The Euro-zone
stresses and structural vulnerabilities will continue to be an
extremely important market focus. There has been an important movement
in bond markets with yields in several countries reduced to below zero
as defensive demand increases. If this trend cannot be reversed there
will a further increase in speculation that there will be a break-up of
the Euro area.
Key events for the forthcoming week:
| Date | Time (GMT) | Data release/event |
| Wednesday July 25th | 08.00 | German IFO business confidence index |
| Wednesday July 25th | 08.30 | UK GDP (Q2 advance) |
| Friday July 27th | 12.30 | US GDP (Q2 advance) |
Dollar:
There
has been further evidence of a slowdown within the US economy with a
series of generally disappointing data, especially for retail sales.
Federal Reserve Chairman Bernanke also took a generally downbeat tone in
his congressional testimony which will increase speculation that the
Fed will move to sanction additional quantitative easing. Global
considerations will remain very important and the US currency should
still gain protection from fears surrounding the international outlook.
Defensive demand for the dollar is liable to be enhanced by reduced
pressure for reserve diversification away from the US currency.
The dollar weakened
for the week as a whole, although there was a recovery from lows as
caution surrounding global growth conditions stifled an equity-market
recovery. The dollar was also resilient against the Euro.
The US retail sales data
was weaker than expected with a headline 0.5% decline for June while
underlying sales declined by 0.4% which was the third successive monthly
fall which will undermine second-quarter growth estimates. The New York
PMI data was slightly more optimistic with a gain to 7.4 from 2.3
previously.
Principal attention surrounded Fed Chairman Bernanke’s testimony
to Congress. The Fed chief was concerned over the labour market and was
also less confident in the economic outlook with warnings that there
had been a deceleration. Bernanke continued to insist that the Fed had
tools available and would take further action if required. There were no
hints of immediate action, but the more dovish underlying tone
suggested a shift towards further measures after the Summer if there was
no improvement in the labour market.
There was a 6.9% increase in US housing starts
to an annual rate of 760,000 which was offset by a dip in permits for
the month. There was a slight downgrading of growth prospects in the
latest Fed Beige Book.
Initial jobless claims increased to
386,000 in the latest week from 352,000, although the underlying trend
may well have been little changed. Existing home sales fell to 4.37mn
from 4.62mn previously which dampened confidence in the housing sector.
The Philadelphia Fed manufacturing index did register a monthly
improvement, but it was still weaker than expected for the fourth
consecutive week and negative throughout the past quarter.
| Euro |
The Euro-zone
crisis will continue to dominate in the short-term. There will be some
relief if there is agreement on Spain’s support package for the banking
sector. Nevertheless, the underlying rend in bond yields will remain
extremely important and the widening divergence within the markets
suggests that underlying stresses are increasing as capital flows out of
peripheral economies. Unless this trend can be reversed, there will be a
very high risk of terminal stresses within the Euro area and growing
pressure for a split. This speculation may perversely help underpin the
Euro with volatility set to increase. If the Euro area does hold
together, there will be pressure for a more aggressive ECB stance.
The Euro was
able to resist further losses against the dollar, but it remained
vulnerable on the crosses with record lows against the Australian
dollar.
Yield trends remained very important within the
Euro-zone and global markets. There was a negative yield at the latest
German 2-year bond auction for the first time on record and market
yields remained below zero in six countries as there was further
evidence of capital flows away from peripheral economies. The Bank of
Spain reported a further drop in bank deposits for June and the bad loan
ratio within the banking sector increased to near 9.0% according to the
latest data.
There were sharply higher yields in the latest
Spanish bond auctions and there was also a sharp decline in the
bid/cover ratios which suggested particularly weak investor demand. Benchmark Spanish bond yields moved above the 7.0% level with fears that Spain was sliding deeper towards requiring a sovereign bailout.
The
Euro rallied on reports that the EFSF might be able to buy Spanish
bonds if there were spare resources from the rescue package, but this
was later denied by the European Commission with the Eurogroup set to
meet to finalise the bailout package on Friday. A successful outcome
would provide some temporary relief.
Fed Chairman Bernanke’s
warning that Europe was not close to a long-term solution which will
tend to reinforce global growth fears and these concerns were echoed
within the IMF’s latest report as it saw severe downside risks
surrounding the Euro-zone outlook. The IMF called for a further cut in
ECB interest rates and for quantitative easing which will tend to
undermine the Euro.
Yen:
There
will be further concerns surrounding the Japanese economy with the
fundamental outlook still extremely vulnerable. Competitiveness issues
will also be important and there will be strong pressure for yen gains
to be resisted especially if there is a weaker tone for the Chinese
yuan. Global considerations will remain extremely important and there is
still likely to be underlying yen demand, especially with major fears
surrounding the Euro-zone outlook. In this environment, the yen can
still resist aggressive selling pressure.
The dollar was
undermined by the weaker than expected US data with additional
speculation over further Fed action to support the economy and a test of
support below 78.50. There was evidence of semi-official bidding below
the 78.50 level which helped trigger a small-scale recovery.
The yen also
gained support on defensive grounds as funds continued to shun European
peripheral bond markets. There were also further concerns surrounding
the Asian outlook. There will, however, be competitiveness pressures if
there is further weakness for the Chinese yuan.
The yen
continued to gain underlying support from weaker than expected US
economic data and by continuing safe-haven demand as Euro-zone fears
intensified. Ranges were relatively narrow, especially as there were
still important reservations surrounding the threat of Ministry of
Finance intervention to restrain the yen.
| Sterling |
There
will be further concerns surrounding the UK growth prospects,
especially with fears over the impact of Euro-zone recession conditions.
Sterling has again been broadly resilient in the face of quantitative
easing and economic fears with defensive demand for UK bonds
still having an important in supporting the currency. This demand may
continue in the short-term, but there is still a high risk that domestic
fears will overwhelm these inflows and Euro-zone fears are likely to
increase volatility.
Sterling pushed to 44-month highs against the Euro with a peak beyond 0.78 while the UK currency also managed an advance against the dollar.
The latest consumer inflation data
was weaker than expected with a decline in the annual rate to 2.4% for
June from 2.8% previously, the lowest rate for two years. There was
evidence that a combination of poor weather and weak demand had pushed
retailers into additional discounting which helped keep the rate down.
The unemployment claimant
count data was close to expectations with a 6,100 increase in the total
for June following a 6,900 increase the previous month. The ILO data
was more favourable as the unemployment rate dipped to 8.1% from 8.2%.
The Bank of England
recorded a 9-0 vote for unchanged interest rates while there was a 7-2
vote for the additional GBP50bn quantitative easing. All members agreed
that further stimulus was warranted and there was discussion of an
additional GBP75bn. The new lending programme discouraged the more
aggressive stance at this stage and two members voted for no change.
The retail sales data was weaker than expected with a 0.1% monthly gain
for June following a revised 1.5% gain the previous month.
There
was further evidence of safe-haven considerations as demand for
non-peripheral European bonds remained extremely strong which continued
to have a positive Sterling impact as the Euro remained weak on the
crosses. There is likely to be longer-term speculation that Sterling
could be subjected to renewed selling.
Swiss franc:
With
confidence in the Euro-zone outlook remaining extremely weak, defensive
flows into the Swiss currency are likely to continue, especially
following the move to cut deposit rates to zero. The National Bank is
still being forced to defend the minimum level on a daily basis and if
pressure increases further there will be strong demands for the bank to
consider capital controls or negative official interest rates to weaken
franc demand. There is still the medium-term possibility that the
minimum level will break if the Euro slides sharply against the dollar.
The Euro was trapped close to the 1.2010 level against the Euro during the week while the dollar hit resistance above the 0.9850 area.
The
trade account remained in surplus and there was a gain in exports for
the first time in four months which provided some support. There will
still be strong pressure for franc gains to be resisted with further
concerns surrounding the deflation threat.
The latest Swiss ZEW
survey was little changed at -42.5 for July which will maintain a lack
of confidence in the economic outlook and pressure for franc gains to be
resisted. The Economics Ministry reaffirmed its commitment to the 1.20
minimum level, but there will be increasing pressure on the National
Bank if conditions deteriorate further and defensive capital inflows
intensify.
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| Australian dollar |
The Australian dollar
found solid buying support on dips and pushed to two-month highs near
1.0450 before edging slightly weaker. There were gains for global equity
markets and a recovery in commodity prices which helped underpin the
Australian currency. There were some further expectations of an
underlying shift in reserves into the Australian dollar, especially with
a lack of confidence in other major currencies and the currency moved
to a four-month high above 1.04 against the US currency.
The Reserve Bank was
more confident surrounding the growth outlook in the latest minutes
which also provided relief for the currency with reduced expectations of
further near-term interest rate cuts. There were still important
uncertainties surrounding the Chinese economy which restrained buying to
some extent.
The Australian dollar will find it difficult to sustain any further significant advances given unease surrounding domestic and regional growth trends.
Canadian dollar:
The Canadian dollar was able to maintain a strong tone during the week with gains to beyond the 1.01 level against the US currency.
The Bank of Canada
held interest rates at 1.0% following the latest policy meeting and was
still uneasy surrounding the global growth outlook. The Canadian currency derived support from a rally in oil prices as well as a wider gain for commodity prices.
Concerns
surrounding the global economy and commodity-price trends will tend to
limit scope for Canadian dollar gains even if oil prices resist further
declines.
Indian rupee:
The rupee was
able to maintain a solid tone during the week, although it was
difficult to sustain gains with selling pressure towards the 55 level
against the US dollar.
There was a continuing mood of optimism
towards the government’s reform efforts which helped underpin the
currency. Regional and global equity markets were also still important
in pushing the currency stronger. There were still important
reservations surrounding the growth outlook and fears surrounding the
Euro-zone economy also had a negative impact on the rupee.
Doubts surrounding the regional economy will still tend to limit the scope for rupee gains even if domestic confidence and reform optimism is sustained.
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| Hong Kong dollar |
Hong Kong dollar:
The Hong Kong dollar was unable to make any serious attack on the 7.75 band limit against the US currency
and was trapped in narrow ranges with resistance on any move towards
the 7.7550 area. Global risk appetite was slightly firmer, but the local
currency was unable to translate this into gains, especially with major
underlying doubts surrounding the mainland Chinese economy.
Even
with speculation over a medium-term policy shift, uncertainty
surrounding the Chinese outlook should prevent serious near-term
pressure on the peg.
Chinese yuan:
The
yuan was unable to make any significant headway during the week and the
spot rate edged slightly weaker beyond 6.37 against the dollar. The
weakness persisted even with the PBOC attempting to move the official
rate slightly stronger with the yuan very close to its weakest limit
within the permitted daily band.
There was evidence of corporate
dollar demand during the week amid further speculation over an
underlying US currency shortage. There were further important
reservations surrounding the Chinese economic outlook and speculation
that there would be a further reduction in reserve ratio requirements.
The yuan is
likely to be subjected to underlying selling pressure given a
developing dollar shortage within the economy and unease over the growth
outlook.
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