Weekly FX Commentary

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Weekly FX Commentary:

Global central bank and government actions will continue to be extremely important in the short-term with a potentially very important set of events due in September. The ECB will be looking to enact bond buying next month, but there could still be important barriers, especially with political stresses within Germany. There will be major concerns surrounding the Greek outlook and default threat  There will be pressure on the US Federal Reserve to relax policy further with the next FOMC meeting due in September. Dollar: There have been mixed US economic releases over the past week with some relief over the latest retail sales data and a solid housing-sector release offset by weak releases for the latest regional PMI surveys. There will be a further discussion of Federal Reserve policies ahead of the September FOMC meeting and comments from Fed Chairman Bernanke will be watched very closely at the end of August. Risk appetite has held relatively firm and there have been further hopes for quantitative easing which will tend to limit underlying defensive dollar demand. There should still be solid dollar buying support on dips given the underlying global risks. The dollar edged weaker during the week as a whole with a retreat to two-week lows, although ranges were relatively limited. The latest US retail sales data was stronger than expected with a 0.8% increase for July from a revised 0.7% decline the previous month while there was also a core 0.8% increase. Although there was a decline in consumer confidence for the month, the data did lessen speculation over further Federal Reserve quantitative easing to some extent which also helped underpin US yields and provided some net dollar support. The latest US consumer inflation data was weaker than expected with no increase in headline prices while there was a 0.1% increase in core prices to give a 2.1% annual increase. The data will maintain expectations that the Fed will not feel constrained by inflation considerations if it deems further quantitative easing necessary. The latest New York PMI index was substantially weaker than expected at -5.9 for August from 7.4 previously and this was the first negative reading for over 18 months while the Philadelphia Fed index was weaker than expected at -7.1 from -12.9. The other data was more supportive with industrial production rising 0.6% while there was a the strongest NAHB house-building index for five years at 37. Housing starts edged lower, but permits rose to a fresh five-year high of 0.81mn which provided support. Initial jobless claims were little changed at 366,000 from a revised 364,000  The Bloomberg consumer confidence index also dipped to a nine-month low. There have been mixed data releases over the past week and the overall analysis has been that the Federal Reserve is less likely to move to additional quantitative easing in September. Markets, however, seem reluctant to believe this analysis as equity markets maintained a firm tone. Euro Market tensions will remain very high in the short-term with a further period of uncertainty ahead of key events during September. There will continue to be some degree of optimism surrounding potential bond purchases by the ECB, but this will also be offset by underlying uncertainty surrounding the potential constraints imposed by the German government and by the Constitutional Court if it imposes conditions on the ESM introduction while any rejection would be a severe Euro setback.  There will also still be important underlying concerns surrounding the Spanish outlook and the need for a sovereign support package. Overall, the Euro will struggle to make significant headway. The Euro was able to edge slightly higher during the week as a whole, although momentum was lacking with no attempt at breaking above the 1.2440 level. There were reports that there could be a further delay to the German Constitutional Court ESM ruling. A new lawsuit had been filed which demanded that a ruling needed to be delayed until another lawsuit had been ruled on in the European Court of Justice. There were slightly better than expected GDP releases from Germany and France, but there was a second-quarter 0.2% contraction for the Euro-zone as a whole which was in line with expectations.  The data maintained unease over both the economy as a whole and the rate of deterioration in the peripheral economies which will increase internal stresses. The German ZEW index weakened for the fifth successive month with a decline to -25.5 for July from -19.6 previously. Spanish Prime Minister Rajoy stated that the government had still not decided whether to request a sovereign bailout as it needed further details on conditions which would be attached. There were indications that the German Constitutional Court still wanted to make its ESM ruling on September 12th despite the other lawsuits being submitted, although the situation could change rapidly. There was a significant decline in Spanish bond yields during the day with 10-year yields declining to a 1-month low which helped underpin Euro sentiment, especially with advances for European equity markets. German Chancellor Merkel repeated that all measures would be taken to protect the Euro and also reinforced the necessity of conditionality. These comments maintained pressure on the Spanish government to apply for EFSF support which would be one condition before the ECB could consider buying bonds. There were still very important underlying political stresses and unease surrounding the Greek situation with Prime Minister Samaras due to meet Euro-zone leaders over the next few days in an attempt to secure easier loan terms and further financing. Yen:  There has been a shift in relative yields over the past week with rising yields important in providing initial dollar support.  The possibility of further monetary easing in the US and Euro-zone will still tend to underpin the yen in the short-term. The Japanese currency will also continue to gain underlying support from unease surrounding the regional economy and a lack of growth in the global economy.  The Bank of Japan will continue to be an important focus in the short-term and there will be pressure for the central bank to relax monetary policy further to help support competitiveness.   There was net dollar support from a further significant rise in US Treasury yields which helped underpin the dollar.  The relationship between the dollar/yen rate and US yields remains very important and there will be reduced interest in yen buying if US yields remain higher with the dollar pushing to one-month highs above 79.50. There will be further concerns surrounding the regional economy and pressure for China to maintain competitiveness which will also maintain pressure for the Bank of Japan to resist any yen gains. There will still be an increase in exporter selling as the dollar rises, especially if it moves towards the 80 level. Sterling There will be further concerns surrounding the UK economic outlook with fears over further short-term weakness. There will also be an important element of uncertainty, especially as there has been conflicting evidence from recent economic data. There will be net expectations that the Bank of England will move to additional quantitative easing within the next few months. Evidence of a domestic rebound would provide some degree of support for Sterling, but it will be difficult to make much headway, especially as defensive demand as an alternative to the Euro-zone is liable to be weaker. Sterling was able to secure an advance against the dollar with a peak in the 1.5750 area while Sterling pushed to two-week highs beyond 0.7850 against the Euro. The latest inflation reading was significantly higher than expected with an increase to 2.6% from 2.4%, contrary to expectations of a further decline. There was also a higher than expected reading for core inflation as there was less discounting than normal for the month as prices had already been cut to boost demand. The latest labour-market data was stronger than expected with a 5,900 decline in the claimant count for July following a revised 1,000 increase the previous month and the ILO unemployment rate also declined to 8.0% from 8.1% as employment was boosted ahead of the Olympics. There were concerns that unemployment would increase again once the games had finished which dampened the impact. The Bank of England minutes from August recorded unanimous votes to keep interest rates and the amount of quantitative easing on hold at the meeting. The majority of members were content to assess the impact of previously-announced bond purchases, although a minority did consider further action at this meeting. The headline retail sales report was stronger than expected with a 0.3% gain for July while there was a significant upward revision to the previous month’s data to 0.8%. Sterling continued to gain net support from buying support on the crosses as the Euro retreated to two-week lows near 0.7810 before a tentative rebound. Swiss franc: There will be further concerns over potential deflation within the economy and there will be continuing pressure on the National Bank to maintain the minimum Euro level. There will still be important uncertainties surrounding the policy, especially if the bank has to maintain or increase very high intervention levels as this would be an important medium-term source of instability. For now, the bank is likely to maintain a determined stance, but there will still be medium-term uncertainties, especially if Euro-zone fears intensify. The dollar retreated to lows around 0.97 against the franc during the week with the Euro trapped close to the 1.2010 area. There was a slightly weaker than expected reading for producer prices with a 0.3% decline for the month and an annual 1.8% fall. The data will maintain expectations that the National Bank will continue to maintain the minimum Euro level to stave-off the deflation threat, although wider Euro-zone political and economic pressures are likely to dominate Swiss franc trends and policies. Rumours that the National Bank was diversifying its Euro holdings increased speculation that the bank was still being forced to intervene aggressively to prevent the Euro weakening.  Australian dollar The Australian dollar hit resistance close to 1.06 against the US currency during the week and retreated to lows towards 1.0450 where solid buying support did emerge. Domestically, a decline in consumer confidence was offset by a rise in business confidence and the overall impact was limited as global trends tended to dominate. Although there were further concerns surrounding the regional economic outlook, commodity prices were generally firm which helped curb selling pressure. The Australian dollar will find it difficult to advance significantly, especially given the decline in key commodity export prices and regional growth fears. Canadian dollar: The Canadian dollar maintained a robust tone against the US currency during the week and challenged levels beyond 0.99 against the US currency. The currency was boosted by a rise in oil prices during the week. The domestic influences were limited with net reported capital outflows following substantial inflows the previous month. Concerns surrounding the global economy will tend to limit scope for further significant Canadian dollar gains even if a near-term robust tone is sustained.