Weekly FX Commentary

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Weekly FX Commentary:

The Euro-zone will remain an important short-term focus as uncertainty surrounding the Spanish situation continues. There will be a series of important Summit meetings during the month with Spain under intense pressure to make a bailout request. There will, however, be the threat of increasing tensions, especially given political protests and growing fears over the implications of continuing recession. Central banks will maintain an aggressive stance in providing substantial global liquidity which will help protect risk appetite, at least to some extent.

Key events for the forthcoming week

Date	Time (GMT)	Data release/event
Friday October 5th	12.30	US employment data
Monday October 8th		Eurogroup meetings
Tuesday October 9th	08.30	UK industrial production

Dollar:

The US economic releases have maintained a mixed tone during the week with stronger than expected readings for the PMI data increasing expectations of a stronger fourth quarter.  The Federal Reserve, however, has stated its determination to maintain quantitative easing until unemployment falls which will limit any dollar support.  The US should still gain some support from expectations of out-performance compared with the Euro-zone.  International growth considerations will also remain important and there should be some underlying dollar support from fears over the outlook. The US currency will, however, find it difficult to gain strong support given reduced reserve support from reserve managers.

The dollar was unable to secure any significant gained during the week with an underlying lack of enthusiasm for the currency not offset by risk-related demand.

The latest US ISM manufacturing index was stronger than expected with the first reading above the 50 level for four months at 51.5. The latest ISM non-manufacturing index was stronger than expected at 55.1 for September from 53.7. There will be relief surrounding the orders data, but some disappointment surrounding the employment component which dipped to just above 50.

The US jobless claims data was slightly better than expected at 367,000 in the latest week from a revised 363,000 previously which offered some encouragement surrounding the labour market. The latest payroll data will inevitably be important for sentiment on Friday with employment gains and trends in the workforce watched very closely, especially given the potential political implications.

The Fed minutes were generally dovish as the Fed reinforced its unease surrounding employment trends. Some members were uneasy over further quantitative easing and there was also some pressure for the Fed to drop references to rates being left low for an extended period.

Euro

There will be further expectations that Spain will apply for a bailout package in an attempt to stabilise the economy. This should provide some degree of support for the Euro, but market anxiety will quickly increase if Spain continues to resist. There will also be major unease surrounding the growth outlook and prospects of growing political turmoil in peripheral economies if recession intensifies.  Greece remains in severe difficulties and there will be increased friction between core and peripheral economies.  In this context, there will be threat of renewed tensions within the Euro-zone and downward pressure on the Euro could intensify rapidly. The Euro maintained a firm tone during the week and pushed to challenge resistance levels above 1.30 against the US currency with the currency gaining underlying support from an underlying reduction of short positions. There were further expectations that Spain was close to requesting a bailout following media reports the previous day that only Germany was now resisting an early move. Prime Minister Rajoy did state that there was harmony between the central government and regions, but markets were broadly focussed on the bailout situation and Rajoy bluntly stated that a request was not imminent. There was some increase in tensions surrounding the ECB bond-buying programme with increased speculation that it could be declared illegal and that there was the possibility of legal action by the Bundesbank as underlying stresses remained high. There were mixed readings for the latest Euro-zone PMI data with the Italian services data figure for example stronger than expected, but the net tone was generally weak with particular concerns surrounding a sharp downturn in France and Spain. Markets have been extremely uneasy surrounding Spanish prospects for months and confidence in the French economy has also deteriorated amid fears that they could start showing the same vulnerability as peripheral economies. Uncertainty surrounding Spain continued with the Madrid government concerned over the terms of any loan package and warning over the threat to Euro stability. There were further uncertainties surrounding Greece with Finance Ministry suggesting that there were still big differences between the government and troika over austerity measures. The troika also suggested that GDP could contract by a further 5% in 2013. As expected the ECB left interest rates on hold at the latest council meeting with the benchmark rate at 0.75% and the deposit rate left at zero.  President Draghi’s news conference was relatively subdued. He continued to emphasize the need for conditionality in the bond-buying programme, although also insisted that conditions did not need to be punitive. Draghi was generally downbeat over the economic outlook with the potential for growth and inflation forecasts to be lowered even with headline inflation set to remain above 2.0% through the remainder of this year. Yen: The Bank of Japan will remain under strong pressure to enact even more quantitative easing, especially with demands for the yen to be weakened and there is increased unease within the Finance Ministry with demands for the buying of overseas bonds.  Markets remain very uneasy over the US and Euro-zone fundamentals which will still provide some degree of yen protection, especially if global growth concerns intensify.  The dollar pushed to highs near 78.70 against the yen during Thursday, supported by a general improvement in risk appetite, but was unable to sustain the gains and weakened back to the 78.30 area. New Finance Minister Jojima stated that the Finance Ministry and Bank of Japan would work together to beat deflation which had some negative yen impact, especially as it reinforced speculation that the Bank of Japan could embark on fresh monetary easing at this week’s policy meeting. There was uncertainty surrounding the monetary policy decision, especially with underlying pressure for government action.  The pressure on the bank and unease over the deflation threat was illustrated by attendance at the meeting by the Economy Minister for the first time in nine years. In the event, the Bank of Japan announced no further policy moves with quantitative easing held steady. The yen strengthened to highs in the 78.30 area against the dollar following the decision.

Sterling

Although there will be expectations of an improved third-quarter economic performance, there will also be unease that the economy will falter again during the fourth quarter. There will be speculation that the Bank of England will sanction further quantitative easing in November. For now, in relative terms, Sterling should be able to gain some protection from the aggressive monetary action elsewhere, especially if there is any sign of improved UK growth. It will still be difficult for the UK currency to gain strong support. Sterling found support below 1.61 against the dollar and rallied back to the 1.62 area despite net losses against the Euro as it dipped to two-week lows near 0.8050. The latest manufacturing PMI data was weaker than expected with a retreat to 48.4 for September from a revised 49.6 the previous month and  this was the fifth successive reading below the 50 benchmark. The latest consumer lending data was also weaker than expected with a net decline as consumer credit contracted for the second successive month. The services-sector data recorded a decline to 52.2 for September from 53.7 the previous month. There was some disappointment surrounding the release, although there will be some relief that the data held above the 50 level and also out-performed the Euro-zone area. The latest housing equity withdrawal data recorded a net repayment of housing debt for the 17th successive quarter and at the highest rate since the second quarter of 2011 which will continue to be a drag on the consumer spending outlook. As expected, the Bank of England held interest rates at 0.50% at the latest policy meeting and the amount of quantitative easing was held steady at £375bn. There were widespread expectations that the MPC could consider further action at the November policy meeting which had some impact in curbing Sterling demand. The latest housing data was weaker than expected with the Halifax Bank reporting a second successive monthly decline in house prices with a 0.4% for September from a revised 0.5% dip the previous month. Swiss franc: Medium-term fears over the impact of quantitative easing will maintain the potential for defensive capital inflows into the Swiss franc. This will be particularly important if there is any increase in stresses between the core and peripheral economies which will maintain fears over a potential break-up within the Euro-zone. The dollar was unable to hold above the 0.94 level against the franc during the week and retreated to lows near 0.9300 as the Euro found support in the 1.2085 region on the cross and moved back above the 1.21 level There was a weaker than expected PMI release of 43.6 for September from 46.7 previously which increased doubts surrounding the economic outlook and offset the impact of a stronger than expected retail sales release.   The Swissmem industry group warned that it would be catastrophic for the economy if the Euro minimum level was abandoned. The latest reserves data recorded an increase of close to CHF9bn which suggested that pressure on the Euro had eased, but was still an important market factor.

Australian dollar The Australian dollar remained under pressure during the first half of the week and dipped to re-test early September lows below the 1.02 level. The Reserve Bank of Australian cut interest rates by 0.25% to 3.25% which had a negative impact on the currency. The data release were also generally negative with a weaker than expected reading for retail sales and a sharply wider than expected trade deficit as commodity exports came under pressure. The currency gained some degree of relief from a generally weaker US currency and an improvement in risk appetite as central banks maintained an aggressive liquidity stance with some expectations of further reserve diversification into the Australian currency. Continuing vulnerability in the Chinese and global economy is likely to keep the Australian dollar generally on the defensive, especially given domestic vulnerability. Canadian dollar: The Canadian dollar drifted slightly weaker during the week as a whole, but the currency did find support on retreats towards the 0.99 level and moved back to the 0.98 level Oil prices recovered after a sharp decline which provided relief for the currency and there was reduced underlying demand for the US currency. There were no major Canadian economic releases during the week. Net monetary policy trends should be supportive, but it will still be difficult for the Canadian dollar to make significant gains given persistent global growth doubts.