Weekly FX Market Analysis: Concerns surrounding the Euro-zone economic outlook

Weekly Market analysis

There will also be further concerns surrounding the Euro-zone economic outlook, especially with downbeat ECB forecasts and peripheral economies still trapped in recession. The banking sector will also be an important focus with continuing fears surrounding the threat of de-leveraging. The ECB discussion of negative deposit rates will have an important impact in unsettling the Euro. The dollar will still find it difficult to gain strong support given expectations of further Fed quantitative easing. Key events for the forthcoming week Date Time (GMT) Data release/event Tuesday December 11th 10.00 German ZEW index Wednesday December 12th 17.30 US FOMC interest rate decision Thursday December 13th 13.30 US retail sales Dollar: There have certainly been mixed US growth indicators and there are concerns over a potential slowdown, but there will be expectations that the US will out-perform.  Both fiscal and monetary policies will remain an acute focus in the short-term. Negotiations surrounding the fiscal cliff will continue in the short-term with still little progress in talks between Congress and the Administration. If there is no progress within the next three weeks, sentiment could deteriorate sharply. There will be speculation that the Federal Reserve will announce additional bond buying plans next week to offset the ending of Operation Twist. The dollar should still prove broadly resilient, but struggling to gain strongly. The dollar was on the defensive initially, but did regain ground later in the week as European currencies were subjected to renewed selling pressure. The latest US ISM index recorded a 2012 low with a decline to 49.5 from 51.7 the previous month as the employment index also dipped to below the 50 level for the first time in three years. There was a slight deterioration in risk appetite following the release, although the impact was limited by a monthly gain in the US PMI index produced by Markit which triggered uncertainty surrounding the situation. There were fresh proposals on the US budget talks from both the President and House Republicans, although there was no evidence of significant progress at this stage with brinkmanship ahead of the year-end deadline still a notable feature. There was a weaker than expected ADP employment reading of 118,000 for November following a revised 157,000 gain the previous month.  There was a stronger than expected ISM services-sector reading of 54.7 from 54.2 previously.  There was, however, some disappointment surrounding the employment sector with a decline to 50.3 from 54.9 previously and there was caution ahead of Friday’s payroll release with a weaker headline figure expected. Euro There will be further relief surrounding the Greek Euro-zone package, especially if a successful debt buy-back programme can be implemented. There will still be a high degree of unease surrounding underlying trends as the peripheral economies remain trapped in recession.  There will be speculation that the ECB will sanction a further cut in interest rates and introduce negative deposit rates which would reinforce the Euro-zone underperformance in growth terms.  There is also still the risk that sovereign fears will intensify again. In this environment, the Euro will find it difficult to make much headway.  After advancing early in the week, the Euro was subjected to renewed selling pressure. There were better than expected terms for the planned Greek debt buyback which helped underpin sentiment. There was also a slightly more robust tone to Euro-zone sentiment and peripheral bond yields declined. There were some concerns surrounding the Spanish outlook with expectations that the 2012 budget target would be missed, but there was a slightly more confident tone surrounding the banks. There was some relief surrounding the Euro-zone PMI services-sector with a final reading of 46.7 from a flash 45.7, even though there was a further deterioration in the Italian reading. In contrast, there was a weaker than expected reading for Euro-zone retail sales with a monthly decline of 1.2% decline with an annual decline of over 3% which reinforced fears surrounding the spending and wider growth outlook. There was little change in yields at the latest Spanish auction, but total issuance was slightly lower than expected which suggested that demand was fading and there was a significant increase in yields following the auction.  There were reported comments from government officials suggesting that Spain would apply for sovereign bailout if there was a guarantee on yields, something which will be resisted strongly by the ECB which had some impact in unsettling the Euro. Italian political stresses as Berlusconi’s PD party did not support the government in the Senate vote on growth measures. Although the bill was approved, there were fears over renewed political instability and an early election as Berlusconi withdrew support from the government. There was a renewed decline in German bond yields. As expected, the ECB left interest rates at 0.75% at the latest Council meeting. There was a downgrading of growth and inflation forecasts at the meting with the 2013 GDP estimates for example cut to a range of -0.9% to +0.3% which suggested that greater risk of contraction than growth for the year. In the press conference, Draghi stated that there had been a wide discussion of interest rates, but with no decision which suggested that several members had pushed for a cut at this meeting. This reinforced speculation that rates could be cut early next year and a remark that the ECB was operationally prepared for negative deposit rates was particularly important in undermining the Euro. The comments reinforced fears surrounding the economic outlook and potential for lower interest rates which both sapped currency support. Yen:  There will be further concerns surrounding the Japanese economy.  The LDP, continues to hold an opinion-poll lead ahead of the December 16th General Election, maintaining expectations that there will be a much more aggressive monetary policy and potential changes to the Bank of Japan mandate next year. These expectations will undermine the yen, but there will still be the threat of political deadlock which could delay action. The yen will also gain defensive support at times when risk appetite deteriorates. The yen was subjected to solid selling pressure on any significant gains as underlying yen sentiment remained weak with the dollar finding support below 82. There was caution over selling the Japanese currency further, especially in view of the substantial build up in short speculative positions seen over the past few weeks. There was also a reluctance to commit funds ahead of an extremely uncertain election later this month, especially as parliament is liable to be increasingly fragmented. Underlying yen sentiment also remained weak amid expectations that the Bank of Japan would take a more aggressive stance on monetary policy either by its own volition or due to enhanced government pressure. The latest opinion polls suggested that the LDP would be  able to secure a majority in the lower house following the December 16th election which maintained expectations of a weaker yen. Sterling There will be further doubts surrounding the UK economic outlook, especially with the OBR announcing a further significant downgrading of forecasts. The outlook for weak growth will also increase unease surrounding the debt outlook with the government admitting that targets will no longer be met. In this environment, there will unease over the threat of a downgrading to the AAA credit rating and there will also be intense pressure on the Bank of England to maintain a very aggressive monetary policy. This combination is unlikely to provide strong Sterling support. Sterling moved to test resistance levels above 1.61 against the dollar before losing ground later in the week even though it recovered losses against the Euro. There was a decline to 49.3 for the November manufacturing index from 50.9 previously, the fourth month of contraction seen during the second half of 2012. There was a weaker than expected reading for the UK PMI services-sector index of 50.2 from 50.6 previously which was the lowest reading since January 2011 as orders declined for the first time in close to two years. The government Autumn Statement was broadly in line with expectations as the GDP forecast was cut to -0.1% for 2012 with a 2013 forecast of 1.2% compared with the previous 2.0% with a downgrade of medium-term expectations. Given weaker growth, the Chancellor warned that the government’s debt targets would not be met with the debt/GDP ratio not peaking until 2015/16.  Fitch warned that the peak debt expectations were close to the limit for an AAA rating which will reinforce expectations of a 2013 downgrade. Although there was a substantial debate over the potential impact of any rating cut, there was an underlying mood of caution. The latest UK trade account data was weaker than expected with a goods deficit of GBP9.5bn from GBP8.4bn the previous month as exports were generally disappointing which had some negative impact on sentiment. There were no surprises with from the Bank of England with interest rates and quantitative easing on hold. Swiss franc: The National Bank will remain strongly committed to maintaining the 1.20 minimum Euro level in the short-term, especially with competitiveness still a very important issue, illustrated by the decline in consumer prices for November. There will be the potential for further inflows into the Swiss currency if there are further stresses within the Euro-zone.  Overall, the central bank should be able to hold the line in the short-term. The Euro advanced to an 11-week high just above the 1.2140 area against the franc on reports that the negative interest rates imposed by Credit Suisse and UBS on large-scale foreign deposits could be as much as 1%.  There was uncertainty surrounding the move with Credit Suisse suggesting a variable rate was likely. There was still important uncertainty surrounding the underlying Euro-zone outlook and yields on Swiss Treasury bills remained below zero which still suggested firm underlying defensive demand for the currency. There was a 0.3% decline in consumer prices for November compared with expectations of no change which reinforced unease surrounding the deflation threat and will also maintain pressure for franc gains to be resisted with the National Bank. The Euro retreated back to below 1.21 while the dollar found support close to 0.9250. Australian dollar The Australian dollar proved resilient on dips and tested resistance levels around 1.05 against the US currency. The Reserve Bank of Australia decision to cut interest rates by a further 0.25% to 3.00% had been priced in and dip not trigger additional selling. There was greater optimism surrounding the Chinese economy. There was also a stronger than expected labour-market report with employment increasing by over 12,000 which helped underpin confidence. There were still generally cautious remarks from Reserve Bank officials on the state of demand within the economy and the trade deficit widened to a four-year high. The Australian dollar has proved to be broadly resilient, but will find it difficult to make significant headway given the net global and domestic risk profile. Canadian dollar: The Canadian dollar was able to resist any further test of support beyond parity against the US currency and again tested resistance around the 0.99 level. As expected, the Bank of Canada held interest rates at 1.0% following the latest council meeting. The bank also resisted any significant shift to a more dovish tone on future policy which helped support the Canadian currency. Even with near-term resilience, the Canadian dollar is likely to weaken gradually, especially with growing unease surrounding the global growth outlook.