency was generally resilient in the face of deteriorating risk appetite as it gained support from the high level of international oil prices.

The Canadian dollar will continue to draw support from the high level of energy prices. It will still be difficult for the currency to advance far from current levels.

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The rupee initially maintained a firm tone against the US dollar and advanced to a 7-week high just beyond 45 against the US currency with support from expected capital inflows associated with BPs joint venture with Reliance.

The currency was unable to sustain the gains and weakened back towards 45.50 later in the week. There was selling pressure from the combination of high oil prices and a deterioration in risk appetite which renewed downward pressure on the stock market.

The rupee will continue to find it difficult to secure strong support, especially as emerging-market sentiment is likely to remain generally fragile in the short-term.

Hong Kong dollar:

The Hong Kong dollar found it difficult to make any headway against the US currency during the week and after a move to near 7.7810 against the US currency there was a renewed weakening back to test support just beyond 7.7950.

The currency was undermined by generally weak risk appetite and weakness in regional stock markets. There was also further uncertainty over Chinese policies given the persistent inflation fears and risk of further monetary tightening.

The Hong Kong dollar will remain vulnerable when international risk appetite deteriorates, but heavy pressure should be resisted given the US Fed stance.

Chinese yuan:

The yuan edged slightly firmer against the US dollar during the week, but the general performance was disappointing given that the US currency was generally vulnerable as it consolidated just stronger than 6.58.

There were further expectations that inflation concerns would lead the central bank to tolerate a firmer currency. In the event, the bank resisted any significant strengthening of the currency as it targeted two-way trade.

The IMF again called the yuan substantially undervalued, but international pressure tended to ease, especially with a focus on Middle East and North African tensions

The evidence suggests that the central bank will continue to tolerate only gradual yuan appreciation as it looks to avoid any increase in economic instability.

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