Forex Weekly

FX Weekly Review-30th August-5th September 2010
By George Tchetvertakov, Head of Market Research

•Mixed macro data from the G20 led to mixed price action in most currency pairs

•A broadly risk-neutral week included several positive surprises to appease the recovery skeptics. Double-dip fears in the US eased away from the brink with additional Fed easing now more likely to be delayed further

•Swisse strength once again making the headlines as EUR/CHF tested fresh record lows – central bank intervention speculation in the G20 is not purely JPY related anymore as market rumors of fresh SNB action begin to surface

•Sterling pairs took a hit, as macro data disappointed and growing fears of QE expansion began to feed through into intra-day price action. A higher probability of additional Fed easing is spurring investors into pricing in a higher likelihood of the BoE following suit

•Commodity currencies performed well with best gains coming against the US Dollar but closed the week only marginally higher in non-US crosses

USD
The US Dollar suffered substantially amidst prevailing uncertainty and growing fears that the US economy will continue to languish in an anaemic state at best with a worst case scenario of another downturn still not conclusively ruled out. Last week provided a mountain of US data – most of which met expectations but several key indicators did manage to underline the fragility, not only of the US recovery but also of the US economy in general because of the dependence on service sector activity.

Housing is showing mixed signs of recovery - pending home sales (5.2% vs. -1.3% exp.) figures from the US reassured the recovery naysayers and tempered the deterioration in confidence surrounding the US/global recovery. US Existing home sales (3.83m vs. 4.68m exp.), released the previous week, were much weaker than expected, heightening fears of ongoing consumer sclerosis as individuals continue to show signs of retrenching, deleveraging and paying down debt rather than making large purchases or investments. The 27% fall in existing homes sales has been widely attributed to foreclosures and limited job growth – both significant, depressive impacts on the US housing market.

The US labour market was again at the heart of FX market speculation as two key employment reports were released last week. The first week of each month usually contains US labour market statistics which are anticipated intently by market participants. Last week’s numbers were fairly negative because the much awaited bounce in overall hiring was missing, but on the other hand, the recovery in private sector jobs growth (+67k) seems to be continuing. The ADP report, released on Wednesday (-10k vs. 20k exp.) is often viewed as a prelude to the key non-farms report on Friday and given the negative print, speculators were expecting a weak number on Friday. However, the non-farm report (-54k vs. -101k exp.) surprised to the upside and helped the Dollar recover significant ground against the Yen. More importantly, the sturdy print helped to push back double-dip fears in the US. In our view, the latest US labour market figures are inconsistent with an assumption that a sharp slowdown is under way. However, gains made following the employment report were largely given back as a disappointing ISM survey (51.5 vs. 53.6 exp.) closed out a week of topsy-turvy macro data, which more than anything, indicates that the US continues to struggle with finding a solid platform for future growth.

Overall, this report insinuates a slowdown in manufacturing in August. Although the service sector gain goes someway to offsetting this, the likelihood of the US being more reliant of service industries to fuel its recovery is very high indeed.

By market close last Friday, USD was lower against every currency except Sterling (+0.55%) with largest losses against NOK (-2.19%), AUD (-1.69%) and SEK (-1.53%). In addition to mixed domestic macro data, Dollar weakness was helped by the broadly positive risk profile of financial markets last week. For all the doom and gloom expectations formed in recent weeks, actual numbers were fairly positive given their prior expectations.

EUR
The Euro was largely unchanged against its G20 counterparts as macro data met expectations and European sovereign debt/credit market problems stayed out of the headlines. Peripheral bond auctions weren’t stellar enough to justify strong EUR rallies and not pessimistic enough to raise fresh funding concerns. For now, investors are more or less comfortable with the idea that European nations will gradually pay down their large debts via draconian fiscal cuts and loose monetary policy. Short-term shocks to this assumption usually come from weak bond auctions, credit downgrades or softening GDP data – an absence of such factors helped the Euro to stay well supported against cyclical currencies.

The headline event for Euro traders was the ECB interest rate decision (unchanged at 1%) and the accompanying press conference. Prior to the announcement, investors were anticipating an outside chance of additional easing measures by the ECB in light of recent weakness in the US. Trichet’s comments were very balanced and lacked significant new information in their assessment of the Euro-zone. Overall, the accompanying statement and press-conference were broadly positive for the Euro and European asset classes. Below are the key highlights:

"Looking ahead, the recovery should proceed at a moderate pace with uncertainty still prevailing."
"The risks to this improved economic outlook are slightly tilted to the downside with uncertainties still prevailing.”
"On the one hand, global trade may continue to perform more strongly than expected, thereby supporting euro area exports. On the other hand, concerns remain relating to the emergence of renewed tensions in financial markets and to some uncertainty about growth prospects in other advanced economies at the global level. In addition, downside risks relate to renewed increases in oil and other commodity prices and protectionist pressures, as well as the possibility of a disorderly correction of global imbalances."
"Annual HICP inflation rates are expected to increase slightly while displaying some volatility. Looking further ahead, in 2011, inflation rates should remain moderate overall, benefiting from low domestic price pressures."
"I'm absolutely clear the Governing Council has no intention to signal any change in the present interest rates."
"The Governing Council continues to view the current key ECB interest rates as appropriate."
"We have to remain cautious and prudent. We don't declare victory ... I already said that the double-dip was not in the cards in our own analysis."

GBP
Sterling took a strong hit in all currency pairs, finishing the week as the weakest currency in the G20. The prime reason for the sell-off was the avalanche of weak data coming out of the UK. In fact, the not too dissimilar timing of souring data in the UK contrasted with the US has spurred legitimate QE expansion speculation; this also weighed on Sterling currency pairs.
Weaker lending figures to individuals (£0.3bn vs. £0.7bn exp.) and a weaker Services PMI survey (51.3 vs. 53.0 exp.) acted as two clear indications of weakness in the UK consumer sector. British service sector activity grew at its slowest pace since April 2009 this August and although investors are expecting a bumpy recovery, the worrying fact remains that PMI survey data tends to lead actual economic statistics by a couple of months. If survey data continues to weaken as it is doing so currently, expectations of a double-dip recession will gather momentum. Manufacturing survey data (54.3 vs. 57.1 exp.) was also weaker than expected, led by the weakest growth in new orders since June 2009. It would seem that the hugely impressive recovery in UK industry over the past 9-12 months could be losing its momentum. On the positive side, export orders showed improvement and falling input prices were a good signpost for containing rising inflation expectations.

By the end of the week, all Sterling pairs without exception were lower with largest losses coming against AUD (-2.21%), JPY (-1.79%) and CAD (-1.65%).

JPY
The Yen maintained its upward march against most other currencies with the added bonus of positive domestic data. Safe-haven demand wasn’t the primary reason for JPY upside last week. Industrial production (0.3% vs. -0.3% exp.), retail sales (3.9% vs. 3.6% exp.) and capital spending (-1.7% vs. -6.6% exp.) numbers indicated to market participants that Japan is continuing on its course of gradual recovery despite persistent deflation and slow economic growth. The other positive factor that worked in the Yen’s favour was overly optimistic investor expectations of BoJ expanding their JGB buying programme. At their scheduled policy meeting in the early hours of last Monday (unchanged at 0.1%), the BoJ failed to appease market expectations of an escalation in bond purchases – the net effect on the Yen was a positive one that gave JPY pairs an excellent start to the week.

The main talking point surrounding the Yen remains that of intervention. Market participants are keenly watching the price action in USD/JPY because of its close proximity to its all time low of 79.75 reached in 1995. The further we get to this key level, the more aggressive intervention speculation is likely to get. The BoJ would consider intervening in order to help Japanese exporters but previous interventions simply led to more volatility and paradoxically, a higher Yen as intervention attracted a broad range of USD supply from a wide spectrum of countries, yet focused on the USD/JPY market in particular. Speculative capital aimed at fighting the official BoJ stance is also common when intervention is rumoured/actually occurring.

CHF
The Swissie had a mixed week, remaining within tight ranges in most pairs. Largest gains were against USD (+1.08%) and GBP (+1.62%) mainly because of USD and GBP weakness rather than CHF strength. Domestically, macro data was very positive – the highlights were a strong quarterly GDP number (+0.9% vs. +0.8% exp.) and blistering retail sales figures (4.8% vs. 2.3% exp.). Stronger than expected growth and sales data put downward pressure on EUR/CHF. A good round of figures added to safe-haven demand that has been gradually gaining momentum since extremely weak macro figures started surfacing in the US in early August.

EUR/CHF reached an all-time record low of 1.2850 and sparked renewed intervention speculation. The SNB has been an active CHF seller over the course of 2010 in an attempt to help Swiss exporters via a weaker CHF and simultaneously deterring deflationary effects on the Swiss economy.

Preview-6th-12 September 2010

•Shortened week likely to see lower trading volumes due to US labour day holiday

•FX price action likely to be policy driven with four G20 central banks meeting – BoJ, RBoA, BoC and BoE

•Strong batch of trade balance figures could be significant; most focus will be on China

It’s likely to be a relatively quiet week this week in comparison to last. The economic calendar is thin with policy decisions and trade balance data taking most importance.In the UK, the BoE will announce its latest policy decision on Thursday. We foresee an unchanged decision on both the headline rate (0.5%) and asset purchases (£200bn). We think the MPC may be more concerned about the health of the UK recovery and thus there is an outside chance of a dovish policy meeting. A key reason why the BoE may be concerned is because of a fairly sudden and strong deterioration in the external environment i.e. the US. If the MPC deems US macro deterioration as signs of an imminent downturn in the UK due to close economic ties between the UK and US, then some form of dovish policy move and/or statement is very plausible. However, in our opinion, even if these concerns have grown amongst BoE members in recent weeks, a policy move now would be premature. More likely, the BoE will wait for the Fed to take action (which is unlikely in itself) before sketching out their own policy changes. Also, a fresh round of QE by the Fed would make the corresponding BoE QE expansion feel more solid in the eyes of investors. Realistically, we think that spearheading QE-part 2 can only be done by either the US or Japan without suffering severely negative consequences as a result. If the UK were to take the lead on this issue, there is a strong chance investors would begin to lose confidence in the UK as an investment destination and Sterling as an investment currency. Furthermore, the ECB has clearly become more confident regarding the ongoing recovery judging by ECB member comments over the past few weeks. Taking all this into consideration, event risk with the BoE is on the downside i.e. if we do see a huge surprise, against all market expectations; it is likely to be softer monetary policy via more asset purchases rather than tighter policy.

In Australia, the RBoA is also due to announce its policy decision this week. We see it as almost a certainty that interest rates will be kept on hold for the time being. The RBoA has been crystal clear that future interest rate changes will be increases as part of its policy normalisation objective following the financial crisis of 2007-09. The RBoA was one of the first and most aggressive central banks in the G20 – increasing the Aussie benchmark rate six times up to 4.5% in May 2010 from a low of 3% in October 2009. At this stage however, the US recovery has begun to falter which is a negative development for the Australian economy. We think this fact alone will deter a premature rate increase even though Australia is experiencing strong economic growth, consumer demand and housing demand domestically.

The BoJ will also stay on hold but could announce further easing measures such as an expansion to JGB asset purchases and/or Yen intervention. The main talking point surrounding the Yen remains that of intervention. Market participants are keenly watching the price action in USD/JPY because of its close proximity to its all time low of 79.75 reached in 1995. The further we get to this key level, the more aggressive intervention speculation is likely to get. The BoJ would consider intervening in order to help Japanese exporters but previous interventions simply led to more volatility and paradoxically, a higher Yen as intervention attracted a broad range of USD supply from a wide spectrum of countries, yet focused on the USD/JPY market in particular. Speculative capital aimed at fighting the official BoJ stance is also common when intervention is rumoured/actually occurring.

The USD/JPY rate will be a key indicator, not only because it has a huge impact on trade/investment flows but also because of its high correlation to US yields. With USD/JPY approaching its all-time low, we think weakness in this pair can only be reversed as and when the US embarks on a broad recovery that includes jobs growth.

In Canada, the BoC is in a dilemma. After two rate hikes Canada finds itself in a situation where domestic activity including retail sales, consumer spending and employment are doing well enough to push up inflation fears but simultaneously, its primary trading partner (the US) is gradually slipping further towards recession. The influence of the US is significant and weaker US demand for Canadian goods could weigh on Canadian growth over the medium-term. We see the likelihood of a hike as being close to 65%. It is worth noting that any CAD strength as a result of policy tightening would evaporate incredibly quickly should the accompanying statement indicate a pause from here on in. In all scenarios, CAD price action volatility should increase for this week.

FX Weekly Review-30th August-5th September 2010
By George Tchetvertakov, Head of Market Research

• Mixed macro data from the G20 led to mixed price action in most currency pairs

• A broadly risk-neutral week included several positive surprises to appease the recovery skeptics. Double-dip fears in the US eased away from the brink with additional Fed easing now more likely to be delayed further

• Swisse strength once again making the headlines as EUR/CHF tested fresh record lows – central bank intervention speculation in the G20 is not purely JPY related anymore as market rumors of fresh SNB action begin to surface

• Sterling pairs took a hit, as macro data disappointed and growing fears of QE expansion began to feed through into intra-day price action. A higher probability of additional Fed easing is spurring investors into pricing in a higher likelihood of the BoE following suit

• Commodity currencies performed well with best gains coming against the US Dollar but closed the week only marginally higher in non-US crosses

USD
The US Dollar suffered substantially amidst prevailing uncertainty and growing fears that the US economy will continue to languish in an anaemic state at best with a worst case scenario of another downturn still not conclusively ruled out. Last week provided a mountain of US data – most of which met expectations but several key indicators did manage to underline the fragility, not only of the US recovery but also of the US economy in general because of the dependence on service sector activity.

EUR
The Euro was largely unchanged against its G20 counterparts as macro data met expectations and European sovereign debt/credit market problems stayed out of the headlines. Peripheral bond auctions weren’t stellar enough to justify strong EUR rallies and not pessimistic enough to raise fresh funding concerns. For now, investors are more or less comfortable with the idea that European nations will gradually pay down their large debts via draconian fiscal cuts and loose monetary policy. Short-term shocks to this assumption usually come from weak bond auctions, credit downgrades or softening GDP data – an absence of such factors helped the Euro to stay well supported against cyclical currencies.

"On the one hand, global trade may continue to perform more strongly than expected, thereby supporting euro area exports. On the other hand, concerns remain relating to the emergence of renewed tensions in financial markets and to some uncertainty about growth prospects in other advanced economies at the global level. In addition, downside risks relate to renewed increases in oil and other commodity prices and protectionist pressures, as well as the possibility of a disorderly correction of global imbalances."

"Annual HICP inflation rates are expected to increase slightly while displaying some volatility. Looking further ahead, in 2011, inflation rates should remain moderate overall, benefiting from low domestic price pressures."

"I'm absolutely clear the Governing Council has no intention to signal any change in the present interest rates."
"The Governing Council continues to view the current key ECB interest rates as appropriate."
"We have to remain cautious and prudent. We don't declare victory ... I already said that the double-dip was not in the cards in our own analysis."
GBP
Sterling took a strong hit in all currency pairs, finishing the week as the weakest currency in the G20. The prime reason for the sell-off was the avalanche of weak data coming out of the UK. In fact, the not too dissimilar timing of souring data in the UK contrasted with the US has spurred legitimate QE expansion speculation; this also weighed on Sterling currency pairs.

Weaker lending figures to individuals (£0.3bn vs. £0.7bn exp.) and a weaker Services PMI survey (51.3 vs. 53.0 exp.) acted as two clear indications of weakness in the UK consumer sector. British service sector activity grew at its slowest pace since April 2009 this August and although investors are expecting a bumpy recovery, the worrying fact remains that PMI survey data tends to lead actual economic statistics by a couple of months. If survey data continues to weaken as it is doing so currently, expectations of a double-dip recession will gather momentum. Manufacturing survey data (54.3 vs. 57.1 exp.) was also weaker than expected, led by the weakest growth in new orders since June 2009. It would seem that the hugely impressive recovery in UK industry over the past 9-12 months could be losing its momentum. On the positive side, export orders showed improvement and falling input prices were a good signpost for containing rising inflation expectations.
By the end of the week, all Sterling pairs without exception were lower with largest losses coming against AUD (-2.21%), JPY (-1.79%) and CAD (-1.65%).

JPY
The Yen maintained its upward march against most other currencies with the added bonus of positive domestic data. Safe-haven demand wasn’t the primary reason for JPY upside last week. Industrial production (0.3% vs. -0.3% exp.), retail sales (3.9% vs. 3.6% exp.) and capital spending (-1.7% vs. -6.6% exp.) numbers indicated to market participants that Japan is continuing on its course of gradual recovery despite persistent deflation and slow economic growth. The other positive factor that worked in the Yen’s favour was overly optimistic investor expectations of BoJ expanding their JGB buying programme. At their scheduled policy meeting in the early hours of last Monday (unchanged at 0.1%), the BoJ failed to appease market expectations of an escalation in bond purchases – the net effect on the Yen was a positive one that gave JPY pairs an excellent start to the week.

• Shortened week likely to see lower trading volumes due to US labour day holiday

• FX price action likely to be policy driven with four G20 central banks meeting – BoJ, RBoA, BoC and BoE

Strong batch of trade balance figures could be significant; most focus will be on China
It’s likely to be a relatively quiet week this week in comparison to last. The economic calendar is thin with policy decisions and trade balance data taking most importance.
In the UK, the BoE will announce its latest policy decision on Thursday. We foresee an unchanged decision on both the headline rate (0.5%) and asset purchases (£200bn). We think the MPC may be more concerned about the health of the UK recovery and thus there is an outside chance of a dovish policy meeting. A key reason why the BoE may be concerned is because of a fairly sudden and strong deterioration in the external environment i.e. the US. If the MPC deems US macro deterioration as signs of an imminent downturn in the UK due to close economic ties between the UK and US, then some form of dovish policy move and/or statement is very plausible. However, in our opinion, even if these concerns have grown amongst BoE members in recent weeks, a policy move now would be premature. More likely, the BoE will wait for the Fed to take action (which is unlikely in itself) before sketching out their own policy changes. Also, a fresh round of QE by the Fed would make the corresponding BoE QE expansion feel more solid in the eyes of investors. Realistically, we think that spearheading QE-part 2 can only be done by either the US or Japan without suffering severely negative consequences as a result. If the UK were to take the lead on this issue, there is a strong chance investors would begin to lose confidence in the UK as an investment destination and Sterling as an investment currency. Furthermore, the ECB has clearly become more confident regarding the ongoing recovery judging by ECB member comments over the past few weeks. Taking all this into consideration, event risk with the BoE is on the downside i.e. if we do see a huge surprise, against all market expectations; it is likely to be softer monetary policy via more asset purchases rather than tighter policy.