| Weekly Market analysis | ||||||||||||
| There has been an important easing of immediate fears surrounding the Euro-zone as financial risks have eased, at least for now. There will be some optimism surrounding risk appetite, although confidence could still prove to be very fragile, especially given important structural vulnerability. There will also be further concerns surrounding the US debt-limit negotiations over the next few weeks. Key events for the forthcoming week
Dollar: The US economic indicators have been mixed, but have generally indicated solid growth, especially with a further decline in jobless claims. The Federal Reserve has continued to emphasise the importance of unemployment to its policy decisions and will continue bond purchases in the short-term. If growth continues to improve, there will be pressure for at least a modest slowdown in quantitative easing and rising bond yields would also provide some net dollar support. The US currency could gain on defensive demand if debt-ceiling talks create renewed animosity, although there would also be potentially important implications for the US credit rating. The dollar was resilient against most currencies during the week, although it did decline to lows around 1.34 against the Euro. The US retail sales data was slightly stronger than expected with a 0.5% headline increase for December and a core increase of 0.3% while there was also a generally optimistic tone surrounding the housing sector. The New York PMI index was much weaker than expected at -7.8, although this is an erratic data series. Regional Fed Governor Rosengren stated that there could be policy tightening if the unemployment rate fell to 6.5%. Ratings agency Fitch stated that the US would be subjected to a formal ratings view for a potential downgrade if there was no agreement to raise the debt ceiling and political comments will remain under close scrutiny. The inflation data was marginally lower than expected with a headline decline in prices of -0.1% which will maintain the scope for the Federal Reserve to maintain an expansionary policy. The Beige Book release was also broadly in line with recent reports with growth described as modest or moderate in all the Fed districts. Housing starts increased to a fresh four-year high of 954,000 for December. There was also a sharp decline in jobless claims in the latest week with a reading of 335,000 the lowest for five years. In contrast, the Philadelphia Fed index was sharply weaker than expected at -5.8 from +5.8 the previous month. The data overall helped maintain a confident tone surrounding the economy and there was a rise in US Treasury bond yields. The dollar failed to secure much in the way of support, especially with German yields also increasing during the day which prevented an improvement in yield spreads. Fed Chairman Bernanke’s comments surrounding the economy were broadly neutral as he insisted that the Fed was not out of policy options even with interest rates close to zero. He stated that growth was showing some signs of improvement with quantitative easing having a positive impact, although it was described as early days. He promised that the bond-purchase programme would be reviewed on a regular basis while he did not expect inflation to be a significant issue as he kept all options open. |
| Euro |
Structural fears surrounding the Euro-zone will remain lower in the short-term. There has been a continuing easing of peripheral bond yields with investor sentiment also improving which could trigger renewed capital inflows. The ECB is much less willing to consider a further cut in interest rates which will provide some Euro support. Growth concerns will, however, remain a very important focus and the drop in financing costs will also deter political action on structural reform. In this environment, confidence could quickly deteriorate again, especially if political tensions intensify. The Euro maintained a strong tone during the week, although the bulk of the gains were on the main crosses as the US currency was relatively resilient. The currency was cushioned buy a sharp decline in bond yields at the latest Spanish Treasury bill auction. Prime Minister Rajoy stated that Spain would not need a bailout and was confident that the banking sector would not need additional funds. Outgoing Eurogroup head Juncker stated that the Euro was dangerously high. Euro-zone officials have generally stayed quiet on currency issues over the past few months and the Juncker comments will be taken as indicating that there is now greater concern surrounding the exchange rate. There will also be some unease that this signals a new phase in potential global currency wars. ECB council member Nowotny stated that there was no cause for concern surrounding the Euro, contradicting Juncker’s comments. Nowotny also stated that he didn’t expect to see a long-term rise in the Euro against the dollar. The ECB remains reluctant to get involved in exchange rates and will certainly not want to get in the business of targeting exchange rates. There will, however, be some speculation that the ECB will be more willing to consider a cut in interest rates if there are significant currency gains, especially as there will be a further deflationary impact. Yen: There will be intense pressure for the Bank of Japan to engage in further aggressive policy easing with widespread expectations that the central bank will introduce a revised 2% inflation target at the forthcoming meeting. There will also be scope for a further monetary easing. Comments from government officials will be watched very closely, but the net stance is likely to be to back further yen losses. Markets have priced in substantial policy easing and there will be scope for a sharp correction, especially if risk appetite deteriorates. The yen briefly corrected strongly during the week before being subjected to renewed heavy selling pressure. There were significant comments from Finance Minister Amari who stated that excessive yen weakness could have a negative impact on the economy by pushing up import prices which suggested that the government would not push for further aggressive yen losses. Later in the week, Finance Minister Amari back-tracked from earlier comments warning against excessive yen depreciation and there will also be market confusion over government intent. There were still widespread expectations of further aggressive Bank of Japan monetary action next week as underlying sentiment remained extremely weak. There were some media reports that the central bank could consider dropping paying interest on excess reserves and would consider an open-ended commitment to bond purchases. The government and Bank of Japan are working on a joint statement and there were also comments from government officials that a rate of 100-110 would be appropriate which triggered a test of yen support beyond the 90 level with fresh 29-month lows. |
| Sterling |
There will be further uncertainty surrounding the UK growth outlook with speculation that there will be a fourth-quarter contraction which will reinforce fears surrounding the government finances. There will also be persistent unease surrounding the threat of a credit-rating downgrade. Sterling has been an important beneficiary of defensive support during the Euro-zone crisis and there will be further suspicions that there will be sustained capital outflows given that Euro-zone fears have eased. Given the underlying lack of confidence in the fundamentals, the UK currency is likely to be subjected to underlying selling. Sterling was firmly on the defensive against the Euro during the week as it retreated to nine-month lows beyond 0.8370. Sterling also retreated to six-week lows below 1.60 against the dollar. There were further concerns surrounding the AAA credit rating with Fitch warning that the downgrade risks were increasing. The headline UK consumer inflation rate was in line with expectations at 2.7% while the core rate edged down to 2.4% from 2.6% and the overall impact was limited with no implications for monetary policy. There was a slightly more optimistic tone surrounding the housing market as the official index recorded a 2.1% increase in the year to November. The latest RICS housing data was stronger than expected with a reading of zero for December from -8% previously which was the first time a negative figure had not been reported since July 2010. The other economic data was generally weaker than expected. There was only a small recovery in industrial production for November as a recovery in energy-sector output was offset by another decline in manufacturing production which reinforced unease surrounding the outlook. The NIESR estimated a 0.3% decline in GDP for the three months to December and there was another weak reading for construction output which reinforced fears surrounding a fourth-quarter GDP contraction. Swiss franc: The Swiss franc was a key beneficiary of defensive inflows during the Euro-zone crisis and there will be further speculation that there will be a sharp reduction in defensive inflows. There will be scope for a reversal in speculative capital inflows which could trigger fresh selling on the Swiss currency. There will, however, be the potential for a reversal in trends if Euro-zone fears intensify again. The Swiss currencycould also still gain support as an alternative save-haven asset, especially with the Japanese yen weakening sharply. The Swiss franc weakened sharply during the week with very sharp losses to beyond 1.25 against the Euro. The dollar was able to take advantage of the franc vulnerability and pushed to a peak near the 0.94 level. There was a decline in defensive demand for the franc given reduced fears surrounding the Euro-zone structural vulnerability. There was a rise in yields on the latest Swiss Treasury bill auction which suggested that defensive franc support had eased and there was also a shift in risk reversals which indicated that underlying Swiss currency demand had fallen. The latest retail sales data recorded a 2.9% annual increase in the year to December which did not have a significant impact. There was a 0.2% decline in consumer prices for December to give a 0.4% annual decline which will reinforce potential deflation fears and a determination to prevent franc gains |
| Australian dollar |
The Australian dollar was unable to break above the 1.06 area and weakened to lows just below the 1.05 level before consolidating in the middle of the range. The currency was unsettled by a weaker than expected labour-market report as there was a decline in employment fell by over 5,000 while the unemployment rate rose to 5.4%. The other data also provided little in the way of support The currency was still cushioned by a generally solid tone towards risk appetite and a lack of interest in the US currency. Despite some support from greater optimism surrounding China, the Australian dollar is unlikely to make much headway, especially with further rate-cut expectations. Canadian dollar: The US dollar was unable to push above the 0.99 level against the Canadian currency during the week before re-testing support below 0.9850, although the main feature was generally very narrow ranges. There was a recovery in gold and oil prices which provided some degree of support for the Canadian currency. Relatively narrow ranges are liable to continue for now with the US currency broadly resilient on valuation grounds despite optimism surrounding Canadian fundamentals. |
