Weekly FX Commentary

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Weekly FX Commentary:

There has been a slightly more optimistic tone surrounding the US and Chinese economies with greater confidence that a hard landing can be averted. There will still be an important element of caution, especially with important fears surrounding the Euro-zone economy as peripheral recession continues. In this environment, risk appetite could deteriorate rapidly which would provide defensive dollar support.

Key events for the forthcoming week

Date	Time (GMT)	Data release/event
Tuesday October 30th		Bank of Japan interest rate decision
Thursday November 1st	09.30	UK PMI index (manufacturing)
Friday November 2nd	12.30	US unemployment report

Dollar:

The US economic releases have maintained a generally mixed tone with slightly more optimistic consumer spending data still offset by investment doubts. The Federal Reserve remains committed to a highly-expansionary monetary policy with continued mortgage-backed securities buying and this will limit US dollar support on yield grounds even though Treasury bond yields are at a five-week high. There will also be caution ahead of the presidential election given uncertainties surrounding trade and fiscal polices. The global growth outlook will remain extremely important and the dollar should still be able to secure some support on defensive grounds. 

The dollar was able to find support during the second half of the week as the Euro failed to hold gains. US corporate earnings reports were generally weaker than expected which had a significant impact in curbing risk appetite and provided some defensive dollar support while Euro-zone uncertainties persisted.

The Federal Reserve left policy unchanged at the latest FOMC meeting with a continuing pledge to buy mortgage-backed securities until the labour-market improves substantially. There was a slightly more optimistic tone surrounding consumer spending and the housing sector, but there were still concerns surrounding unemployment. There was an 11-1 vote as Lacker dissented as the Fed still expected rate to be kept at exceptionally low levels until at least 2015.

The latest US jobless clams data was better than expected with a decline to 369,000 from a revised 391,000 the previous week which maintained expectations that the labour market was broadly stable.

The headline durable goods orders data was also stronger than expected with a 9.9% increase for September following a revised 13.1% decline the previous month while there was a 2.0% core increase. Excluding transport and defence distortions, the evidence suggested no significant improvement in orders.

There were some rumours surrounding a US rating downgrade by Fitch, but the agency was quick to remind markets that it was not expecting any change this year.

Euro

Economic and political headlines remain slightly calmer which has help ease underlying selling pressure on the Euro with a stabilisation for example in bank deposits. There are still major concerns surrounding the economic outlook given fresh deterioration in PMI indicators and the underlying situation remains extremely tense as conditions within peripheral economies continue to deteriorate. There will be some relief if Spain does decide to request a bailout, but the underlying economic trends are unlikely to support the Euro for long and much more serious destabilisation remains an important risk, especially with the intractable Greek debt situation. After initial gains, the Euro was hampered by a lack of definitive progress and retreated over the second half of the week and it failed to hold above 1.30. There was further initial relief surrounding the election in Spanish region Galicia as the PP held a majority. The victory bolstered sentiment surrounding the party at a national level and there was also some speculation over increased support for austerity measures.  There were also expectations that the election outcome would move Spain closer to requesting a bailout, although there were no moves by the government. Moody’s downgraded five Spanish regions which did not have a major impact. There were further concerns surrounding the economy which reinforced the urgency of the situation as the Bank of Spain stated that GDP probably fell 0.4% for the third quarter, the same contraction as for the previous three months. There were also further concerns that 2012 budget targets would be missed due to the impact of recession and benchmark bond yields rose during the week. There was a renewed downturn in the German PMI indices with the manufacturing index weakening to 45.7 from 47.4 and the overall Euro-zone index fell to 45.3 from 46.1 which offset a marginal improvement in the services sector and pushed the composite index to a 40-month low. There was also a weaker than expected reading for the German IFO index with a slide to 100 for October from 101.4 which was the sixth successive decline. Although the readings are not extreme in historic terms, there were concerns that dark clouds were gathering in the Germany economy. There were also fears that weakness in Germany would make it even more difficult for the peripheral economies to secure any recovery which would certainly increase pressure on the Spanish economy. There was further uncertainty Greece following announcements and denials on Wednesday. The Greek government confirmed that it had not secured a two-year extension for the budget programme and there was still resistance to required troika labour-market demands by the Democratic Left coalition party. There will be fears that an agreement could still prove to be elusive and there will also be fears that the Greek government will effectively attempt to blackmail the Euro-zone and IMF into providing additional support even if the government fails to agree reform measures. There were also reports that Greece could need additional funding of around EUR30bn which would cause major friction within the core Euro-zone countries and uncertainty will tend to undermine sentiment. Yen: The dollar will gain initial support from higher US Treasury yields. There will be pressure on the Bank of Japan to announce additional stimulus measures at the forthcoming monetary meeting and, even if they resist this time, the underlying pressures will continue. There will also be speculation that any new government will also announce additional measures to underpin growth and weaken the Japanese currency. The fundamental outlook remains weak, but if risk appetite deteriorates, the yen will still gain some degree of defensive support.  The dollar pushed higher against the yen with four-month highs above the 80 level as the yen was generally on the defensive. There was a battle between speculative dollar buying by hedge funds and selling by Japanese exporters with the dollar buyers generally gaining the upper hand. There was further speculation that the Bank of Japan would introduce further monetary easing measures at next week’s policy meeting as the government maintained pressure on the central bank for further action. The dollar hit resistance in the 80.30 area against the yen on Thursday and dipped to lows just below the 80 level early in the US session with the economic releases providing no significant support. Despite mixed data, US Treasury yields did hit a five-week high which helped cushion the dollar.

Sterling

The stronger than expected UK third-quarter GDP data will underpin near-term sentiment and will also dampen expectations that the Bank of England will announce further quantitative easing at the November monetary meeting.  There will still be concerns over the underlying outlook given that there was an artificial boost from the Olympics and there will also be concerns over the impact of a weak Euro-zone economy.  In this context, confidence could deteriorate rapidly. Sterling trends will also be influenced by underlying trends in risk appetite and weaker confidence would be a negative factor. Sterling recovered from a low below the 1.60 level against the US dollar during the week and gained some support from greater confidence in the economy in choppy trading with gains towards 0.8000 against the Euro.   The third-quarter GDP reading was stronger than expected with a 1.0% gain which was the strongest figure for five years. There was a recovery following the second-quarter holiday-related dip and there was also a boost from Olympic ticket sales with expectations that underlying growth was below 0.5%. The data did, however, dampen expectations that the Bank of England would move to sanction additional quantitative easing at the November MPC meeting which had an important impact in supporting the UK currency. The latest CBI industrial orders data was weaker than expected with a slide to -23 from -8 previously which maintained concerns over the impact of weak Euro-zone demand, although the underlying components were more favourable Swiss franc: There has been some underlying reduction in defensive flows into the Swiss currency as expectations of a Spanish aid request have eased immediate fears surrounding the Euro-zone. There are still very important stresses within the Euro area and there is still demand for Swiss bills at negative interest rates which indicates a high degree of market caution and pressure on the minimum Euro level could intensify again quickly. The dollar found support in the 0.92 area against the franc during the week and pushed back to the 0.9350 area as the Euro stabilised around the 1.21 area. The weaker than expected Euro-zone economic data increased fears that there would be further economic stresses surrounding the Euro while political tensions surrounding Greece also increased. This combination could also trigger a fresh flow of funds into the Swiss currency.

Australian dollar

The Australian dollar found support in the 1.0250 area and pushed higher later in the week, although gains were still relatively modest with resistance near 1.04 against the US currency. There was a stronger than expected headline inflation reading of 1.4% for the third quarter which served to dampen expectations of a further Reserve Bank interest rate cut at the November meeting. There was also some revival in optimism towards the Chinese economic outlook which also helped support the Australian currency. There was still a generally cautious outlook given stresses within the Euro-zone. Although there has been a slightly more optimistic tone towards the global economy, the Australian dollar will find it very hard to make much headway Canadian dollar: The Canadian dollar was subjected to net selling pressure during the week and did retreat to lows beyond 0.9950 against the US currency. Oil prices were generally weaker which curbed buying support for the local currency. The Bank of Canada left interest rates on hold at 1.0% and, although there was a more hawkish than expected statement, the central bank monetary policy outlook overall suggested that the possibility of an interest rate increase had declined which sapped support, although the impact was measured given very loose policy elsewhere. It will be difficult for the Canadian dollar to make significant gains given persistent global growth doubts, especially with a slightly more cautious central bank tone.