Weekly Forex Currency Review 28-02-2014

Emerging markets will be an important short-term focus with concerns surrounding underlying tensions in Ukraine while China will also be a very important focus, especially with the yuan weakening sharply. Any evidence of a sustained downturn  in the US outlook would have important consequences for the dollar and underlying risk conditions. Pressure on the ECB will also continue to increase if there is a weaker than expected inflation release and evidence of a fresh downturn in demand.
 
Key events for the forthcoming week

 Market analysis

Dollar:

There have been further doubts surrounding the US economic outlook with a raft of mixed data. There are important doubts as to the extent of how much of the vulnerability has been related to adverse weather and how much has been a reflection of underlying vulnerability. For now, the Federal Reserve remains on track for a further tapering of bond purchases and is looking to end the programme by the Autumn. A further run of weak data would start to raise fresh doubts over the tapering programme process which would undermine the dollar’s yield support and trigger position liquidation. There should still be underlying US currency support on structural and valuation grounds. 

The dollar did move to a two-week high on a trade-weighted basis, but was unable to sustain the move as it still struggling to sustain buying support. Safe-haven considerations were significant. The Euro was seen as vulnerable to some extent but with Euro-zone assets still being seen as having some defensive qualities and the overall dollar performance was mixed. The latest US PMI services data release was weaker than expected with a decline to 52.7 for February from 56.7 which maintained unease over the near-term outlook. 

There was a 13.4% annual increase in the Case-Shiller US house-price index and a 0.8% monthly increase in the latest monthly survey which provided some underlying confidence in the housing sector. In contrast, there was a weaker than expected reading for the Richmond Fed index.

Although the headline consumer confidence reading was light of expectations at 78.1 from a revised 79.4 previously, there was an increase in the current situation component to a six-year high which helped underpin overall economic sentiment and offer reassurance over the labour market with new home-sales data also robust.

Headline durable goods orders were slightly weaker than expected with a 1.0% decline, offset by a firmer underlying reading with growth of 1.1% while jobless claims rose to 348,000 in the latest week which curbed further dollar buying support.  
Prepared Senate testimony from Fed Chair Yellen was unchanged from the House statement two weeks ago and provided no major market impetus. She reinforced the emphasis on the Fed’s dual mandate. She did refer to some signs of softness in recent data, but that the Fed was, at present, still on track for a further tapering of bond purchases with the programme potentially ending in Autumn.

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The Euro-zone data will remain an important short-term market focus.  The ECB is looking at forecasts for a rebound in growth and a limited recovery in inflation to justify not moving to a more accommodative monetary policy. There are important doubts surrounding the economic outlook and further evidence of weakness following the disappointing PMI data would be very important in increasing underlying concerns and raising pressure on the ECB.  There will be a risk that confidence suddenly deteriorates sharply. In the short-term, the current account surplus and potential capital repatriation will still provide important underlying Euro protection.

The Euro held relatively steady as it was again able to find support on any significant dips and tested 3-week highs near 1.3800 against the dollar before fading.

As expected Renzi was handed the presidential mandate to attempt to form a new Italian government following Prime Minister Letta’s resignation on Friday. The immediate market impact was very limited with no evidence of stresses in Italian bond markets as sentiment was supported by Moody’s return of Italy’s credit rating to stable from negative.  There will be a potentially less forgiving tone if Renzi struggles to put together a workable coalition.

In its latest monthly report, The Bundesbank expressed its opinion that it was possible to stop sterilisation of bond purchase related to SMP bond purchases. This will increase speculation that it’s a possible move at March’s ECB council meeting which would represent a limited monetary easing.

There will be some further speculation over various policy actions in March, but overall sentiment has edged away from expecting major measures given that medium-term inflation forecasts have not signalled deflation concerns. There was a weaker than expected reading for the German ZEW business expectations index which declined to 55.7 from 61.7 previously which did not have a major impact.

There was a notable decline for the French manufacturing PMI index, compounded by a sharp fall in the services sector index to 46.9 for the month from 48.9 previously. The German manufacturing data was also disappointing which raised fresh concerns over the Euro-zone growth outlook.

Yen:   

The dollar will continue to secure near-term support on yield grounds. The Japanese balance of payments position remains substantially weaker as imports continue to rise. This situation will continue to weaken the yen’s underlying support with expectations of medium-term depreciation. The Bank of Japan will continue to consider further quantitative easing, but there will be some reconsideration if there is a further increase in inflation. The yen will still gain some degree of support when risk appetite deteriorates with a further reduction in short speculative positions. 

The yen maintained a solid tone during the week with a generally fragile trend in risk conditions limiting selling pressure and pushing the dollar lower despite yield support There was a further decline in the Chinese yuan on Wednesday as the PBOC continued to push the fixing lower. There were further uncertainties surrounding the motivation for the move, in particular, there were uncertainties whether it heralded a move to widen the yuan band or reflected structural weakness within the economy.

The latest Japanese industrial production was stronger than expected and there was a modest gain for household spending. The net impact was a slightly firmer yen despite some concerns that inflation could be peaking which would increase pressure for further Bank of Japan action.

The Chinese yuan remained an important focus during the day with a further slide to the 6.18 area against the dollar which maintained a very cautious tone towards risk appetite and the dollar retreated back below the 102 level with lows near 101.50.

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Sterling will continue to gain short-term support on growth expectations, especially with Vodafone-related inflows. The Bank of England will continue to resist any near-term policy tightening and yield considerations will become significantly less favourable if there is evidence that growth conditions are starting to fade. There are important balance of payments vulnerabilities and there will need to be an economic rebalancing for greater confidence in its durability. Confidence will also tend to erode if there is a sustained deterioration in risk appetite with the risk of substantial capital outflows. 

Sterling again proved resilient during the week and found solid support with a renewed move higher to above 1.67 against the dollar later in the week as the Euro retreated to lows below 0.82. There was still underlying speculation that there would be Sterling demand associated with payments to Vodafone shareholders and volatility was an important feature. 
The latest UK economic data was stronger than expected with a CBI retail sales survey outcome of +37 for February from +14 previously and companies were optimistic surrounding March’s outlook. There was also an increase in BBA mortgages to the highest level since 2007.

The second reading for fourth-quarter UK GDP data was unchanged at 0.7%, in line with expectations. There was a slight downward adjustment to consumer and government spending while there was a higher than expected reading for investment which will trigger some optimism that the economy is more balanced. 

MPC member Broadbent maintained the possibility of an interest-rate increase in 2015, but he also insisted that too much was being made of specific dates. MPC members as a whole are continuing to insist that there is no immediate prospect of a rate increase which put some downward pressure on gilt yields.

The consumer confidence reading was unchanged on the month at -7 which suggests no major change in spending trends at this stage with markets waiting for key PMI releases next week which will be important in determining near-term direction.

Swiss franc:

The Swiss currency will gain support if emerging-market sentiment deteriorates again.  There will also be capital inflows if the ECB takes a more aggressive monetary policy. National Bank concerns over inflation will tend to remain in abeyance for now and there will be a strong commitment to the minimum Euro level. Market scepticism will tend to increase if there is a sustained attack on the 1.20 minimum level and asset-price inflation looks to increase further.

Underlying pressure on the Euro was a significant feature during the week with a fresh decline to 10-month lows near 1.2150 against the Swiss franc while the dollar was blocked below 0.90 and retreated back below the 0.89 level. There was franc demand in the context of defensive qualities as risk appetite remained fragile, although tensions did subside slightly later in the New York session.

Domestically, a weaker than expected GDP release did not have a major impact as markets focused on the possibility of more aggressive ECB action which would further enhance the franc’s qualities.

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The Australian dollar was again subjected to choppy trading conditions during the week and registered net losses as it tested support levels near 0.89 against the US dollar before a limited recovery.

Domestically, there was a weaker than expected reading for investment spending which had some negative impact on the currency, although international considerations tended to dominate.  

There were fresh concerns surrounding the Chinese outlook, especially with a sharp weakening of the yuan and there was further downward pressure on industrial commodity prices which also undermined the Australian currency.

The Australian dollar will be vulnerable to renewed selling on any evidence of substantial deterioration in the Chinese outlook and commodity-price weakness.
 
Canadian dollar:

The Canadian dollar was unable to sustain a recovery against the US dollar and retreated back beyond the 1.11 level against the US currency. Overall confidence in the domestic economy remained weaker than expected and there was selling pressure was triggered by a decline in key commodity prices. 

The Canadian dollar will be unsettled by evidence of  weaker capital inflows and any selling will increase if there is further downward pressure on key commodity prices. 

Indian rupee:

The rupee was generally resilient near 62 against the dollar despite fresh tensions surrounding key emerging markets as a whole. There was greater confidence over the domestic economy with hopes that the fundamentals would be resilient. In this context, there was evidence of further net capital inflows which helped the currency.

There will still be important concerns surrounding the global environment and there will be increased pressure on the currency if wider emerging tensions intensify.

The rupee can prove resilient on increased confidence surrounding the domestic fundamentals. Wider emerging-market vulnerability will still tend to dominate.

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The Hong Kong dollar was unable to make further progress against the US dollar during the week and retreated to test support beyond the 7.76 level against the US currency. The currency was unsettled by losses for the Chinese yuan and there were also concerns surrounding the implications of aggressive lending by local banks to mainland China which could trigger a sharp increase in losses. 

Longer-term appreciation pressure on the Hong Kong dollar will continue to ease if the Chinese yuan continues to weaken and emerging-market stresses intensify. 
 
Chinese yuan:

The yuan weakened sharply during the week as a whole and registered the sharpest weekly decline since the limited float was introduced with the spot rate at a 10-month low beyond the 6.18 level against the US dollar. 

There were expectations that the PBOC was looking to push the currency weaker in order to deter aggressive speculative capital inflows which has helped fuel the sharp rise in domestic lending. There has also been speculation that the central bank is looking to engineer higher volatility ahead of any widening of the trading band. 

There were further concerns over the domestic economy and fears that any measures to deflate a credit-fuelled bubble could quickly escalate into a more serious and sharp deterioration in the economy. 

The pace of yuan selling is likely to slow in the very short-term, but longer-term vulnerability will be a feature if there is sustained economic deterioration. 

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