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Commentary for the week of 01/27/2012

The Australian dollar ended the week up 1.6% against the US dollar reflecting the bounce in risk assets and currencies on a surprisingly dovish FOMC meeting forecasting near zero rates through 2014 and on optimism the Euro Zone crisis is moving closer to being contained and in particular that Greece has moved close to a deal on swapping its debt (lowering its debt burden) with private sector creditors. The AUD is also benefiting from higher commodity prices as China is seen having achieved a soft landing. Aussie final goods PPI in Q4 rose 0.3% from Q3 and 2.9% from a year ago. Home prices edged up in Q4 from Q3 while Q4 inflation was unchanged from Q3 and rose 3.1% from a year ago suggesting the RBA will cut rates in early February.
In the coming week Australia releases data on private credit, business confidence, international trade and building approvals. We expect the AUD to end next week higher against the USD as investors and traders react to stronger-than-expected economic data from the US and Asia and eye firmer commodity prices. However, the run up in the AUD against the USD of nearly 4% in the last 3 weeks suggests the pace of appreciation is due to slow markedly next week and a return of risk aversion associated with Euro Zone debt and bank concerns should check upside for the currency.

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Reduced anxiety over the Euro Zone debt markets and banking system in the wake of successful debt auctions from the Euro Zone, easing in the FOMC statement language (sees near zero Fed funds rate through 2014 versus mid-2013 previously) and expectations the Greek government and its private sector creditors are close to an agreement on a haircut on Greek bonds of up to 70% (debt swap) helped the British pound end the week up 1.0% against the US dollar. UK public borrowing fell in December but net debt hit a record GBP1trln (64.2$ of GDP) suggesting the austerity effort remains a challenge. GBP gains were checked some by the UK Q4 GDP report showing the economy declined 0.2% from Q3. CBI manufacturing orders index rose to -16 in January from -23 in December. CBI retail sales volume index fell to -22 in January and worse than -5 market expectations.
In the coming week the UK releases data on consumer confidence, consumer credit and PMI. We expect the GBP to end next week lower against the USD reflecting elevated risk aversion as markets seek the safety of USD and US Treasuries in light of the crisis resonating in the Euro Zone and as the outlook for UK growth remains poor relative to the US economy's growth prospects suggesting the BOE will resort to more QE before the Fed does.

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The Canadian dollar ended the week up 1.3% against the US dollar reflecting a broad rally in risk currencies and assets on optimism the Euro Zone policymakers are getting their arms around the crisis and after the Fed moved its forecast for raising rates out 18 months to the end of 2014. Moreover, Bernanke said QE is on the table and portrayed the US economy as facing significant downside risk which many saw as a sign the Fed will likely buy assets later this year (QE). Also firm commodity prices helped support the CAD. Canada November retail sales rose 0.3% month-over-month after +0.9% in October. Home price index fell 0.2% in November fro October. Consumer confidence rose in January to 73.9 from 69.9 in December. December employment was revised to a net 21,600 gain from 17,500 in the initial release.
In the coming week Canada economic releases include figures on GDP, PPI, PMI and employment. We expect the CAD to end next week lower against the USD reflecting signs the US economy is doing relatively better than Canada's economy while the ever present European crisis is also likely to support the USD despite an expected deal on Greek debt haircuts by the government and its creditors as the focus of the market shifts to Portugal which many think is also a candidate for debt restructuring/default.

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The Chinese yuan ended the week up 0.3% against the US dollar as the recent run of appreciation in the yuan continued in a week when local markets were mostly closed for the Lunar New Year. Rumors of a RRR cut (reserve requirement rate) by the PBOC continued to make the rounds but there was nothing from officials to suggest this is in the cards.
In the coming week China releases its official PMI and HSBC releases its PMI. German Chancellor Merkel is in China to discuss economic issues. We expect the yuan to continue its modest crawl higher against the USD which is consistent with official policy and should leave the currency narrowly up against the greenback next week.

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The euro finished the week up 2.2% against the US dollar helped by the Fed's FOMC statement moving the date for a hike in rates (forecast) to end-2014 from mid-2013, a rally in European debt markets as periphery members of the Euro Zone successfully sold debt and on reports that Greece is close to a deal with its creditors for a voluntary debt swap. Risk assets and FX were broadly higher with markets secure in the notion that the Euro Zone had averted disaster due largely to the success of the ECB's 3-year LTRO which stuffed the banks with liquidity and funding (another one late Feb scheduled). Markets ignored Fitch downgrade decisions impacting the ratings of 5 Euro Zone members and included a 2-notch downgrade for Italy and Spain respectively. ECB President Draghi said a major funding crisis had been averted. Euro Zone composite PMI in January rose to 50.4 from 48.3 in December. Euro Zone consumer confidence rose to -20.6 in January from -21.3 in December. Germany's Ifo index on business activity rose to 108.3 in January from 107.3 in December. Euro Zone M3 slowed to 1.6% year-over-year in December from 2.0% in November. Industrial orders fell 1.3% in November from October and were down 2.7% from a year ago. German consumer sentiment (GfK) rose to 5.9 in February from 5.7 in January. Spain's unemployment rate rose to 22.85% in December, more than double the Euro Zone average.
Key economic data from the Euro Zone next week include figures on economic sentiment, unemployment, inflation, PPI, retail sales and PMI. Heads of state hold a Summit to approve the fiscal compact on Monday. Germany reports data on inflation and retail sales. We expect the EUR to end next week lower against the USD as risk aversion climbs on disappointment (again) over weakness in Euro Zone periphery debt markets as Portugal's default risk grows and Greece's debt restructuring is widely seen as temporary and leaves a hard restructuring on the table for 2012. It should also become increasingly clear to market participants that a Euro Zone recession is likely which should press the ECB into cutting rates more (next ECB Governing Council meeting is in February) and introducing unconventional monetary policy (in addition to its unconventional credit easing measures) at some point in 2012 which can't be good news for the euro ahead we think. Moreover, in the very near-term, the only simulative policy avenue to take for the Euro Zone is to encourage an orderly decline in the euro we believe.

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The Japanese yen ended the week up 0.3% against the US dollar as Japanese exporters bought yen and as market participants sense the risk for intervention in the yen against the dollar by Japanese officials is falling in light of US official criticism and a focus shifting to euro versus the yen by Japanese authorities. But yen gains were limited against the USD by the broader move into risk currencies and assets in light of JPY safe-haven appeal (rises in period of rising risk aversion) and in light of news Japan ran a trade deficit in 2011, the first since 1980. Exports fell 8% year-over-year in December and imports rose 8.1% highlighting the weakness in external demand, reduced domestic energy output and ongoing supply disruptions. BOJ minutes from the December board meeting showed the Bank was more guarded on growth in light of delays in quake reconstruction and external headwinds from the Euro Zone crisis. Japan reported a decline in December inflation with CPI down 0.1% from a year ago. Retail sales in December rose 2.5% from a year ago.
In the week ahead Japan releases data on unemployment, household spending and housing starts. We look for the yen to end next week narrowly lower against the dollar reflecting growing signs the strong yen is undermining economic activity and demands a greater official role in driving the yen down ahead. Still elevated risk aversion associated with the Euro Zone debt and banking crisis should check JPY downside versus the USD and keep the yen tracking higher against the euro we believe.

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The Mexican peso soared another 2.0% against the US dollar for the week adding to last week's 3.2% surge helped by the Fed forecasting near zero Fed funds rate through 2014 versus mid-2013 previously and after Bernanke said QE was on the table in light of the downside risks for growth and high unemployment rate. But also the MXN was helped by a broad rally in risk currencies versus the USD on expectations Europe's policymakers were getting their arms around the debt and banking crisis as Greece and its private creditors are reportedly close to a deal on restructuring the government's debt. Mexican central banker Carstens repeated the case for steady policy ahead and data continued to impress markets suggesting the scope to cut rates ahead is narrowing. The economic activity index in November rose 0.17% from October and 3.75% from a year ago. Inflation hit a one-year high in the first half of January at 3.94% thanks to higher food prices and was CPI up 0.32% from December. The trade balance was in $7.7mln surplus in December down from $232mln surplus in November. Retail sales rose 2.2% month-over-month in November and were up 7.5% from a year ago.
In the coming week Mexico releases data on consumer confidence. We expect the peso to weaken against the US dollar next week reflecting higher risk aversion as European concerns resurface around the Euro Zone periphery debt markets as economic growth in the Euro Zone periphery heads south which should see risk FX like the peso weaken against the "risk free" USD.

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The Russian rouble surged 4.2% against the US dollar this week supported by signs the European sovereign debt crisis is closer to being contained as Greece and creditors are reportedly close to a deal on restructuring government debt voluntarily. The Russian central bank ruled out near-term rate cuts which was constructive for the RUB. Also elevated energy prices added support to the RUB. Healthier Euro Zone periphery bond markets supported risk more generally. The unemployment rate in December fell to 6.1% from 6.3% in November. Industrial production rose 2.5% in December from a year ago, the smallest advance in 2 years. PPI was up 0.2% month-over-month in December and was up 12% from a year ago.
In the coming week Russia releases data on housing completions, capital investment, wages and retail sales.. We look for the rouble to weaken against the USD next week as risk aversion rises on EU crisis anxiety returning in light of doubtrers over the success of Greek debt swap talks in removing default risk entirely, as worries over Portugal's solvency rise, recent rating downgrades for 5 of the Euro Zone's 17 members by Fitch and on a dim outlook for Euro Zone growth while governments across the region pursue austerity measures. Also look for lower energy prices in response to expectations the European economy is slowing to weigh on the rouble ahead we think.

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Dovish FOMC meeting which moved a Fed funds forecasted hike to the end of 2014 from mid-2013 and falling risk aversion on expectations Greece and Greek creditors (debt holders) will finalize a debt swap agreement helped the Swedish krona rally 0.7% against the US dollar for the week. But the SEK gains versus the USD were modest as the currency fell against the euro on growing expectations the Swedish economy is weakening rapidly and will require even more easing by the Riksbank. The unemployment rate in December rose to 7.1% from 7.0% in November. PPI fell 2.1% year-over-year in December and was down 0.2% month-over-month. The trade surplus narrowed in December to SEK2.8bln from SEK3.8bln in November. Retail sales rose 0.1% month-over-month in December and were up 1.5% from a year ago.
In the week ahead there Sweden releases data on PMI. We look for the SEK to weaken next week against the USD in light of ongoing concerns over the Euro Zone debt crisis and ability of Portugal to avoid a debt restructuring. Moreover, the slowdown in Swedish and Euro Zone economic activity and implications for monetary policy should see the SEK sag more ahead versus the USD we believe.

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The Swiss franc ended the week up 2.4% against the US dollar after the Fed lengthened its forecast for raising rates by 18 months to the end of 2014 and portrayed a US economy at significant risk of a slowdown and possibly in need of more QE ahead. Also reports Greece and its creditors were close to a deal on debt swap which is key to Greece getting the next loan disbursement in time for a near EUR15bln bond maturity March 20 helped the CHF and risk FX more generally. And market participants continue to trade the CHF closer to the official 1.20 ceiling versus the EUR to test central bank resolve to defend the level. SNB officials repeated the central bank will use an infinite amount of CHF to defend the ceiling if necessary. Pressure on the SNB to lower the ceiling to 1.30 is evident still but there is no indication the SNB is contemplating a change. Markets ignored a decline in the Swiss KOF index on economic activity to -0.17 in January down from +0.01 in December and the first negative reading since August 2009.
In the coming week Switzerland releases data on international trade, retail sales and PMI. We look for the CHF to end next week lower against the USD as risk aversion resurfaces as markets eye Greek debt swap talks, rising default risk for Portugal, weak Swiss economic activity and recent rating downgrades across much of the Euro Zone. That said downside should be checked somewhat as market participants continue to test SNB resolve to defend the CHF ceiling against the EUR at 1.20 we think.

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A Fed pledge after the FOMC meeting Wednesday to keep Fed funds near zero through 2014 versus mid-2013 previously and expectations that Greece will soon conclude a deal with its main private sector creditors to haircut its debt by up to 70% in a debt swap helped risk assets and FX rally and left the US dollar index down 1.6% for the week with the greenback hitting a 6 1/2-week low against the euro. FX traders and investors remain burdened by short euro exposure and the single currency was broadly higher in the week (up 2.2% against the USD) as short positions were partly covered. Bernanke in the post-FOMC press conference said further asset purchases were possible and considered at the latest FOMC meeting which added to USD selling pressures as Fed balance sheet expansion has been associated with a weaker dollar in the past (QE). Bernanke also painted a rather downbeat portrait of the US economy which many found surprising in light of recent data suggesting economic activity was picking up. Market participants largely ignored news that Fitch downgraded five Euro Zone sovereign on Friday including a two-notch downgrade for Spain and Italy respectively. Further signs of an easing in anxiety in financial markets were seen in credit, equity and bond markets. US Q4 GDP grew 2.8% SAAR below the 3.0% pace expected and this was mainly due to a surge in inventories which are likely to prove temporary. US consumer sentiment for the end of January rose to 75 from a preliminary reading of 74 and 69.9 in December. New home sales fell 2.2% in December from November to a 307,000 per annum pace. Pending home sales fell 3.5% in December month-over-month. Leading indicators (index) rose 0.4% month-over-month in December. Durable goods orders rose 3.0% month-over-month in December and were up 2.1% excluding transportation. US jobless claims in the week ending January 21 rose 11,000 to 377,000, though is still trending lower.
In the week ahead the US releases data on personal income and spending, home prices, Chicago PMI, national ISM, auto sales, jobless claims, productivity, factory orders and employment. The EU will hold a summit next week when the bailout fund will be needed to be boosted to help calm market anxiety and which Germany opposes. With the US dollar index down 3.2% in the last two weeks on growing optimism that the Euro Zone has moved back from the edge of the abyss on its debt and bank crisis thanks to the success of the ECB's 3-year LTRO (bank liquidity operation), we think the balance of risks this week are for a higher dollar as markets eye ongoing risks in the Euro Zone (liquidity is not solvency) and on signs that Portugal may need debt restructuring along the lines of Greece. Moreover we think the Euro Zone recession now likely underway will come to weigh on the euro and help the dollar index push higher. And the ECB should cut rates again in February while the scope for the Fed to add to QE is limited until later in the spring and we think this will weigh on the euro and give the dollar broader support.

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