Weekly FX Market Commentary

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Weekly Market analysis

Following the US Presidential election, there will be a grater focus on US fiscal policy with fears that brinkmanship over the ‘fiscal cliff’ issue will contribute to a deterioration in risk appetite. There will be further concerns surrounding the Euro-zone outlook, especially with no move by Spain to request a bailout. Underlying risk appetite is likely to be generally fragile given concerns surrounding further banking-sector de-leveraging. Key events for the forthcoming week Date Time (GMT) Data release/event Wednesday November 14th 09.30 UK unemployment Wednesday November 14th 10.30 UK inflation report Wednesday November 14th 13.30 US retail sales Wednesday November 14th 19.00 US FOMC minutes Dollar: Following the re-election of President Obama, there will be expectations that the Federal Reserve will maintain a highly expansionary monetary policy which will tend to limit dollar support. Fiscal policy will be an extremely important short-term focus with automatic tightening due at the start of 2013 unless a compromise deal can be reached. There will be concerns surrounding a weaker US  economy, but there will also be a negative impact on risk appetite which will underpin US demand. There will be expectations that US growth will out-perform the Euro-zone and the dollar should be able to maintain a firm tone. The dollar was able to make gains during the week as the Euro was subjected to renewed selling pressure and the dollar index attacked two-month highs. There was caution ahead of the US Presidential outcome, although markets were generally expecting an Obama victory. This would  imply a continuation of very loose Federal Reserve monetary policy which would tend to undermine dollar support. After an initial Euro retreat on early results, confirmation of a second Obama term pushed the Euro higher with a peak in the 1.2870 area.  The Republicans maintained control of the House of Representatives. Following Obama’s re-election, a more confident mood surrounding risk appetite could not be sustained. Ratings agency Fitch stated that there would be no honeymoon period for Obama on fiscal policy with the US facing automatic tax increases and spending cuts at the start of 2013 if no budget agreement can be reached. With potential divisions within Congress, fears surrounding deadlock continued. There was a decline in the US trade deficit to US$41.5bn for September from US$43.8bn the previous month as exports pushed to a record high.  The latest US jobless claims data recorded a decline to 355,000 in the latest week from 363,000 previously, with some uncertainties surrounding the impact of hurricane Sandy.  There were further concerns surrounding the US fiscal outlook even with some signs of conciliatory gestures from the House of Representatives Speaker. There were still concerns over potential medium-term implications for the US credit rating. Euro Greece has managed to pass austerity measures in parliament, butt he underlying economic outlook remains extremely weak as GDP continues to contract.  There will also be intense political stresses and the coalition government is vulnerable to collapse. Even if another loan tranche is secured, confidence will remain very weak and there will be continuing fears surrounding the Spanish outlook. There will be strong pressure on the ECB to cut interest rates again and the underlying lack of growth will continue to undermine the Euro even if more severe outcomes such as a break-up can be avoided.  Confidence in the Euro deteriorated again with fears over the economic outlook and underlying political stresses and it dipped to two-month lows against the dollar. A small recovery in Euro-zone peripheral economy services PMI readings was offset by deterioration in Germany and the overall outcome was a small downward revision to the flash estimate. There was also a significantly weaker than expected reading for German industrial orders of -3.3% which had a negative Euro impact. The Greek government eventually secured a narrow vote in favour of its austerity package as Democratic Left abstained rather than voting against. This failed to provide any significant Euro relief, especially as there was further speculation surrounding the next loan tranche. There were reports from the German Finance Ministry that it would not be possible to reach agreement on Greece at next week’s Eurogroup meeting and a decision may not be made for weeks. There were reports that the Spanish government would not apply for an aid request during 2012 and speculation that the ECB was not looking to launch its bond-buying programme in the short-term.  There was a satisfactory Spanish bond auction which helped stabilise sentiment to some extent as the country completed its 2012 funding and would start pre-funding 2013 needs. As expected, the ECB left interest rates on hold at 0.75% following the latest policy meeting. In the press conference following the meeting, Draghi remained generally downbeat surrounding the economic outlook with expectations that growth forecasts would be downgraded in December’s staff  projections.  There were further concerns that the ECB was not addressing the Euro-zone credit crunch and speculation that interest rates could be cut at December’s meeting given growth fears. Yen:  There will be further concerns surrounding the Japanese economy with particular fears surrounding the corporate sector as exports and profits remain under intense pressure. In this environment, there will be pressure for additional Bank of Japan monetary action and an intervention policy to weaken the yen. Politically, there may be less opposition to intervention from an Obama administration. The Japanese currency will still gain significant defensive support when there is a deterioration in risk appetite.    The dollar was unable to push above 80.50 against the yen and dipped sharply after the US elections as equity markets were subjected to renewed selling pressure. There were continuing fears surrounding the Japanese economy with machinery orders falling by a greater than expected 4.3% for October  while consumer confidence also deteriorated. Japanese weakness will maintain pressure for yen gains to be resisted and for further monetary easing to be sanctioned. There were expectations that the US Treasury would not take a more confrontational stance over currency issues which should lessen yen buying to some extent. The dollar did find support in the 79.30 with risk appetite improving slightly following the Chinese economic data. The Bank of Japan will also remain under strong pressure to relax monetary policy again and the dollar consolidated around the 79.50 area. The Japanese Finance Minister warned that intervention was an option which had some impact in curbing yen demand Sterling The Bank of England decision to resist further quantitative at this stage will provide some initial Sterling support, especially with on-going bond purchases in the US.  Growth prospects will be extremely important for Sterling sentiment and any further evidence that fourth-quarter output is weakening again would be a very negative factor for the UK currency, especially as there would be fresh concerns surrounding a credit-rating downgrade.  Sterling will also tend to be vulnerable if there is a sustained deterioration in risk appetite. Sterling was marginally weaker against the dollar, but there was a firm tone against the Euro as the UK currency pushed to five-week highs beyond 0.80. The latest PMI services-sector data was significantly weaker than expected with a decline to 50.6 for October from 52.2 previously and was the slowest rate of expansion since December 2010. The economic data remained generally downbeat with a larger than expected 1.7% decline in industrial production for September. Although the data was distorted by a sharp drop in oil and gas output, there was a negative impact on confidence. The Halifax also recorded a fourth successive monthly decline in house prices and there was a slowdown in the latest NIESR GDP estimate to 0.5% in the three months to October which will maintain fears that the economy is losing momentum again. The Bank of England left interest rates on hold at 0.50% following the latest policy meeting and also decided against increasing the total amount of quantitative easing from GBP375bn. There had been some speculation that further bond purchases could be announced and Sterling did secure a relief rally following the decision with a peak just above 1.6000. Markets will look at the vote split carefully in two weeks time given expectations of a split. The latest inflation report will also be watched closely next week. Swiss franc: There has been some underlying reduction in defensive flows into the Swiss currency, illustrated by the decline in reserves for the first times in 10 months. The underlying Euro-zone situation is still extremely vulnerable and there will be the threat of further defensive capital inflows if fears surrounding Spain and Greece escalate further.  At this stage, the National Bank will have to maintain the Euro minimum level as policy shift would destabilise markets and increase deflation fears. The Euro lost ground against the franc during the week with a further test of support close to 1.2050. The dollar held a firm tone, but was unable to move above 0.95. There was a generally downbeat economic assessment from the ECB which provided some degree of franc support, especially with concerns that Spain would decide not to make a bailout request this year. The National Bank maintained its insistence that the minimum Euro level will be defended aggressively. The latest reserves data recorded a monthly decline for the first time in ten months which suggests that underlying pressure on the Euro minimum level eased substantially during October. Australian dollar The Australian dollar found support in the 1.0350 area against the US dollar during the week and had a slightly firmer tone with a peak above 1.0450 before drifting weaker. There was a more confident tone surrounding the Chinese economy which helped underpin the Australian currency. The Reserve Bank left interest rates on hold at 3.25% at the latest policy meeting, contrary to expectations of a further rate cut which provided some currency support, especially with a solid employment increase for the month. The currency gained some support on speculation over reserve diversification, but there was also some suspicion that the central bank was attempting to steer the currency weaker. The Australian currency will gain some support from a slightly more optimistic tone surrounding the Chinese economy, but gains are likely to be very limited. Canadian dollar: The Canadian dollar initially pushed to highs beyond 0.99 against the US currency, but was unable to sustain the gains and retreated back to test support close to parity later in the week as oil prices were subjected to renewed selling pressure. There was a sharp decline in building permits which undermined confidence and there were also fears that there would be a negative impact on the economy from any renewed weakness in the US economy. The Canadian dollar can prove to be broadly resilient, but there is scope for net losses against the US currency given growth fears and the recent trend in oil prices.