Weekly FX Commentary

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Weekly FX Commentary:

	Risk appetite will tend to remain stronger in the short-term with relief surrounding the ECB bond-buying plans and the German Constitutional Court ruling compounded by support from the additional Federal Reserve quantitative easing. Confidence surrounding the global economy could still deteriorate very quickly, especially given unease surrounding the Chinese outlook and geo-political risks.

Dollar: The Federal Reserve action to announce a further round of quantitative easing will continue to undermine the dollar in the short term, especially with the Fed taking an aggressive stance and promising further action if necessary. The US currency will be vulnerable on yield grounds and an improvement in risk appetite would also tend to curb dollar demand. There will be some optimism that positive action will help underpin the economy which would potentially attract growth-related capital inflows.  The global growth and geo-political situation will also be watched very closely in the short-term which will provide some underlying protection to the US currency given global fears. The dollar was unable to make any significant headway during the week and weakened sharply following the Federal Reserve policy meeting with the Euro pushing to four-month highs against the US currency. The US trade deficit was little changed at US$42.0bn for July from US$41.9bn the previous month as trade volumes edged lower. There was a particular sharp decline in exports to the EU, reinforcing fears over weak Euro-zone demand. The data was overshadowed to a large extent by comments from Moody’s that the US could lose its AAA rating unless there was an improvement in the US fiscal situation next year. There were also further expectations that the Federal Reserve would push towards additional quantitative easing at Thursday’s policy meeting which kept the dollar firmly on the defensive. The Federal Reserve meeting was inevitably the main market focus with expectations that there would be further quantitative easing. In the statement, the Fed announced that further bond purchases would be introduced with US$40bn monthly purchases of mortgage-backed securities in addition to the continuation of Operation Twist. The Fed emphasised the importance of the labour market and pledged to maintain an aggressive monetary stance until there was a sustained improvement in conditions. The Fed also indicated that it would take further action if there was no improvement in the labour market with a generally dovish tone. Lacker dissented against the decision as he opposed additional measures and the revised guidance on the time frame for low interest rates. There was a downgrading of 2012 growth forecast and the Fed also committed to maintaining ultra-low interest rates until at least the middle of 2015 compared with the end of 2014 previously. Euro Immediate Euro sentiment will remain stronger following the ECB decision to propose peripheral bond buying. There will also be relief surrounding the German Constitutional Court ruling which will allow the ESM to come into operation.  There will still be some doubts whether the ECB bond-buying plan will be effective, especially as there could still be legal challenges. There is also the risk that Spain will not co-operate with the plans and try not to apply for a support package given unease over the political ramifications. Underlying stresses and a lack of growth will also limit scope for Euro gains. The Euro secured further gains during the week as underlying sentiment improved and it pushed higher against major currencies. The German Constitutional Court stated that the ESM decision would go ahead as planned on Wednesday which provided some degree of Euro relief. There were also expectations that the Court would not block the ESM and fiscal compacts. There were further uncertainties surrounding the Spanish situation with speculation that Catalonia would push towards full independence. There were also still fears that Spain would continue to stall on seeking a bailout which could undermine the ECB bond-buying programme. There were further reports that France was putting pressure on Prime Minister Rajoy to accept a bailout while the government still held firm in its determination to avoid an early decision. The official German Court decision was for the ESM to be approved with conditions. The principal condition was that German contributions of more than EUR190bn would need to be approved in the Bundestag. There was an important sense of relief following the decision which boosted the Euro. There were, however, some reservations over the conditions, especially as there could be important stresses if the ESM and a lack of firepower if the Euro comes under heavy pressure in the future. There were also concerns over potential action against the ECB bond-buying plans Yen:  The Federal Reserve action to sanction additional quantitative easing will tend to underpin the yen in the short-term as relative yields improve, especially with expectations of further ECB action.  There will be additional pressure on the Bank of Japan to take additional action and there will also be an increased risk of intervention given fears surrounding competitiveness.  The yen will gain protection if global growth fears fail to ease significantly, but it will be difficult for the currency to make further gains given intervention pressures.   The dollar weakened during the week as it retreated to 7-month lows close to 77 before a slightly recovery. Finance Minister Azumi stepping-up the rhetoric against a strong yen and stating that it was ready to act The dollar spiked lower following the US Federal Reserve decision before finding support and rallying. Strong gains for equity markets dampened any underlying yen buying support. There was an increase in Japanese rhetoric against a stronger yen with warnings that further measures could be taken There will also be increased pressure for the Bank of Japan to take additional measures to boost the economy and weaken the yen. Pressures on the central bank were illustrated by the government’s downgrading of its economic assessment. Markets will remain on high alert over potential intervention Sterling There will be further important concerns surrounding the UK economic outlook, especially with the housing-market remaining under stress. The relative yield outlook has, however, been improved by the Federal Reserve move to additional quantitative easing, especially with expectations of further ECB action.  Sterling may also be able to gain support from hopes of an improvement in the global growth outlook. Given the weak underlying fundamentals it will still be difficult for Sterling to make much headway, especially if there is a credit-rating cut. Sterling continued to push higher against the dollar with highs close to 1.62 against the US currency while the UK currency lost some ground against the Euro with lows beyond 0.80. The UK trade account was stronger than expected with a decline to GBP7.1bn for July from GBP10.1bn the previous month as exports recovered ground which provided some degree of relief. New MPC member McCafferty stated that he would need for evidence before deciding whether there would be justification for any further quantitative easing at forthcoming meetings. Similarly, Dale also stated that he had an open-minded approach to further quantitative easing. The headline employment data was stronger than expected with a decline of 15,000 for August following a revised decline of 13,600  the previous month. There was, however, an increase in the unemployment rate to 8.1% and the jobless decline was triggered to a large extent by gains in part-time employment. Although underlying sentiment towards the economy remains very cautious there has been some support from optimism that Euro-zone conditions could improve. MPC member Broadbent stated that higher than expected inflation could be significant in limiting the scope for further monetary relaxation. Swiss franc: There will be some easing of pressure on the Euro minimum level against the franc given the sense of relief surrounding the Euro-zone outlook.  Deflation fears may also ease slightly, but this is liable to reflect stronger energy prices rather than any improvement in the growth outlook. In this environment, the National Bank will continue to enforce the minimum Euro level in the short-term.  If there is renewed Euro selling on fears of currency debasement elsewhere, the bank may still have to consider some form of capital controls. The dollar weakened against the franc with lows near 0.93 while there were net franc losses against the Euro as overall Euro pressures eased The Swiss National Bank held interest rates unchanged in the 0.00-0.25% band following the latest policy meeting and there was no change to the minimum Euro level. Bank Chairman Jordan stated that there was no alternative to the minimum level even though pressure on the Euro had eased. A generally stronger Euro will tend to increase the bank’s resistance to franc gains on competitiveness grounds even though a stronger than expected producer prices reading could ease deflation fears. The dollar hit resistance above the 0.94 level and dipped to lows below 0.9350 as moves were cushioned by an advance in the Euro to above the 1.2150 level. Australian dollar The Australian dollar was able to resist renewed downward pressure during the week and pushed sharply higher to a peak towards the 1.06 against the US dollar. Although the currency was undermined by unease surrounding the domestic and global growth outlook, these fears were offset by a generally weaker US currency. The latest Federal Reserve move to boost quantitative easing also had an important impact in undermining the US currency as equity markets rose strongly following the decision. There were also hopes that the Chinese government would be able to boost the economy through fresh stimulus measures. Despite Fed action, unease surrounding the regional economy and weakness in key commodity prices is likely to curb any strong recovery in the Australian dollar. Canadian dollar: The Canadian dollar maintained a firm tone over the week with only limited corrections weaker and gains to a fresh 3-month high beyond 0.97 following the Fed meeting as the US currency remained firmly on the defensive. There was underlying confidence surrounding the domestic fundamentals and the currency gained support following the latest Federal Reserve decision to boost quantitative easing, especially with fresh gains for commodity prices following the decision while Middle East tensions helped underpin oil prices. Even with high oil prices and a weak US currency, it will be difficult for the Canadian dollar to make much further headway given persistent global growth doubts.