Weekly FX Commentary

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Weekly FX Commentary:

The Euro-zone will be an important short-term focus without any deal reached on Greece. The most likely outcome is that will be a compromise deal, but this will not solve underlying issues as the economy continues to contract.  US fiscal negotiations will also be watched very closely with any deal providing short-term relief to risk appetite. Underlying growth concerns are still likely to be important in curbing risk conditions. Key events for the forthcoming week Date Time (GMT) Data release/event Monday November 26th Eurogroup meeting Tuesday November 27th 09.30 UK GDP (Q3 revised) Thursday November 27th 15.00 US consumer confidence Dollar: There will be further uncertainty surrounding the US economic outlook with the data vulnerable to further distortions, but there will be some unease over evidence of a slowdown. The Federal Reserve has indicated that it will maintain a very loose monetary policy over the next few months and there will certainly be some pressure within the Fed for even more bond purchases at the December meeting. Fiscal policy will also be watched very closely and any budget agreement would underpin US growth hopes, but would also dampen defensive dollar demand.  Underlying global risk trends should still prove to be broadly supportive for the US currency, especially if Euro-zone fears intensify again. The dollar proved broadly resilient on a trade-weighted index during the week, but it did lose ground against European currencies with the Euro pushing to three-week highs near 1.29. The latest US housing starts data was stronger than expected with an increase to a fresh four-year high of 894,000 while permits were broadly in line with expectations. Regional Fed President Lacker was again generally critical of the US policy stance with a warning against further quantitative easing which did provide some initial dollar support, although Lacker is certainly a minority opinion. Fed Chairman Bernanke warned over the need to avoid a fiscal confrontation and increased pressure on Congress. There were no indications that there would be any fresh monetary stimulus at this stage even though the pace of recovery was still described as weak. There were still expectations that there could be additional policy measures in December with Operation Twist due to expire, especially with Bernanke stating that it would do whatever is necessary to support the economy and curb unemployment. There was a decline in US jobless claims to 410,000 in the latest week from 451,000 previously as the impact of Hurricane Sandy started to fade. There was an improvement in the PMI manufacturing index to 52.4 from 51.0 previously. Market activity faded during the New York session ahead of Thursday’s Thanksgiving Holiday with the Euro holding above the 1.28 level. Regional Fed President Williams continued to push for further quantitative easing which helped undermine the dollar Euro Despite continuing tensions with the IMF, there is a strong probability that there will be some form of agreement to provide the next loan tranche to Greece which will provide initial relief.  There will, however, be major concerns surrounding the underlying outlook as any fudged deal is unlikely to convince markets that the overall debt burden and overall issues are being tackled. A lack of growth will remain an extremely important issue both for the peripheral and core economies. There will also be pressure for the ECB to adopt a more expansionary policy to support the growth outlook with the Euro still vulnerable.  the Euro dipped sharply following Moody’s announcement of a downgrade to the French credit rating to AA1 from AAA, but overall selling pressure was contained and the Euro also recovered ground after failure to reach agreement on Greece. Following a 12-hour meeting, the Eurogroup failed to reach agreement over the latest loan tranche to Greece. The IMF has insisted that changes to the austerity programme need to be made in order to reach a projected debt/GDP target of 120% by 2020.  On current projections, this ratio is likely to be around 145% according to internal documents with the risk that it will be substantially higher. This increases pressure for official debt-write-downs as the only realistic method to ease the debt burden. Germany and other ‘hard’ Euro-zone members are very strongly opposed to any official haircut and no deal was reached. The Euro weakened sharply to lows below 1.2750 against the dollar and a further Eurogroup meeting will be held on Monday in an attempt to bridge the divide. The latest Euro-zone PMI manufacturing data was marginally better than expected with a recovery to 46.2 from 45.4 previously. In contrast, there was a weaker than expected reading for the services sector with the lowest reading since the middle of 2009 as output, orders and employment all fell sharply. There will also be concerns that the rate of deterioration in peripheral economies accelerated again during the month. There was also a further drop in consumer confidence to the weakest reading for three years which will maintain fears surrounding the outlook. The German IFO index increased for the first time in 7 months which provided some relief. There was a satisfactory Spanish bond auction as Spain looked to start the 2013 programme and benchmark yields dropped from levels seen earlier in the week. There were further expectations that the Eurogroup would be able to secure a Greek deal next week with suggestions that the IMF would allow an increase in the projected 2020 debt/GDP ratio to 124% of GDP from 120%. There were still concerns surrounding remarks from ECB member Asmussen who maintained pressure on the German government by stating that countries who had a red line on debt write-downs needed to compromise elsewhere. Yen: There will be further concerns surrounding the Japanese economy with particular fears surrounding exports following another monthly trade deficit. The political situation will be very important with a general election scheduled for the December 16th.  The LDP, which is ahead in opinion polls, has pledged to push for a much more aggressive monetary policy and will also push to curtail Bank of Japan independence. Both these factors would tend to undermine the yen and underlying sentiment remains extremely weak. The yen could still gain significant support if risk appetite deteriorates. The dollar remained under heavy pressure during the week and retreated to 7-month lows beyond 82.75. The Euro also pushed to a six-month high against the Japanese currency with a peak above 106.50. The latest Japanese trade data was weaker than expected with a headline JPY549bn deficit for October, the worst outcome for this month for 30 years as exports declined by 6.5% over the year. The data reinforced negative sentiment towards the Japanese economy and yen. Underlying sentiment remained very weak on expectations of a major shift in economic policies. Parliament was dissolved with elections scheduled for December 16th and there were comments from LDP leader Abe that a new government would push for aggressive monetary policies and a weaker yen.  There were further expectations that an LDP government, if elected next month, would push for monetary easing by the Bank of Japan and would look to curb the bank’s powers in order to secure higher nominal GDP growth and a higher inflation rate. Sterling There will be further doubts surrounding the UK economic outlook with speculation that the economy will contract again in the fourth quarter which would increase fears that the economy will enter recession again. The Bank of England certainly remains very cautious over further quantitative easing, but will consider further action if the economy deteriorates again. There will be further concerns surrounding the fiscal outlook and fears that any further deterioration will prompt a credit-rating downgrade which would increase the threat of capital outflows. Sterling overall will struggle to secure gains. Sterling proved resilient against the dollar with support below 1.59 while the UK currency weakened against the Euro. The Bank of England minutes from November’s meeting recorded a 9-0 vote for unchanged interest rates and there were comments suggesting that a cut in rates was very unlikely over the next few months. There was an 8-1 vote for resisting any further quantitative easing with Miles voting for a further GBP25bn in bond purchases. The bank’s assessment suggested that they are expecting a GDP contraction for the fourth quarter with only a very weak expansion during 2013. Unease surrounding growth trends was also increased by the latest government borrowing data. There was a higher than expected shortfall in October with tax receipts declining. For the first seven months of the fiscal year, there was an underlying increase in the deficit to GBP73.3bn from GBP68bn last year which increased speculation over a credit-rating cut. The latest CBI industrial survey remained weak with a reading of -21 for November from -23 the previous month with a deterioration in output expectations to the lowest level of the year. This weakness will maintain concerns surrounding the economic outlook with particular doubts surrounding exports given Euro-zone vulnerability. Swiss franc: There has been some underlying reduction in defensive flows into the Swiss currency, but there will be the risk of fresh inflows if Euro-zone tensions intensify again.  The National Bank will remain strongly committed to maintaining the 1.20 minimum Euro level in the short-term, especially with an annual decline in exports according to the latest data.  Overall, the bank should be able to prevent franc gains for now even though longer-term doubts surrounding the peg’s sustainability will persist. The dollar was on the defensive against the franc during the week and retreated to lows below 0.9350. The Euro was unable to make any impression on the Swiss currency and generally traded below 1.2050. The latest Swiss trade data recorded an annual decline in exports with particular concerns surrounding the machinery sector There was a further round of rhetoric from National Bank officials stating that the Euro minimum level was an essential policy tool. Weakness in Euro-zone economies will have an important impact in undermining exports and this will make it even more of a priority to protect competitiveness and resist franc appreciation. Australian dollar The Australian dollar found support in the 1.03 area against the US dollar during the week and rallied to the 1.04 area as underlying ranges were slightly narrower than previously. The Monetary policy minutes were in line with expectations with the bank suggesting that rates could be cut again. There was evidence that the Reserve Bank was looking to hoard foreign currencies and also curb Australian dollar appreciation. The Australian currency will find it very difficult to make significant headway, especially with speculation that the Reserve Bank will covertly curb currency gains. Canadian dollar: The Canadian dollar found support close to 1.0050 against the US currency during the week and strengthened to the 0.9950 area before consolidating just stronger than parity.  There was fluctuations in commodity prices, but there was no significant net support for the Canadian currency. The retail sales data was weaker than expected as was the wholesales data which maintained some concerns surrounding the economic outlook. The Canadian dollar is likely to weaken gradually against the US dollar, especially with growing unease surrounding competitiveness in the economy.