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Weekly Market analysis

The Euro-zone debt crisis will continue to be a very important influence and there will also be continuing unease surrounding the potential for global de-leveraging and an underlying shift back into US dollar assets. Liquidity will be weaker in the short-term which will maintain the risk of erratic currency moves during the next two weeks at least.

Key events for the forthcoming week

Date /// Time (GMT) /// Data release/event

Tuesday December 20th /// 09.00 /// German IFO business survey

Wednesday December 21st /// 09.30 /// Bank of England MPC minutes

Dollar

The latest US economic data has maintained expectations that the economy can avoid recession in the short-term. The monetary policy implications will be limited as the Fed will maintain interest rates close to zero throughout this period, but there should be some positive impact on capital inflows. Defensive considerations are likely to remain very important in the short-term with further demand for US Treasuries. Any further de-leveraging within the banking sector and fears over the global economy would also be important in supporting the dollar, especially if emerging-market sentiment deteriorates further.

Confidence in the global economy was generally weaker which helped underpin the dollar as it pushed towards 2011 highs. There was a downgrading of several global banks by Moody’s which damaged sentiment to some extent and IMF Head Lagarde also warned over the threat of a sharp global downturn. In this environment, there was the risk of further de-leveraging in the banking sector and a flow of funds into the dollar. There was also some evidence of capital repatriation by European institutions.

The US industrial production data was weaker than expected with a 0.2% monthly decline for November. In contrast, the New York manufacturing PMI index rose to 9.5 from 0.6 previously while the Philadelphia Fed index also increased. Jobless clams fell to 366,000 in the latest week from 385,000 previously, maintaining a slightly more positive view over US prospects. The US retail sales data was slightly weaker than expected with a headline and core increase of 0.2% for November. Although this dampened optimism to some extent, there was still confidence that the US economy was at least holding its own.

At the latest Federal Reserve meeting, the FOMC was slightly more optimistic surrounding the economic outlook while expressing expectations that inflation would settle near or slightly below the desired level. There was no policy action and no hint over a move to further quantitative easing although regional Fed President Evans dissented as he wanted additional action. There were also no changes to the communication policy. The Fed was still uneasy over the Euro-zone risks and will be prepared to act as required over the next few months.

Euro

The Euro-zone situation will continue to be monitored very closely in the short-term and confidence will inevitably remain very fragile. The EU Summit did little to improve the prospect of short-term stability, but the ECB actions to provide longer-term liquidity will be important in easing some stresses within the banking sector. There will still be a high degree of uncertainty and there will be pressure on the ECB to cut interest rates further, especially as there will expectations of recession. In this context, the Euro will be undermined by a lack of yield support and structural fears will trigger bouts of strong selling pressure.

The Euro was subjected to heavy selling pressure before finding some respite later in the week. There were persistent doubts surrounding the EU Summit with fears that little progress had actually been made with progress towards tighter fiscal integration not addressing the near-term difficulties. German Chancellor Merkel insisted hat there would be no increase in the ESM fund and markets were concerned that there would be no new mechanisms to help support the Euro-zone economy or alleviate the debt burden. The Greek Finance Minister warned that the budget deficit was wider than expected for the first 11 months of 2011 as recession continued to undermine tax revenue and there was also no deal on a private-sector debt restructuring.

Several non-euro-zone countries expressed doubts surrounding the proposed legislative changes and there were persistent fears that there would be no economic back-up for the fiscal commitments. Bundesbank Head Weidmann again opposed any form of monetary financing by the ECB with a stark warning over the need to maintain central bank independence and avoid printing money. He also stated that there was growing scepticism surrounding the peripheral bond buying programme within the ECB and was also cautious over the prospect of boosting IMF funding.

The Euro-zone PMI manufacturing index edged higher to 46.9 for December from 46.4 previously with a similar improvement in the services sector. There was relief that the indices had not declined further, although the data still suggested that recession was likely over the next few months. The latest Spanish auction result was also better than expected which helped lower peripheral yields.

Although there was no announcement on credit ratings by Standard & Poor’s, markets remained on high alert as French officials attempted to downplay the potential impact of any cut. ECB President Draghi remained very cautious over the possibility of any additional monetary support by the central bank, but there was further speculation that interest rates would be cut and that the bank would eventually cave-in to demand for action if the situation deteriorated further.

Sterling

Confidence in the UK economic outlook is liable to deteriorate further with recession fears continuing, especially given the Euro-zone downturn. The budget outlook has weakened further and there will be severe debt implications if there is another recession. There will be speculation over additional Bank of England quantitative easing once the current round of bond purchases is completed in February. Political tensions with Europe will be potentially important in the medium term. There is still the potential for near-term defensive Sterling demand as an alternative to Euro-zone assets, although these flows could suddenly reverse if there are increased credit-rating fears.

Sterling dipped to lows around 1.54 against the dollar before finding support. There were sharp moves on the crosses as the Euro weakened sharply to nine-month lows below 0.84. There was Sterling buying in relation to corporate dividend payments.

Although there was also evidence of UK demand as a refuge from the Euro-zone. In this context, the controversial UK decision to veto a EU Treaty did not have a negative short-term currency impact. The UK unemployment claimant count increase was lower than expected for November at 3,000 following a revised 2,500 increase the previous month, but there was an underlying increase in unemployment to a 17-year high which maintained unease over the economy.

There was a 0.4% decline in retail sales for November which was slightly worse than expected, although it was offset by an upward revision to October’s data. Markets remained extremely cautious over the data and the UK outlook given reports of weak spending trends. The consumer inflation rate fell to 4.8% for November from 5.0% previously which was in line with market expectations.

Bank of England MPC member Dale was very cautious over the economic outlook and there will be expectations of further quantitative easing as inflation falls.

There was defensive Sterling demand, although there was also some evidence that it might be fading as there was a lower bid/cover ratio in the latest auction. A call from French ECB Board member Noyer that the UK credit rating should be downgraded did not have a major impact, although it did ensure further political tensions.

Weekly Market analysis

After a brief respite during the holiday period, Euro-zone fears have increased again. There will be continuing unease surrounding the bank-sector outlook and fresh speculation that the Euro area will be forced to break apart. Global de-leveraging throughout the banking sector will be an important focus and should maintain underlying dollar demand during the first quarter.

Key events for the forthcoming week

Date /// Time (GMT) /// Data release/event

Friday January 6th /// 13.30 /// US non-farm payrolls

Thursday January 12th /// 12.00 /// Bank of England interest rate decision

Thursday January 12th /// 12.45 /// ECB interest rate decision

Dollar

There will be further cautious optimism over the US economy. Although the Federal Reserve will maintain extremely low interest rates throughout the year and will be prepared to take further action if necessary, there will be the potential for investment inflows, especially given doubts surrounding the European economies. Defensive considerations will remain extremely important for the US currency and there will be inflows due to underlying de-leveraging in the financial sector, especially with weaker emerging-market confidence. In this context, the dollar should be able to maintain a firm tone in the short-term.

The dollar dipped lower at the start of trading in 2012, but it quickly found fresh buying support and secured a strong advance against the Euro to beyond 1.28, although it lagged behind against the other major currencies.

The US ISM manufacturing data was stronger than expected with an increase to a six-month high of 53.9 for December from 52.7 previously which maintained the sense of cautious optimism towards the US outlook, especially as the orders component was strong. The FOMC minutes from December’s meeting were broadly in line with expectations. The Fed did indicate that its internal Fed Funds forecasts would in future be released with the minutes and there was some speculation that this would lead to interest rates being left at ultra-low levels for even longer.

The ADP employment data was significantly stronger than expected with a reported increase of 325,000 for December from a revised 204,000 the previous month while jobless clams also fell. Although the correlation between the two is inconsistent, there was increased optimism surrounding Friday’s monthly payroll data.

Although there was some disappointment surrounding the ISM services-sector index with a reading of 52.6 from 52.0 previously, underlying optimism remained intact. In this context, there was evidence of a significant divergence as the dollar tended to gain support from stronger than expected data, in contrast to much of the second half of 2011 when the US currency lost ground as risk appetite improved.

Euro

Confidence in the Euro-zone will remain extremely fragile. There will be further concerns over the sovereign-debt situation given the risk that funding costs will continue to increase. The banking sector will remain a key focus as unrealised losses on bonds continue to undermine balance sheets and force additional capital raising. There will be further concerns surrounding the Greek situation with open recognition that failure to secure a second bailout would trigger a Euro exit. Even if the Euro area can be sustained intact, there will be very strong pressure for an even more expansionary ECB policy to ease the threat of a deep recession. In this context, the currency is liable to remain on the defensive.

The Euro initially attempted to gain ground with a record high number of speculative positions encouraging some short covering. The currency was unable to sustain the gains and weakened sharply for the weak as a while as it dipped to 16-month lows against the dollar and 11-year lows against the yen.

Markets remained uneasy over the very heavy timetable of debt issuance over the next few weeks which will test investor confidence in the region. The latest French bond auction recorded a small increase in yields compared with the previous sale in December and bidder interest was generally lacklustre. Although by no means a disaster, the auction reinforced an underlying lack of confidence.

There were further concerns over the Spanish economy with speculation that the country would need to draw on IMF support, especially with regional debt fears. There was a significant widening of Spanish yield spreads during the day which undermined Euro confidence. There was a warning from Greek officials that they would have to leave the Euro area if a second rescue package failed.

There were further concern surrounding the Euro-zone banking sector with a further sharp decline in Unicredit’s share price as well as rumours of capital raising by Deutsche Bank. There were concerns surrounding provisions in the rights issue to guard against the possibility of Euro break-up and this further unsettled market confidence. There were also further fears surrounding a contagion threat from Hungary as fears over the economy increased sharply.

As far as data releases were concerned, there was a small upward revision to the PMI services-sector data while the flash consumer headline rate declined to 2.8% for December from 3.0%. There will be further pressure on the ECB to take a more aggressive stance on monetary policy and there will also be continuing criticism of what the market sees as covert quantitative easing.

Sterling

There will be further concerns surrounding the UK economy. The most recent business surveys have shown some important relief, but there is a high risk that the data has been distorted by weather-related factors and there will still be the threat of a sharp downturn over the next few months. There is also the potential for further Bank of England quantitative easing which would reinforce medium-term Sterling fears. In the short-term, there is still the potential for defensive capital flows into UK bonds, especially if Euro-zone fears increase further, although there will be the risk that these flows suddenly reverse. Sterling will also be vulnerable if there is any downgrading of the AAA credit rating.

Sterling weaker against the dollar over the week, although losses were limited. The UK currency continued to advance against the Euro and strengthened to 16-month highs beyond 0.83 which equates to a Sterling/Euro level above 1.20.

The latest PMI manufacturing index was stronger than expected with a recovery to 49.6 for December from a revised 47.7 previously. The services-sector index was also stronger than expected with a reading of 54.0 for December from 52.1 previously and all three PMI readings were stronger than expected. Although there was caution surrounding the outlook, the data triggered some reassessment of the immediate UK recession risks and this was also important in supporting Sterling.

There was a further decline in money supply for the month and the very weak rate of monetary expansion will maintain fears over the 2012 economic outlook as well as maintaining pressure for the Bank of England to engage in further quantitative easing.

The Bank of England warned that credit conditions were liable to tighten further and there will also be further concerns surrounding the consumer spending outlook.

There was a strong increase in overseas holdings of UK bonds which matches the evidence of substantial buying as a defensive play against Euro-zone turbulence.

Weekly Market analysis

The ECB has had some success in easing credit conditions within the Euro-zone and there has been some lessening of the global dollar shortage. In this environment, risk conditions could remain slightly more favourable initially, but it will be difficult to secure a sustained improvement given the global risks with a particular focus on the Chinese outlook.

Key events for the forthcoming week

Date /// Time (GMT) /// Data release/event

Tuesday January 17th /// 10.00 /// Germany ZEW survey

Tuesday January 17th /// 14.00 /// Bank of Canada interest rate decision

Friday January 20th /// 09.30 /// UK retail sales

Dollar

Despite some disappointment surrounding the retail sales data, there should be expectations of solid near-term US demand. There is little doubt that the Federal Reserve will maintain a very expansionary monetary policy throughout the year with any talk of tightening unlikely to gain any significant traction. Attention will also focus on the threat of further medium-term credit-rating downgrades. Defensive considerations will remain extremely important for the US currency and there will be inflows due to underlying de-leveraging in the financial sector, especially as emerging-market confidence is liable to remain weaker.
In this context, the dollar should be able to avoid substantial selling pressure.

The dollar strengthened sharply at times, but it was unable to sustain the gains and dipped late in the week as the Euro recovered and defensive US demand eased. The latest positioning data also suggested that the US currency was at its most over-bought since the first quarter of 2010 and this also led to caution over further dollar buying.

The headline US payroll data was stronger than expected with an increase in non-farm payrolls of 200,000 after a revised 100,000 gain the previous month while there was another unemployment decline to 8.5% from 8.7%. There were solid private-sector employment gains with notable expansion in the transport sector which also boosted confidence in the economy. The dollar gained ground following the payroll data and pushed to a fresh 16-month high just beyond 1.27 against the Euro.

There were still cautious comments from Federal Reserve member Dudley who maintained a generally dovish stance on policy and there was also speculation that the Fed would look to block any further significant dollar appreciation due to a potential negative impact on exports. The US Federal Reserve Beige book reported further modest growth over the past few weeks which maintained expectations of US out-performance in the short term and this did provide background dollar support.

The headline increase in retail sales was, however, held to 0.1% while there was a core monthly decline of 0.2%. In addition, there was an increase in jobless claims to 399,000 in the latest week, in contrast to recent declines. The dollar gained some initial defensive support following the data releases, but then retreated as the Euro again benefitted from short covering.

Euro

The Euro-zone outlook will remain weak in the short term with further concerns surrounding the recession threat, especially with fears surrounding the peripheral economies. There has been some decline in bond yields which will help stabilise conditions to some extent. The depth of recession and deflation pressures will, however, be extremely difficult to reverse. There will also be continuing fears surrounding the sovereign-debt outlook and severe vulnerability within the banking sector. There will be pressure for the ECB to cut interest rates further over the next few months. Even if this salvages the Euro, the currency is liable to be generally weak over the next few months.

There was still a high degree of unease surrounding the Euro-zone banking sector, especially as Italian banks’ dependence on the ECB for funding increased sharply for December. There was also a record amount of funds parked at the ECB which continued to suggest very little confidence in the sector.

The latest German auction for six-month bills registered healthy investor interest. The main feature was that yields were actually negative for the first time. Although there was a technical change, the fact that investors were prepared to pay to hold German securities also illustrated the break-down in trust.

There were comments from ratings agency Fitch that the ECB needed to do more to prevent a cataclysmic collapse of the Euro which pushed the Euro sharply lower and there were further rumours surrounding a French credit-rating downgrade by Standard & Poor’s in rumour-driven trade.

There were well-received bond auctions from Spain and Italy ahead of the ECB meeting which provided underlying Euro support as peripheral yields fell sharply with the Euro recovering from lows below 1.27.

As expected, the ECB left interest rates on hold at 1.0% at the latest council meeting following cuts at the previous two meetings. Bank president Draghi stated that there was tentative evidence that the massive liquidity operations were having some success in easing credit conditions. Draghi also stated that there were signs that economic activity was stabilising. There were no suggestions that the bank was looking to cut rates again in the very short term, but markets continued to expect further action.

There was further unease surrounding the Greek situation with continuing obstacles to a debt-restructuring deal. Two senior members of the German governing CDU party also stated that a Greek exit from the Euro area could be manageable.

Sterling

Confidence in the UK economic outlook will inevitably remain extremely fragile. The latest survey evidence has, however, been mixed and some signs of resilience will lessen immediate fears surrounding a fresh slide into recession. There is still the potential for further action by the Bank of England to expand quantitative easing, especially if there is a fresh deterioration in the Euro-zone outlook. Defensive considerations will inevitably remain important and there will be some further inflows into the UK as a refuge from the Euro. Yields are extremely low, however, and there could be a rapid reversal in capital flows.

Sterling registered net losses against the dollar, briefly dipping to 3-month lows below 1.53 and also lost ground against the Euro after the recent strong run with the Euro moving back above the 0.83 level.

The latest UK data release were slightly better than expected with the RICS house-price index improving to -16% for December from -17% previously. There was also a stronger than expected reading for the BRC retail sales report with a 2.2% increase in the year to December which may ease immediate fears surrounding retail spending.

The trade data was slightly worse than expected with a GBP8.6bn goods deficit for November from a revised GBP7.9bn previously. The impact was limited as there should still be a narrower deficit for the fourth quarter.

There was a 0.6% decline in industrial production for November as energy output fell and a small decline in manufacturing production. The data is liable to trigger some downward revision to fourth-quarter GDP estimates and the NIESR reported that there was a 0.1% economic expansion for the quarter.

The Bank of England left unchanged interest rates on hold at 0.50% at the latest policy meeting and rates have been left on hold for close to three years. The amount of quantitative easing was also left on hold at GBP275bn for the month. There was further speculation that the Bank of England could announce additional quantitative easing following the conclusion of the existing programme.

Weekly Market analysis

The ECB has continued to have some success in easing credit conditions within the Euro-zone and there has been some lessening of the global dollar shortage while fear surrounding the growth outlook has eased slightly. In this environment, risk conditions could remain slightly more favourable initially which will also lessen defensive US dollar demand, but it will be difficult to secure a sustained improvement given the global risks with a particular focus on the Chinese outlook.

Key events for the forthcoming week

Date----------------------------Time (GMT)----------------------------Data release/event

Wednesday January 25th-----09.30---------------------------Bank of England MPC minutes

Wednesday January 25th-----19.15------------US Federal Reserve interest rate decision

Friday January 27th-----------13.30----------------------------------US GDP (Q4 advance)

Dollar

The underlying data tone has remained firm with solid manufacturing expansion and continued recovery in the housing sector which will maintain expectations of solid growth. The dollar will be in a position to gain yield support, but the impact will be lessened by the Federal Reserve determination to maintain a loose monetary policy. Defensive considerations will remain important and the dollar will lose potential support when fears surrounding the Euro-zone and global economies improve, especially if Libor rates decline. Caution is still liable to prevail, especially given the Asian economic risks and this should be important in curbing underlying dollar selling pressure.

The dollar strengthened sharply at the end of last week following the Standard & Poor’s downgrading of France, but it weakened steadily during the current week as the Euro recovered ground and there was a decline in defensive US demand.

The New York manufacturing PMI index was stronger than expected with an increase to 13.5 for January from 8.2 previously, maintaining the generally robust tone of recent economic releases. The data had some impact in underpinning risk appetite and this also tended to dampen defensive US demand to some extent with markets also on alert for comments from Fed officials ahead of next week’s FOMC meeting.

Housing starts were slightly below expectations at an annual rate of 0.66mn with permits unchanged for the month. In contrast, there was a sharp drop in jobless claims to 352,000 in the latest week from 402,000 previously while the Philadelphia Fed index edged lower to 7.3 from 10.3 previously. Headline consumer prices were unchanged for December with core prices rising 0.1% which did not have a major market impact as the monetary implications remain limited.

The latest Treasury flows data recorded an increase in long-term inflows into the US which provided some relief, although Chinese bond holdings continued to decline.

Euro

The ECB has had success in easing liquidity pressures within the financial sector and this should also ease pressure within the banking sector to some extent. There will also be relief that underlying demand for bonds has held relatively firm during the opening 2012 auctions. There has been some encouraging news from the German economy, but recession conditions are liable to prevail within the peripheral economies which will maintain economic and political pressures. There will also be fears surrounding a Greek default. There will also be pressure for a further decline in ECB interest rates which will curb Euro yield support.

The Euro was subjected to heavy selling pressure on reports of the French Standard & Poor’s downgrade with a cut for Austria also damaging as the EFSF was then stripped of its AAA rating. The Euro recovered from 16-month lows near 1.26 as a covering of short positions was a notable feature.

The German ZEW data was significantly stronger than expected with the headline business confidence index advancing to a six-month high of -21.6 from -53.8 previously and this was the strongest ever recorded one-month advance. There was also a decline in Spanish yields in the latest bond auction which helped underpin sentiment to some extent. There were still major fears surrounding divergence within the Euro-zone area with German economic gains not matched elsewhere and there were also concerns surrounding political divergence following the French AAA credit-rating downgrade which will put additional medium-term strains on the Euro.

There were further talks between the Greek government and major bond holders as they battled to secure a debt-restructuring deal. Even if a deal can be put together, there will be fears that it will be deemed as a default by the credit-rating agencies. Fitch warned in blunt language that Greece was insolvent and would default.

There were reports that the IMF was seeking additional funds to bolster its defences against the Euro-zone crisis. After some initial confusion surrounding amounts, the IMF suggested that it would look to increase funding by an additional US$600bn which would take the total commitment to USD1.0trn. There was, however, no indication of how these funds would be sourced, especially with US opposition to any increase in its contribution.

The latest Spanish debt auction was again stronger than expected in terms of investor interest which helped underpin Euro confidence with a solid French auction also maintaining expectations that the aggressive ECB policy stance was having a positive impact on liquidity which was also helping sustaining investor demand for securities with a positive impact on equity prices for the European banks.

Sterling

Confidence in the UK economic outlook will inevitably remain extremely fragile with particular concerns surrounding the outlook for retail spending. There will be further concerns surrounding the banking sector as lending levels will remain weak. There will be expectations of further Bank of England quantitative easing within the next 2-3 months which will keep yield support at very low levels. While Sterling can sustain defensive support as a refuge from Euro-zone fears, the UK currency can maintain a firm tone, although there is still a risk that capital flows will reverse quickly if UK fears intensify.

Sterling found support on dips to below 1.53 against the dollar and rallied to near 1.55 as the US currency retreated. Sterling corrected back to near 0.84 against the Euro.

The latest report from the ITEM forecasting club suggested that the UK might already be in recession as the Euro-zone crisis had a negative impact on business confidence. The group was, however, optimistic that a deep recession would be avoided.

Headline consumer inflation fell to 4.2% in December from 4.8% previously and there was a smaller decline in the core rate to 3.0% from 3.2%. The headline rate will continue to fall sharply in the short-term as 2011 tax increases come out of the calculation and retail discounting will also have an important impact.

The latest unemployment claimant count was again better than expected with the increase for December held to 1,200 after a revised 200 increase the previous month. The unemployment data was less favourable as there was an increase to a 16-year high of 8.4% from 8.3% and youth unemployment continued to increase.

Elsewhere, the Nationwide consumer confidence index fell to 38 for December from 40 previously and this was the second lowest figure on record. There were further expectations that the Bank of England would move towards additional quantitative easing at one of the next two meetings given fears over weak spending and lending.

There was further evidence of overseas demand for UK bonds as the yield on benchmark bonds fell to fresh record lows near 1.90%.

Weekly Market analysis

The Federal Reserve commitment to maintaining ultra-low interest rates will help underpin risk appetite in the short- term and will also curb any dollar demand. There are still substantial risks associated with the European banking sector as sovereign-debt fears persist and fear will intensify again if Greece formally defaults and, especially if fears intensify surrounding Portugal. The Chinese economic outlook will also be an important focus at the start of the new year.

Key events for the forthcoming week


Date----------------------------Time (GMT)----------------------------Data release/event

Monday January 30th--------------------------------------------------EU Summit

Wednesday February 1st-----09.30--------------------------------UK manufacturing PMI

Wednesday February 1st-----15.00--------------------------------US manufacturing PMI

Friday February 3rd-------------13.30--------------------------------US employment report

Dollar

There will be expectations of solid US growth which will provide some support to capital inflows. The Federal Reserve policies will also be a very important influence and the expected commitment to lower interest rates for an even longer period, coupled with the possibility of further quantitative easing, will undermine yield support and lessen dollar support. International considerations will still play an extremely important role and the US currency will lose defensive support when markets take a more optimistic stance. The overall pressure for financial de-leveraging will, however, continue in Europe and this will both undermine global growth and trigger underlying dollar demand.

The dollar dipped sharply following the Federal Reserve meeting with five-week lows on a trade-weighted basis, but did find some support at lower levels.

There were no Federal Reserve policy decision surprises with interest rates left on hold. The statement was, however, significantly more dovish than expected as the majority of participants were expecting Fed Funds to remain at the current extremely low levels until late in 2014 compared with previous expectations of 2013 previously. In his press conference, Fed Chairman Bernanke was also dovish in his outlook despite being slightly more optimistic surrounding near-term economic prospects. Bernanke stated that further quantitative easing could be considered and, although the Fed adopted an inflation target of 2.0% for the first time, he stated that further easing could be considered even if inflation was above 2.0%.

The dovish statement was important in underpinning risk appetite and was also important in undermining the dollar as it dipped sharply to lows beyond 1.31 against the Euro. There will be the risk of fresh trade tensions and friction with Europe given the perception that the US will resist forcefully any strengthening of the US currency.

The US jobless claims data recorded an increase to 377,000 in the latest week from 356,000 previously while durable goods orders rose 3.0% in the latest month. The data impact was inevitably limited at this stage as markets continued to consider the Federal Reserve statement and prospect for a continuation of near-zero interest rates. The US currency was still unsettled by the possibility of further quantitative easing as defensive dollar demand remained lower.

Euro

There will be further relief that the aggressive ECB liquidity operations have managed to stabilise conditions to some extent and ease the immediate threat of a destabilising credit crunch. The underlying situation is still precarious given exposure to sovereign debt. There will be further fears surrounding the threat of a Greek default and the rise in Portuguese yields will spark additional fears that Portugal will also move closer to default which would destabilise the Euro area. Whatever the outcome, the ECB will also have to maintain a very aggressive monetary policy to help support the economy and offset the deflation threat which will make it very difficult for the Euro to gain ground.

The Euro continued to recover ground, advancing to 2012 highs against the dollar, but was unable to hold its best levels, especially against the yen.

The Euro secured initial support from the latest flash PMI data which recorded an increase in the manufacturing component to 48.7 from 46.9 previously while the services-sector index moved above the 50 level for the first time since the August 2011 release. The data maintained the run of more favourable data seen over the past few weeks and helped ease immediate fears surrounding the Euro-zone outlook, although the Euro area was still dependent on the core economies.

There was further debate surrounding the Greek private-sector debt deal with a suggestion that a new arrangement could be in place by the middle of February. Nevertheless, there was further unease surrounding the situation as default fears intensified with Standard & Poor’s indicating that any agreement was likely to be considered a default.

In the event, there was still a high degree of uncertainty surrounding Greece and no deal was forthcoming with discussions set to continue on Friday. There were also further concerns surrounding the Portuguese situation as benchmark yields continued to rise to record levels with 10-year yields close to the 15% level. There were further rumours of pressure on the ECB to take losses on its substantial holdings of Greek bonds which unsettled sentiment in an environment of uncertainty.

There was also further pressure for the ECB to take a more aggressive stance towards interest rates which curbed Euro support.

Sterling

Confidence in the UK economy will remain weak following the reported GDP contraction for the fourth quarter. There will be further fears surrounding the outlook for retail sales and the economy will also come under further pressure if the Euro-zone outlook continues to deteriorate. The Bank of England is slightly less pessimistic over the economic outlook, but there is still the potential for additional quantitative easing. The outlook for capital flows will remain mixed as there will be the potential for defensive capital inflows, but these flows could reverse rapidly at current yields. Sterling volatility is liable to increase again.

Sterling generally pushed higher against the dollar with a peak near 1.57 even though gains were generally slow while the UK currency dipped weaker against the Euro as international moves dominated for much of the time.

The headline public-sector borrowing requirement was better than expected with a figure of GBP10.8bn for December from a revised GBP15.1bn previously. The market focus tended to be on the level of debt which rose above the GBP1trn level for the first time, but the negative Sterling impact was limited.

Bank of England Governor King remained cautious over the economic outlook with a warning that bank lending would remain weak. He also stated that lower inflation would give the bank scope to provide additional quantitative easing if necessary. King, however, was notably less fearful in his general comments on the economy compared with his tone late in 2011 which helped support Sterling.

The headline figure was slightly weaker than expected with a 0.2% fourth-quarter contraction and there will be concerns over the lack of growth in the private sector. The data will reinforce near-term fears surrounding the economy and the underlying debt trajectory. The Bank of England MPC minutes from January’s meeting recorded a 9-0 vote for keeping interest rates and quantitative easing on hold.

The minutes did, however, reveal greater divergence in opinion surrounding the outlook for growth and inflation. There was still a lack of confidence in the economic outlook, but several members were more doubtful whether there would be a sustained decline in inflation. In this environment, it will be more difficult to secure unanimous support for any further boost to quantitative easing at February’s meeting.

The latest CBI retail sales survey was substantially weaker than expected with a decline to a three-year low of -22 from +9 the previous month and the data reinforced a lack of confidence in the spending outlook.

Weekly Market analysis

Central bank policies will remain an extremely important focus in the short-term and aggressive liquidity operations will help underpin risk appetite globally with reduced fear surrounding the growth outlook. Concerns are liable to return again quickly given the underlying pressure for de-leveraging in the financial sector and high risks surrounding the Chinese economy. There will be further fears surrounding the Greek situation as some form of default remains unavoidable.

Key events for the forthcoming week

Date----------------------------Time (GMT)----------------------------Data release/event

Tuesday February 7th--------3.30---------------------Australia interest rate decision

Thursday February 9th------12.00-----------Bank of England interest rate decision

Thursday February 9th------12.45--------------------------ECB interest rate decision

Dollar

The latest data releases continue to indicate solid US growth is likely in the short-term, although there have been some concerns that momentum will fade over the next few months. The Federal Reserve has reinforced its commitment to maintaining very low interest rates and this will be important in curbing any significant yield support for the dollar. Global influences will remain very important and defensive US currency demand will also stay lower when there is increased optimism that central bank liquidity will underpin growth. Confidence is still liable to fluctuate sharply at times and, given pressure for financial de-leveraging, the dollar should be able to resist heavy losses.

The dollar was generally weaker as an improvement in risk appetite helped curb defensive demand for the currency while yield conditions failed to improve further. Month-end flows triggered fresh volatility with the Euro hitting resistance above the 1.32 area while the dollar found some support at 2-month lows.

The early US economic data was generally weaker than expected with a decline in consumer confidence to 61.1 for January from a revised 64.8 previously, in sharp contrast to expectations of a gain. The Chicago PMI index also weakened to 60.2 for the month from 62.2 previously. The data had a significant impact in undermining risk appetite which provided some defensive dollar support.

The US ADP employment report was slightly weaker than expected with a 170,000 increase for January, but there was still a strong two-month increase following a revised 292,000 gain the previous month. The ISM index rose to 54.1 from a revised 53.1 the previous month. Employment and order components were firm. The other US economic data did not have a major impact with a decline in jobless claims to 367,000 in the latest week from 379,000 previously.

There were divergent views from regional Fed Presidents who are not on the FOMC this year with Fisher stating his opposition to any further quantitative easing while Evans maintained his dovish tone and promoted the case for further monetary action.

Fed Chairman Berrnanke took a more balanced approach in Congressional testimony and was keen to emphasis that the Fed would not abandon the inflation target, although is tone may well have been aimed at placating Republican fears.

Euro

The Euro-zone data as a whole has shown some improvement, but the gains have again been focussed to a large extent in Germany as peripheral economies remain stuck in recession. Although the ECB has managed to avert the immediate threat of a severe credit crunch, underlying financial conditions are likely to remain extremely tough and there will be strong pressure for the ECB to cut interest rates again. It will also be extremely difficult for Greece to avoid a default with Portugal also exposed to a contagion threat. The policy mix will tend to undermine the Euro unless there is increased speculation surrounding the possibility of a hard, smaller Euro area being formed.

The Euro retained a corrective and firmer tone against the dollar and did move to 2012 highs before stalling as it struggled for traction on the crosses.

The Euro-zone PMI manufacturing index edged higher in the final reading with Germany a notable gainer. Optimism was tempered by the fact that indices in Greece, Spain and Italy all remained substantially below the 50 threshold. The flash Euro-zone consumer inflation estimate was unchanged at 2.7% for January and markets still expected that the ECB would look to cut interest rates further this quarter.

There was further speculation over an imminent Greek private-sector debt restructuring deal, although again there was no actual announcement of a deal. There was also some relief surrounding Portuguese debt following a satisfactory bill auction, but yields remained close to record highs as confidence remained very fragile.

Given the Greek debt profile, either the government will have to find additional savings which, politically, will be extremely difficult or there will need to be even bigger losses for private creditors. Any such deal for creditors would be regarded as an effective default by the ratings agencies. There were further concerns surrounding Portugal’s default risk as yields rose to fresh record highs.

There was further downward pressure on the Euro following comments from Euro-group Head Juncker that the Greek debt restructuring situation was ‘ultra-difficult’. Following numerous reports over the past week that a deal was extremely close, the comments inevitably dampened optimism surrounding the near-term situation. More seriously, there were fears that any restructuring deal would still not provide a durable solution given the underlying debt burden. In this context, there were also fears that Greece could still face a Euro exit.

Sterling

Confidence in the UK economy will remain weak with particular concerns surrounding consumer spending. There will also be continuing fears over fragile Euro-zone demand and the weakness in monetary data will be of particular concern to the Bank of England. There will, therefore, be continued speculation over additional quantitative easing within the next few weeks. The immediate impact on Sterling may be limited, especially as there is still the potential for defensive inflows into the UK if Euro-zone fears intensify, but there will be concerns surrounding the medium-term currency outlook.

Sterling maintained a firm tone against the dollar for much of the week and pushed to a five-month high above 1.5850 before stalling. UK currency moves are still influenced strongly by trends in risk appetite and a firm global tone helped boost the UK equity market as well as Sterling against the Euro.

The PMI manufacturing data was stronger than expected with an increase to 52.1 for January from a revised 49.7 although confidence was still fragile and the data is likely to have been distorted by favourable weather conditions. The Nationwide house-price index recorded a 0.2% decline for the second consecutive month, maintaining the recent soft tone in the housing sector.

The latest consumer lending data was weaker than expected with a decline in consumer credit for December and there was also a further sharp monthly drop in money supply. Although the data may have been distorted by special factors, there will be further concerns over banking-sector vulnerability and a lack of lending.

Bank of England MPC member Posen was slightly more optimistic surrounding the economic outlook, but he still proposed additional quantitative easing of around GBP75bn. The currency impact of further easing on this scale should be measured, with uncertainty a key feature ahead of next week’s Bank of England policy meeting.

Weekly Market analysis

The immediate threat of a Greek debt default may have been eased by the latest deal, but the situation is far from secure as there will be intense opposition to the agreement within Greece and major reservations throughout the Euro area. A renewed default threat would be a serious test for the generally more confident tone surrounding risk appetite and confidence in the global economy, especially if confidence in the Chinese outlook deteriorates further.

Key events for the forthcoming week


Date----------------------------Time (GMT)----------------------------Data release/event

Tuesday February 14th----------10.00------------------------------German ZEW index

Tuesday February 14th----------13.30--------------------------------US retail sales

Wednesday February 15th------10.30-----------------Bank of England inflation report

Dollar

Confidence in near-term growth prospects should remain firm, especially after the employment data and this will have some positive impact on sentiment. Monetary policy will, however, remain a very important stumbling block for the dollar, especially with the Fed maintaining a dovish stance and expecting that short-term rates will remain at very low levels until 2014. There will also be longer-term budget fears which will remain a negative influence. The dollar’s correlation with degrees of confidence in the global economy will remain high and it will stay vulnerable when confidence in the global economy is higher.

The dollar was on the defensive for much of the week, but it was able to resist major losses and secured a limited recovery as the Euro and commodity currencies were unable to hold their best levels later in the week.

Following stronger than expected labour-market data at the end of last week, the US jobless claims was better than expected with a decline to 358,000 in the latest week from 373,000 previously, maintaining the recent underlying improvement. The dollar still found it difficult to gain any additional support given the Federal Reserve stance. There was strong demand at the latest Treasury bond auction which suggests underlying confidence in the global outlook may still be very fragile. The US economic indicators were relatively minor, but maintained a firm tone as consumer credit rose by a further US$19.8bn and consumer confidence improved.

Although this suggests solid growth, the data impact was limited and tended to be overshadowed by comments from Fed Chairman Bernanke. His remarks were broadly unchanged from last week with no concession to the payroll data as he stated that the data was understating the unemployment problem. Regional Fed President Williams stated that further quantitative easing would be a close call and took a generally dovish tone while Lacker stated that further easing was unlikely. Markets will maintain expectations of a dovish tone given the overall FOMC composition.

Euro

The German economy is still performing well and there has been some evidence of stabilisation in the Euro-zone as a whole. The outlook is still very weak, however, and fears surrounding the peripheral economies will inevitably stay very weak as the peripheral economies remain trapped in recession. Any Greek deal is unlikely to provide sustained relief, especially as there will be major doubts surrounding implementation of further austerity measures. The ECB will remain under pressure to provide further relief in the form of lower interest rates and aggressive repo operations. The net capital-account trends are likely to remain broadly negative for the Euro.

The Euro attempted to regain more ground during the week and did test important resistance levels against the US currency before buying support faded above 1.33.

Greek talks dominated for much of the week as wrangling over an agreement continued. There were reports that the ECB would be willing to exchange its Greek debt holdings with the EFSF which boosted sentiment. There were also comments from several officials that the Euro would be able to survive without Greece in the single currency and speculation that reduced fear surrounding the consequences of a Greek exit would encourage a hard line.

As expected, the ECB left interest rates on hold at 1.0% at the monthly meeting. In the press conference following the decision, there was a slight adjustment in the tone from bank President Draghi. The economic outlook was subject to high uncertainty and downside risks which was a slightly more positive statement than last time when the downside risks were described as ‘substantial’. There were still expectations that the ECB would be prepared to cut interest rates again if the outlook deteriorated. Draghi refused to comment on the issue of Greek bonds.

Ahead of the Euro-group meeting in Brussels, the Greek government stated that it would accept the conditions for a EUR130bn second loan package to prevent a debt default. The government will still need to find an extra EUR350bn in savings to meet troika demands and will also need rapid parliamentary approval for the measures. Two coalition party members resigned immediately following the deal and there will inevitably be a hostile response within Greece. These uncertainties prevented the Euro from gaining much traction and it again failed to hold above the 1.33 level.

Sterling

There will be further concerns surrounding the consumer spending outlook. Business surveys have been generally mixed and fears over recession have eased slightly following more robust business surveys. The Bank of England decision to expand quantitative easing should not have a major impact for now, especially with other central banks maintaining a very aggressive monetary stance. The Euro-zone situation will be watched very closely and there will be the potential for defensive capital inflows if fear intensifies again.

Sterling tested 5-month highs above 1.59 against the dollar during the week before drifting lower as it also lost momentum against the Euro as the single currency recovered back to near the 0.84 level.

The Monetary Policy Committee (MPC) announced a further GBP50bn increase in quantitative easing while interest rates were unchanged at 0.50% which was broadly in line with market expectations. In justifying the decision, the bank stated that weak growth was likely to push inflation below the 2.0% target on a two-year horizon and there was market speculation that there had been splits within the MPC. Sterling initially advanced on relief that even larger additional quantitative easing had been resisted before drifting weaker again.

The economic data was mixed as a recovery in December manufacturing output failed to prevent a decline for the quarter while the NIESR estimated that that the economy shrank 0.2% in the three months to January.

Weekly Market analysis

The immediate threat of a Greek debt default has been alleviated by the second loan deal, but the medium-term situation is far from secure as there will be intense opposition to the agreement within Greece and major reservations throughout the Euro area. It will still be difficult to secure a sustained boost in risk appetite given the growth doubts with a particular focus on the Chinese outlook. The aggressive monetary policies should still help underpin risk appetite to some extent.

Key events for the forthcoming week


Dollar

The US economic data has remained generally favourable during the month with gains in the housing sector and slid consumer spending levels. Monetary policy will inevitably remain an important focus and there will be some reductions in speculation that the Fed will sanction a further round of quantitative easing. Interest rates will still remain extremely low which will curb any yield support and longer-term fundamental doubts will remain important influence. Global risk appetite will continue to have an important influence and there will be reduced dollar demand when confidence improves, but the net risk profile should limit selling pressure.

The dollar secured buying support at times, but it was unable to make sustained headway during the week and was subjected to net losses against the Euro as position adjustment had an important impact with the Euro pushing to 2012 highs. The US currency was more resilient against commodity currencies.

The US existing home sales data was slightly weaker than expected with a figure of 4.57mn from 4.38mn previously, although this was still a four-month high as the sector continued to show an underlying recovery.

The US labour-market data was again firm with jobless claims unchanged at 351,000 in the latest week while there was an increase in house prices according to the latest monthly report. The dollar gained some support on yield grounds while defensive demand for the currency was generally weaker with the US currency unable to secure sustained support.

Euro

The easing of an immediate default threat surrounding Greece will have some positive influence on the Euro as fear has eased. There will still be serious misgivings over the underlying situation, especially as there will be a high degree of resistance within Greece and risk of changes following scheduled elections in April. There will be concerns surrounding the Euro-zone economy as a whole even with generally optimistic sentiment surrounding the German economy. The ECB will have to maintain an expansionary policy to support the economy which will undermine Euro support.

There was further optimism that the Eurogroup meeting would agree on a loan package for Greece at Monday’s meeting. Over the weekend, there had been speculation that a decision could be delayed until March, but German officials were keen for the issues to be resolved at Monday’s meeting. There was also a mood of cautious optimism, in public at least, with Greek officials also expressing hopes that a deal could be finalised.

The ECB announced that it had not bought any peripheral bonds during the week for the first time since the programme was restarted in August 2011, fuelling market expectations that the ECB and Euro as a whole had moved to an important new phase with a more aggressive monetary policy the instrument for keeping bond yields down.

In the event, a deal was reached with the EUR130bn second loan package in place for Greece. The private-sector debt haircut will be 53.5% and replacement bonds will have an initial coupon of 2%.

There were still fears surrounding the longer-term implications of the deal, especially as there are elections in April which is liable to trigger a fresh reassessment of the deal within Greece. Immediate concerns eased slightly following suggestions that the IMF would be willing to provide additional funding, but there were very important longer-term misgivings over the underlying deal, especially with expectations that Greece would remain in a deep recession which would severely test the domestic willingness to back austerity measures.

As far as the economic data is concerned, the Euro-zone PMI manufacturing index was slightly weaker than expected with only a marginal increase of 49 from 48.8 previously while the services figure dropped to 49.4 from 50.4 as there was a significantly weaker result from Germany. The data did dampen expectations that the economy would be able pull out of downturn.

The German IFO index was again stronger than expected with an increase to a eight-month high of 109.6 from 108.3 the previous month. The Institute remained confident that recession would be avoided, maintaining a more optimistic tone towards the German economy. In contrast, the European Commission issued a generally downbeat assessment of the economic outlook, forecasting a GDP contraction for the Euro area as a whole with a decline in Spain and Italy.

Sterling

There will be further concerns surrounding the consumer spending outlook. The overall economic data has been more favourable with a rebound in key business surveys and the general tone of data releases has eased immediate fears that the economy will slide back into recession. There will be speculation that quantitative easing could be expanded further and underlying yield support remains very limited for the currency. Sterling will tend to lose defensive support if there is a sustained improvement in Euro-zone sentiment with volatility liable to remain high.

Sterling was unable to make headway against the dollar during the week with resistance above 1.58 and retreated to 2012 lows against the Euro with lows near 0.85.

As expected, the Bank of England minutes recorded a 9-0 vote for interest rates to be left on hold at 0.50%. There was a split 7-2 vote on the decision to raise quantitative easing by GBP50bn at the meeting. Posen and Miles votes for a GBP75bn boost to quantitative easing while there were other members of the committee who had reservations about any further boost even though they voted with the majority.

The central bank was slightly more optimistic surrounding the growth outlook, but estimated that further easing was required to prevent inflation under-shooting in the medium term. The minutes were more dovish than expected and pushed Sterling significantly weaker. Technical considerations also played an important part as the Euro advanced on stop-loss buying and investor demand once it broke above 0.84.

The latest CBI industrial orders survey was stronger than expected with a 6-month high of -3 from -16 previously as fears surrounding the export sector eased slightly. There was also a stronger reading for mortgage approvals according to the latest data as buyers secured deals ahead of an ending of tax breaks.

Weekly Market analysis

The immediate attention surrounding Greece and its default threat will ease following the debt swap. There will still be a lack of confidence in the underlying Euro-zone fundamentals given the overall debt profile and expectations that a contractionary fiscal policy will push other vulnerable countries towards eventual default. The underlying Greek situation will also be extremely unstable and unease surrounding the global economy is liable to increase again as Chinese doubts continue to increase.

Key events for the forthcoming week

Date----------------------------Time (GMT)----------------------------Data release/event

Tuesday March 13th--------------10.00-------German ZEW business confidence index

Tuesday March 13th---------------18.15---------Federal Reserve interest rate decision

Thursday March 15th--------------08.30-----------Swiss National Bank policy decision

Dollar

Assuming there is a relatively solid payroll report, underlying confidence in the US economy should remain firm with expectations that the US will be able to out-perform Europe and this should generate capital inflows. The potential beneficial impact will still be offset by expectations of a very expansionary Federal Reserve policy and by speculation that there could still be further quantitative easing to help support the economy. The dollar will gain fresh defensive support if there is a renewed deterioration in risk appetite despite the underlying lack of enthusiasm.

The dollar secured defensive support from a deterioration in risk appetite over the first half of the week. The currency was unable to sustain the advance as confidence in the US currency remained generally fragile with the Euro rallying from lows near 1.31.

The US ISM non-manufacturing index was stronger than expected with an increase to 57.3 for February from 56.8 the previous month, in contrast to expectations of a modest decline for the month. The data maintained a degree of confidence in the short-term US outlook and also reinforced potential US yield support in comparison with the Euro area. The employment component was slightly weaker, but still signalled moderate expansion, underpinning expectations of solid payroll growth.

The US ADP employment report was broadly in line with expectations with private-sector payroll growth estimated at 216,000 for February from a revised 173,000 the previous month. As far as the US jobless claims were concerned, there was an increase to 362,000 in the latest week from 354,000 the previous week which maintained a general tone of optimism towards the consumer conditions.

The positive impact of the economic data was offset by renewed speculation that the Federal Reserve could implement a further limited form of quantitative easing later in 2012 to help support demand conditions.

Euro

Immediate fears surrounding a Greek default have been eased by the private-sector debt rescheduling and approval of a second loan package and confidence will remain slightly stronger in the short-term. There will still be a high degree of fear surrounding the medium-term outlook. The Greek situation is still highly unstable and second-quarter elections will threaten to unravel the deal. Political factors will also be extremely important elsewhere and tensions surrounding France’s presidential election are likely to increase. The ECB will have to maintain a highly-expansionary monetary policy and the Euro will find it very difficult to make significant headway.

The Spanish decision to target a higher budget deficit for 2012 continued to have political ramifications and stresses amid speculation that there could be wider Euro-zone dissent against the fiscal compact and this helped push the currency weaker before rally on expectations of a successful Greek outcome with highs near 1.33.

There was a stream of media reports surrounding the Greek private-sector debt swap deal ahead of the deadline and there was a generally optimistic tone with reduced fears that the participation rate would be below the 75% threshold which would effectively push Greece into default.

As expected, the ECB left interest rates on hold at 1.00% following the latest council meeting and President Draghi claimed that there had been no discussion of lowering interest rates. The risks to the economic outlook were still to the downside according to the staff projections while there was an increase in the inflation forecasts. Draghi tended to concentrate on the inflation aspects early in the press conference which gave the Euro a firm tone. Although expressing confidence in the LTRO actions so far, he did express caution over the need for further action at this time.

There was a further decline in Italian yields during the week which helped underpin confidence in the peripheral economies and also provided some degree of Euro support on reduced fears that Italy would be pushed towards default.

There was official confirmation of the Greek swap late in Asia on Friday with the government securing support of 85.8% of bond-holders. There was disappointment that the threshold for avoiding CAC payments was not reached and the Euro retreated back to the 1.3230 region as the ISDA will meet to discuss a credit event.

Sterling

Confidence in the UK economy is likely to remain slightly stronger in the short-term with reduced fears surrounding a slide into recession following a batch of more favourable data. There will also be lower expectations over any further quantitative easing by the Bank of England. The confidence could still prove to be very brittle given the underlying economic vulnerability and weakness within the banking sector. Safe-haven considerations will remain important and there will be a reduction in Sterling demand if Euro-zone fears ease.

Sterling edged lower ahead of the UK services-sector PMI index on Monday amid rumours of a weaker than expected release. In the event, the index declined to 53.8 from 56.0 the previous month which triggered initial Sterling weakness and a 10-day low below 1.58 against the dollar. The impact was limited by an advance in business expectations to a one-year high.

There were no surprises from the Bank of England interest rate decision with quantitative easing left on hold at GBP325bn while interest rates were also on hold at 0.5%. Rates have now been held at 0.50% for the past three years and the minutes will be watched closely in two-week’s time to assess whether there will be support within the MPC for further quantitative easing.

Sterling gained some support from a recovery in risk appetite, although it was broadly sidelined during the week as attention remained firmly on the Euro area. The UK currency weakened back to the 0.84 area against the Euro.

Weekly Market analysis

Overall strategy: The favourable run of economic data has boosted underlying confidence in the US economy and yield support will remain firmer in the short term. There will be continuing expectations that the US economy will out-perform much of Europe and there will also be further concerns surrounding the Chinese outlook on concerns over a potential hard landing. In this environment, there will be the potential for a sharp deterioration in risk appetite if there is any evidence of deterioration in the US outlook with no major areas able to provide strong support.

Dollar

There will be further short-term confidence in the US economic outlook following the run of generally favourable data releases, especially after the stronger than expected payroll report. The US currency will gain support from the decision not to consider further quantitative easing at this stage, although the Fed will still maintain a very loose monetary policy. The dollar will also gain support on a downgrading of expectations surrounding other major economies with additional backing realistic if risk appetite deteriorates.

The dollar gained support following the stronger than expected US employment last week and maintained a firm tone over the week as a whole, although there was some slowdown in the gains as key resistance levels were approached. The Euro retreated to lows close to 1.30 as the US yield advantage was sustained.

As expected, the Federal Reserve left interest rates on hold below 0.25% following the latest FOMC meeting. There was a more optimistic stance on the economy with expectations of moderate growth and there was greater confidence in the labour market while financial-market tensions had eased. There was no mention of further quantitative easing, but there was still an expectation that interest rates would remain at exceptionally low levels through 2014.

Regional Fed President Lacker dissented against the interest rate pledge and the lack of quantitative easing references helped boost the dollar. US 10-year yields rose to a 15-week high which helped underpin the dollar.

US jobless claims fell to 351,000 in the latest reporting week from 365,000 previously maintaining a run of generally favourable labour-market data. There were robust readings for the regional PMI indices as the New York Empire index rose to 20.2 from 19.5 the previous month, although there was a dip in the orders component. There was a similar pattern in the Philadelphia Fed index as a rise to 12.5 from 10.2 masked a weaker reading for orders which may trigger some unease over the second-half growth outlook.

There was a stronger than expected reading for long-term capital inflows with a rise to US$101bn for January from US$19.1bn previously. There will be relief that there was a rise in inflows, especially with concerns that China had been shifting funds out of US Treasuries and should provide some fundamental dollar support.

The US currency maintained its yield advantage which helped limit pressure for profit taking and the Euro stalled in the 1.31 with some choppy trading conditions following the reports that some of the Strategic Petroleum Reserve would be released.

Euro

The immediate crisis surrounding Greece has been eased by approval of the PSI deal and second loan package. There will still be an important lack of confidence in the underlying Greek situation and expectations that other weaker economies will slide towards default with political pressures set to increase. There will be strong pressure on the ECB to maintain a very expansionary monetary policy and there will also be concerns that political divisions within the Euro area will intensify. In this environment, the Euro is likely to remain generally on the defensive and vulnerable to underlying depreciation given the policy balance.

There was only limited reaction to the Greek PSI deal finally being completed with some degree of caution ahead of the ISDA announcement on whether a credit event would be declared. The ISDA did declare that a credit event had taken place, although the impact was limited.

There was relief that the Greek situation had been resolved for now despite an important lack of confidence in the medium-term outlook. There was speculation that an additional support package may be required for Greece and there were fears that Portugal would get dragged towards a default in the medium term. There were also further tensions surrounding Spain’s 2012 budget target.

There were persistent doubts surrounding the wider Euro-zone economic outlook. Markets were also expecting the ECB to maintain an aggressive monetary policy to help salvage the banking sector which dampened demand for the Euro. Selling pressure was contained to some extent by a stronger than expected reading for the German ZEW index which strengthened to the highest level since 2010.

Sterling

Confidence in the UK economy is likely to remain slightly stronger for now with reduced fears surrounding a slide into recession. There will also be lower expectations over any further quantitative easing by the Bank of England. The confidence could still prove to be very brittle given the underlying economic vulnerability and the potential vulnerability has been illustrated by Fitch’s decision to put the UK AAA rating on negative watch. There will also be further concerns surrounding the banking sector which will limit Sterling support.

Sterling found support close to 1.56 against the dollar during the week and proved generally resilient in the face of a stronger US currency. Sterling was also able to strengthen back to 1-month highs close to 0.83 against the Euro.

There was a 7,200 increase in the UK unemployment claimant count from a revised 7,000 increase the previous month with the unemployment rate unchanged at 8.4%. There was a further decline in average earnings growth to 1.4% from 1.9% according to the latest data with a notable squeeze in government-sector earnings which maintained fears that consumer spending would come under pressure over the next few months which would undermine the wider economy.

There was some negative impact from Fitch’s announcement that the UK credit rating had been put on negative watch. The timing of the announcement was particularly significant with the UK budget due next week. There was speculation that the government would be forced to take a more restrictive stance on fiscal policy to help bolster international confidence. This would maintain expectations that there would be a loose monetary policy which curbed Sterling demand.

Weekly Market analysis

The global economic outlook will remain an important market focus. The dollar will gain support from expectations that the US economy will out-perform other regions in the short-term. If there is any further evidence of deterioration in the Chinese and Euro-zone outlooks, then there is also likely to be a more defensive stance on risk appetite with a shift into more instruments such as the yen and dollar.

Dollar

The US economic data is likely to have been boosted artificially to some extent by favourable weather conditions and there will be scope for some disappointment over the next few weeks. There should still be confidence that the US will out-perform the Euro-zone which will provide continuing yield support. The Federal Reserve will maintain a very expansionary monetary policy which will continue to limit the scope for US support and fundamental doubts are liable to increase. Global considerations will remain important and there is scope for additional dollar demand on defensive grounds if fear increases.

The dollar recovered from lows during the week as there was fresh buying support on defensive grounds as risk appetite deteriorated. The US currency also gained some net support on yield grounds as US Treasuries were generally on the defensive.

The US housing starts data was close to expectations at an annual rate of 0.70mn for February while permits increased to an annual rate of 0.72mn, the highest figure since 2008. The data helped maintain a degree of optimism towards the US economy and helped push US Treasury yields higher. There was still some suspicion that the data should have been even stronger given the favourable weather conditions.

In comments on Tuesday, Fed Chairman Bernanke stated that it would be a mistake to withdraw monetary stimulus too quickly, maintaining expectations that the Fed will be very cautious in removing monetary stimulus which will also limit dollar support.

There was a commentary from PIMCO that it was expecting the dollar to strengthen in the short-term even though it remained uneasy over the currency in the longer-term.
The weak Euro-zone data, following on from the weak Chinese PMI release had a significant impact in damaging risk appetite as global growth fears increased. These fears had an important impact in boosting defensive dollar demand as equity markets were subjected to fresh selling pressure.

The US jobless claims data was slightly stronger than expected with a decline to 348,000 in the latest week from 353,000 the previous week and close to four-year lows. House prices were broadly stagnant with no change reported for January. Regional President Bullard maintained the more constructive Fed tone towards the economy while Fisher stated that he would not support further quantitative easing, although neither of these are voting members this year.

Euro

The ECB has had some important success in stabilising credit conditions and easing an immediate liquidity crisis. There will still be fears surrounding the banking sector and the threat of credit de-leveraging. In this context, there will also be fears surrounding the economic outlook as the peripheral economies remain trapped in recession which will maintain the threat that weaker economies will eventually be forced out of the Euro area. The ECB will be forced to maintain a very expansionary policy which will limit Euro support.

The Euro was blocked on rallies towards the 1.33 level against the US dollar during the week as underlying sentiment remained fragile on longer-term economic doubts. Greece formally approved the loan package which had only a limited impact and the Euro proved broadly resilient.

The currency was subjected to heavy selling pressure during the European session on Thursday as sentiment was undermined by weak economic data. The flash Euro-zone PMI manufacturing index weakened to 47.7 for March from 49 previously, dashing hopes of a further monthly improvement while the services-sector index was also trapped below the 50 level.

The data had a dual negative impact on the Euro with a renewed increase in unease surrounding the regional growth outlook which undermined confidence directly. There has been further evidence of credit-deleveraging and a tightening in lending conditions which will have an important impact in damaging activity. There were also renewed fears surrounding the peripheral economies and yield spreads rose significantly during the day as confidence in Spain was particularly fragile. Spanish bond yields rose to the 5.5% level for the first time since January.

Sterling

Although sentiment surrounding the UK economy has been slightly more positive, there will still be important reservations surrounding the outlook, especially with serious doubts over the consumer spending. The medium-term fiscal outlook also remains precarious and only a small shift in sentiment could trigger a serious deterioration in international confidence. In this context, there will also be renewed fears surrounding the banks, especially if there is a wider deterioration in global risk appetite. With the Bank of England maintaining an aggressive monetary expansion, Sterling support is liable to be limited.

Sterling hit resistance above 1.59 against the dollar during the week and retreated to lows below 1.58 before stabilising. The UK currency was unable to sustain a move through 0.83 against the Euro.

The headline consumer inflation rate was in line with expectations as it declined to 3.4% from 3.6%, although the RPI rate was higher than expected and there was some disappointment that the rate did not decline further. The latest government borrowing data was much weaker than expected with a requirement of GBP12.9bn from a revised surplus of GBP10.9bn the previous month as tax receipts were weaker. The data increased unease over the medium-term budget outlook.

There was no surprise in the Bank of Minutes interest rate decision with a 9-0 vote to leave rates on hold at 0.50%. The quantitative easing vote was more surprising with a 7-2 vote at the meeting as both Posen and Miles voted for an additional GBP25bn in bond purchases. The majority of members were more circumspect surrounding the inflation outlook and opted for an unchanged policy at this month. The more dovish than expected tone had a significant impact in undermining Sterling.

The budget was broadly neutral in overall economic terms with the OBR revising its GDP forecasts slightly higher, although uncertainty remained high. The overall stance continued to illustrate that the government had very little room for manoeuvre.

The latest retail sales data recorded a headline decline of 0.8% for February following a revised 0.3% gain the previous month, the sharpest decline for 9 months. The data reinforced unease over consumer spending trends and dampened the slightly greater mood of optimism surrounding the economy seen over the past few weeks. There was also a decline in the latest Nationwide consumer confidence index.

Weekly Market analysis

Overall strategy: The global economic outlook will continue to be an important market focus. The dollar will gain support from expectations that the US economy will out-perform other regions in the short term. The generally dovish Federal Reserve tone will, however, limit the potential for dollar gains, especially with continuing speculation that there could be additional action to boost the economy through further quantitative easing.

Dollar

The US economy is likely to have been boosted artificially by favourable weather conditions during the first quarter and there will be further scope for some disappointment over the next few weeks. This will dampen any expectations that the Federal Reserve will move towards a policy tightening and there is also likely to be fresh speculation over additional quantitative easing. There is still likely to be confidence that the US will out-perform Europe which will provide some underlying dollar support. The currency will also tend to gain additional defensive demand when confidence in the global economy deteriorates and substantial dollar selling pressure looks unlikely.

The dollar advanced at times during the week, but it was unable to sustain gains and retreated again for the week as a whole with some portfolio adjustment at the end of the first quarter undermining the currency and it failed to hold gains.

The latest US consumer confidence reading was slightly weaker than expected with a reading of 70.2 for March from a revised 71.6 previously. Headline US durable goods orders rose 2.2% for February following a revised 3.6% decline the previous month while core orders rose 1.6%. The US GDP data was in line with expectations at 3.0% for the fourth-quarter final reading. Jobless claims were higher than expected at 359,000 for the latest week from a revised 364,000 previously which also cast some doubts over the US outlook as it maintained the run of slightly weaker data releases.

The US Federal Reserve Chairman was slightly more optimistic surrounding the growth outlook, but he also stated that the labour-market situation was far from normal. He also stated that it would not be the right time to withdraw monetary stimulus. The dovish comments put the US currency under wider selling pressure as yield support declined on renewed speculation over further quantitative easing.

Fed Governor Dudley remained cautious over the outlook, but also stated that there was unlikely to be any immediate action to provide fresh stimulus to the economy. The comments had some impact in reversing quantitative-easing expectations.

The dollar was unable to gain further support on yield grounds and also failed to sustain the advance against the Euro as it retreated back towards the 1.33 area on expectations that US interest rates would stay very low.

Euro

There will be further concerns over the peripheral economies in the short term as recession continues to bite. Demands for further budget cuts will also increase fears that policies are unsustainable which will increase structural fears and invite another phase in the Euro-zone crisis. The ECB has stabilised credit-market conditions, but the net effect has been quantitative easing which will tend to devalue the currency on a medium-term view, especially as it will have to maintain a highly-expansionary policy which will tend to sap any Euro strength.

The Euro was able to resist selling pressure during the week with evidence of solid buying support on dips and it re-tested monthly highs.

The German IFO index was slightly stronger than expected with a headline figure of 109.8 for March from 109.7 previously which was the fifth consecutive monthly increase. An initial Euro rally was not sustained as there were slightly more cautious comments from IFO economists which dampened the mood to some extent.

There had been speculation over the weekend that the German government’s opposition to running the EFSF and ESM in tandem was softening and this stance was confirmed by Chancellor Merkel in comments on Monday. Although there was a continued rebuttal of any move to increase the size of the ESM, the remarks boosted confidence that the Euro-zone firewall would be strengthened which would in theory lessen the potential contagion threat if tensions increased again and this provided background Euro support.

There were further concerns surrounding the Euro-zone outlook with a particular focus on Spain and Italy. Spain’s general strike and uncertainty ahead of Friday’s budget presentation had a significant negative impact on sentiment. There were also fresh concerns surrounding the Italian outlook as yield spreads over German bunds also widened again.

There was also a renewed deterioration in business confidence which reinforced growth doubts and offset the impact of a larger than expected decline in German unemployment, especially as it maintained concerns that the peripheral divergence would continue over the next few months. The dollar also gained some support on the latest OECD report which suggested that the US economy would out-perform Europe. These fears were offset by optimism that EU leaders would agree to a stronger set of support funds at their meetings on Friday and Saturday.

Sterling

There will still be important reservations surrounding the UK economic outlook, especially with serious doubts over the consumer spending. With the OECD warning that the economy is back in recession, there will be further speculation that the Bank of England will decide on additional quantitative easing. Global considerations will remain very important and sentiment will tend to weaken when confidence deteriorates, especially as there will be increased fears surrounding the banking sector and Sterling is unlikely to make much headway.

Sterling maintained a solid tone during the week with technical considerations playing an important role as markets challenged key levels. There was interest in breaking reported option barriers in the 1.60 region with a temporary push above this level while the UK currency was also trading close to the 200-week moving average.

Fourth-quarter UK GDP was revised down to -0.3% from -0.2% previously which had a significant negative impact, especially as there was annual growth of only 0.5% with the economy basically stagnant since the Autumn 2010. There were further concerns over the implications of a decline in disposable income, but investment was revised slightly higher.

Mortgage approvals data was sharply weaker than expected with a fall to 49,000 for the month from 58,000 previously. There was also a decline in the latest Nationwide house-price index with a -1.0% decline for the month following a revised 0.4% gain the previous month which reinforced expectations that the ending of tax reliefs was undermining housing-sector support and revealing underlying vulnerability.

There was a solid reading for consumer lending, but a sharp decline in money supply reinforced fears surrounding bank lending. The net impact was to increase speculation that the Bank of England would have to resort to further quantitative easing.

Weekly Market analysis

After some respite following the Greek loan deal, Euro-zone structural fears have tended to increase again over the past week with a renewed focus on Spain as the restrictive budget undermined confidence in the economy and Euro. There is an important risk that these fears will intensify over the next few weeks. There will be near-term optimism that the US economy will out-perform in the short-term which should provide some net dollar support as global central banks maintain very loose monetary policies.

Dollar

Underlying confidence in the US economy should remain firm in the short-term, especially if there is a robust reading for the latest employment data. There will be reduced expectations that the Federal Reserve will embark on further quantitative easing which will help underpin yield support. There will still be important doubts surrounding the medium-term outlook and the Fed will move quickly to embark on fresh action if there is evidence that demand is faltering again. The global growth outlook will also have an important impact on the dollar. Persistent doubts surrounding the Asian and Euro-zone outlook will tend to underpin the US currency.

The dollar dipped significantly at the beginning of the week, but there was solid buying support on dips and there were net gains for the week as a whole against European currencies, although it was difficult to secure strong gains.

The FOMC minutes from March confirmed that the committee was slightly more optimistic surrounding the economic outlook. The net outlook was to downplay the potential for further quantitative easing unless there was a renewed slowdown in the economy. The underlying policy stance was still broadly dovish with most members still expecting rates to be left at extremely low levels until 2014 and some nervousness that economic conditions would deteriorate again. The economic releases will be watched closely for further evidence on underlying economic conditions.

The market had been positioned for a slightly more dovish Fed tone and there was a sharp rally in the US currency following the release.

The US ADP report was close to market expectations with a 209,000 increase in jobs for March following a revised 230,000 increase previously. The data will maintain optimism over a solid near-term expansion and continue to dampen any immediate expectations of further quantitative easing. Regional Fed President Williams, however, stated that further easing was not off the table. The ISM non-manufacturing index edged lower to 56.0 from 57.3 previously.

Euro

There will be renewed concerns surrounding peripheral economies in the short-term as recession continues to bite. Spain will inevitably be an important focus, especially with severe doubts over the 2012 budget. There will also be major concerns over the banking sector and speculation that a bailout will be required. The ECB will have to maintain an expansionary monetary policy and there will also be speculation that core inflation rates will be allowed to drift higher to help ease peripheral strains. This would tend to weaken the Euro directly and also risk an increase in political tensions.

The Euro was unable to break resistance levels above the 1.3350 against the dollar during the week and dipped sharply during the week with a test of support near 1.31.

Euro-zone unemployment increased to a fresh record high of 10.8% for March from 10.7% previously. Although the data was in line with expectations, there were further concerns surrounding structural weaknesses, especially with youth unemployment continuing to increase to record highs. The elevated unemployment levels will also increase concerns over potential social tensions.

There were further concern surrounding the Spanish economy with major doubts surrounding the effectiveness and sustainability of current economic policies. The latest bond auctions recorded weaker demand compared with previous sales and there was a sharp rise in short-term yields. The net effect was to trigger a further increase in market yields with 10-year yields rising towards 5.70%. There was also a slide in Spanish equities to the lowest level since November. Italian yields also rose during the day, maintaining fears surrounding renewed structural vulnerability.

The economic data was generally uninspiring with a decline in retail sales and smaller than expected increase in German factory orders, although there were upward revisions to previous data.

As expected, the ECB left interest rates on hold at 1.00% following the latest policy meeting. In the press conference, President Draghi stated that there were still downside risks to the growth outlook and that monetary policy would need to remain very accommodative. Although there would be near-term inflation risks associated with the rise in oil prices, he also stated that medium-term inflation remained firmly anchored. The comments increased speculation that the ECB will tolerate some increase in inflation within core Euro-zone economies in order to provide a boost to weaker economies which will tend to undermine the Euro.

Sterling

The most recent PMI surveys have all been stronger than expected and this will have a significant impact in underpinning near-term sentiment. There will also be reduced expectations of further quantitative easing by the Bank of England, although there will still be a high degree of uncertainty. Renewed stresses within the Euro-zone could trigger fresh defensive capital flows into Sterling, but the UK currency will be generally vulnerable if there a sustained deterioration in international risk appetite.

Sterling pushed to challenge resistance levels above 1.60 against the dollar for the first time since November and, although it retreated back below this level, the currency was broadly resilient and there was a further advance against the Euro.

The UK PMI manufacturing index rose to 52.1 from a revised 51.5 previously which was the highest reading for 10 months. The data will help underpin confidence in the economy to some extent, but there will also be concerns that the gains in output were due to a large extent by inventory accumulation, especially in the consumer sector which increases the risk that future output will stall.

The UK services PMI index was stronger than expected with a rise to 55.3 for March following a figure of 53.8 previously as business confidence continued to improve. All the PMI indices have been stronger than expected this week which will maintain a mood of greater confidence surrounding the economy. The Halifax house-price index recorded a 2.2% increase for March, although this was primarily due to buying support before tax reliefs ended.

The data will also reinforce expectations that the Bank of England will resist any further move to expand quantitative easing at the latest policy meeting with the announcement due on Thursday.

Weekly Market analysis

The Euro-zone structural outlook will inevitably continue as an important focus with important concerns that conditions within Spain will deteriorate further given major vulnerabilities within the banking sector. Monetary policy will also be a key short-term focus with the Federal Reserve and Bank of Japan both holding policy meetings during the next week with speculation over additional policy action. Fears over de-leveraging within the banking sector will tend to dampen risk appetite.

Dollar

The latest US economic data has maintained a generally weaker tone with declines in regional PMI surveys and a significant rise in jobless claims. Immediate fears have been eased by solid retail spending data, but there will be some unease over a potential slowdown. These uncertainties will ensure a strong focus on Federal Reserve policies with a key FOMC meeting due next week. The dollar will be vulnerable to sharp selling pressure if there is any move to expand quantitative easing while hints over action would trigger more moderate losses. The overall lack of viable alternatives and global de-leveraging should still provide important US currency protection.

The dollar was unable to make much headway during the week, although there was solid buying support on dips as ranges were relatively narrow.

The US retail sales data was slightly stronger than expected with an increase of 0.8% for the headline and core numbers which will maintain a broadly optimistic tone towards consumer spending. In contrast, there was a decline in the latest NAHB housing index to 25 from 28 previously which will increase the focus on Tuesday’s housing-starts data amid suspicion that the sector was slowing.

There was a decline in housing starts in the latest data to an annual rate of 0.65mn from 0.69mn previously. Unease over a slowdown in the sector was offset by a rise in permits to a 4-year high and the overall impact was limited. There was no change in industrial production for the month which was weaker than expected.

The latest US jobless claims was again weaker than expected with a figure of 386,000 in the latest week from a revised 388,000 previously which was the highest level since January. The other US data was also weaker than expected as existing home sales dropped to an annual rate of 4.48mn from 4.60mn previously. There was also a decline in the Philadelphia Fed index to 8.5 for April from 12.5 which was also the weakest since January as new orders were weak.

The data had a negative impact on risk appetite which provided some support for the dollar on defensive grounds. There was also renewed speculation that the Fed could consider further quantitative easing.

Euro

The Euro-zone structural fears have been thrown back into sharp focus by the stresses in Spain and the tone of unease is likely to remain an important feature. There will be particular fears surrounding the banking sector and fears surrounding peripheral vulnerability in general.

The ECB will be under pressure to re-activate the peripheral bond buying programme and there will be speculation over additional LTRO operations. The Euro will gain net support from expectations over capital repatriation, but underlying investment flows will make it very difficult for the Euro to sustain any gains.
The Euro was broadly resilient during the week and found strong buying support on dips to below the 1.30 level against the US currency.

The German ZEW index was stronger than expected with a further small increase to 23.4 for April from 22.3 previously, in contrast to expectations of a measured retreat. The ZEW also commented that there had been no noticeable deterioration in replies received later in the survey period which eased fears surrounding the outlook. The IFO index also registered a sixth successive monthly gain. The final Euro-zone March inflation rate recorded a small increase to 2.7% from the 2.6% flash estimate.

There were further major concerns surrounding the Spanish outlook as benchmark bond yields rose back to near the 6.0% level. There was also an increase in credit default swaps to a record high just below the 500 basis point level. There were further concerns surrounding the banking sector as non-performing loans rose to an 18-year high, reinforcing fears over a negative spiral of falling house prices and further bad debts. In this environment, there were further declines for the local bourse.

The Italian government stated that the growth and fiscal outlook was weaker than expected which further undermined sentiment. Tensions were illustrated by a decline in German yields to 0.14% at the latest 2-year bond auction. There was a report from ratings agency Moody’s that Spanish and Italian borrowing costs were already at unsustainable levels from a medium-term perspective.
There was a bid/cover ratio above 2.0 at the Spanish 10-year bond auction which provided some relief, although it was a relatively small auction and there was an increase in yields to 5.74% from below 5.50% previously.

Sterling

Confidence surrounding the UK economy is likely to remain slightly stronger in the short-term. There has also been a shift in Bank of England expectations with reduced speculation surrounding further quantitative easing after Posen’s decision to move away from backing further action. The UK currency will also be in a position to gain support from a lack of confidence in the Euro-zone and potential defensive inflows. The UK situation is still very fragile and the currency will be generally vulnerable when global risk appetite deteriorates.

Sterling maintained a robust tone as the trade-weighted index advanced to 18-month highs with the UK currency at a five-month peak against the dollar.
The headline UK inflation rate rose slightly to 3.5% for March from 3.4% previously as prices failed to match the declines seen last year. The latest unemployment data was stronger than expected with an increase in the claimant count of 3,600 in the latest month from a revised 4,500 previously while the unemployment rate dipped to 8.3% from 8.4%, which was the first decline since the third quarter of 2011.

The Bank of England MPC quantitative easing vote was surprising with a 8-1 vote for keeping the total bond purchases on hold at GBP325bn. In particular, markets reacted strongly to Posen’s decision to vote for the majority and drop the call for further monetary action as he has been consistently the most dovish committee member.
The bank was more concerned over the inflation outlook and the risk of stubbornly high price pressures. The central bank was still concerned over the risks of recession, but the net outcome was a drop in expectations surrounding further quantitative easing.

The shift in expectations pushed Sterling to fresh 20-month high beyond 0.82 against the Euro.
Posen confirmed that he had taken a different stance than that in 2011 with reduced fears surrounding a sharp deterioration in economic conditions. Posen also stated that the economy was stronger than would be registered in the official growth data.

Weekly Market analysis

The Federal Reserve has maintained its commitment to low interest rates throughout the next 2 years at least which will provide underlying support to liquidity as well as curbing yield-related demand for the US currency. There will still be underlying fears surrounding the Euro-zone outlook with fears surrounding the Spanish and Italian outlooks. With underlying banking-sector de-leveraging and unease surrounding the Chinese economy, confidence surrounding risk appetite is likely to remain fragile.

Dollar

The Federal Reserve stance will continue to limit the scope for near-term dollar support with expectations that interest rates will remain at very low levels throughout the next two years. There will also be expectations that the Fed will respond to any fresh downturn with fresh quantitative easing. There should still be expectations that the US economy will out-perform in the short-term, especially with persistent Euro-zone fears. Growth expectations should also provide some net support to capital inflows. The dollar will still find it difficult to gain strong support unless there is a serious deterioration in global risk appetite.
The dollar was unable to make any significant headway against major currencies during the week as the Federal Reserve maintained a dovish tone.
The latest US consumer confidence data was slightly weaker than expected with a small decline to 69.2 from a revised 69.5 the previous month. The latest US jobless claims data was again weaker than expected with initial claims at 388,000 in the latest week from 389,000 previously, maintaining the significant deterioration seen during April. In contrast, the pending home sales data was stronger than expected.
The latest durable goods orders data was sharply weaker than expected with a headline 4.2% decline for March as aircraft orders dropped heavily and there was 1.1% underlying decline which will create fresh doubts over investment trends.
The Federal Reserve left interest rates on hold at the latest policy meeting and also maintained its commitment to maintaining very low interest rates. There was a 9-1 vote for the statement with Lacker again dissenting as he opposed the pledge to keep rates at exceptionally low levels through the end of 2014.
The Fed upgraded its growth forecasts for 2012 and was more optimistic surrounding the labour market, but there was still a very notable underlying tone of caution with comments that global financial turmoil still posed important downside risks to the economic outlook. Fed Chairman Bernanke maintained a broadly unchanged stance in his press conference with a promise that the Fed would maintain a highly accommodative policy and would be prepared to take further action if required.

Euro

Euro-zone structural fears will remain an important short-term focus as underlying tensions persist. There will be continuing fears that restrictive fiscal policies will intensify recession conditions in peripheral economies and exacerbate bad loans within the banking sector. There will be strong pressure for further ECB support and there will also be growing political pressure for a shift in underlying policies towards a more growth-orientated strategy. This would, however, risk major tensions with the Bundesbank. The Euro will still gain important support at times, especially with potential capital repatriation.
The Euro was again able to prove resilient during the week even with continuing fears surrounding the structural outlook and there was market frustration that the Euro had not weakened further which triggered a covering of short positions.
The Euro-zone PMI data was weaker than expected with sharply weaker readings for the French PMI services and German manufacturing data. Although the services data was stronger than expected, the net outcome was a decline for both readings with the manufacturing index at the lowest level since July 2009.
The data tended to contradict more optimistic German business surveys, unsettling markets, and there was further peripheral economic unease. As well as the PMI data, the Bank of Spain confirmed that there was a further GDP contraction for the first quarter, maintaining fears over the economic outlook and the banking sector. There were rumours of ECB price checking during the week.
Politically, markets were unsettled by the French election result as the strong polling outcome for the National Front reinforced market fears that support for current economic policies was continuing to weaken. The Dutch government also tendered its resignation after failing to agree budget cuts as the Freedom party withdrew its support, maintaining fears over regional instability. More positively, there was speculation of 2013 budget agreement later in the week
A series of relatively small-scale Euro-zone bond auctions provided some net Euro support in the middle of the week. There were solid bid/cover readings for the latest Spanish bill auction while there was a decline in Dutch yields which eased fears over the impact of political stresses. From a wider perspective, there was greater evidence and speculation that pressure for a change in austerity policies was intensifying.
The Euro was subjected to renewed selling pressure late in the US session as Standard & Poor’s cut Spain’s credit rating by a further two notches to BBB+ which also triggered some fresh unease over Friday’s Italian debt auctions.

Sterling

There will be further uncertainty surrounding the economy in the short-term. The business surveys have been generally optimistic, but there was a sharp contrast with the second-quarter GDP data which officially put the economy back in recession. There will be some renewed speculation that the Bank of England will sanction further quantitative easing in May There will also be serious reservations over medium-term structural vulnerability, especially if there banking-sector fears. There will still be significant defensive demand for the UK currency as Euro-zone fears continue.
Sterling maintained resilient tone during the week and pushed to seven-month highs against the dollar while the trade-weighted index was at the highest level since the third quarter of 2009 with further evidence of defensive inflows into the UK currency.
The ONS reported that the economy contracted by 0.2% in the first quarter of 2012 following a 0.3% decline the previous quarter. Officially, this put the economy in recession for the second time in three years as a small gain in the services sector was not enough to offset weak manufacturing and a sharp decline in construction output.
There was an important element of suspicion surrounding the data with expectations that it would be revised higher. Nevertheless, there was some speculation that the Bank of England would have to consider additional quantitative easing at the May meeting. The data was also politically damaging for the government.
The latest BBA mortgage approvals data recorded a decline to 10-month lows which reinforced concerns surrounding the housing sector. The latest CBI retail sales survey weakened to -6 for April from zero the previous month, but companies were notably more optimistic surrounding the May outlook which provided some relief.
MPC member Weale stated that the case for quantitative easing had been increased by the GDP data, although uncertainty remained very high.

Weekly Market analysis

The Euro-zone policy focus will remain an important short-term focus given an increase in fears surrounding the Spanish outlook in particular. There will be an extremely important focus on whether the downturn is concentrated within the Euro-zone or whether there is a wider retreat for the global economy. The Federal Reserve is on hold in the short-term, but there will still be expectations that the central bank will sanction further action if required and the US economy falters.

Dollar

There have been a series of mixed data releases over the past month and there will be net concerns over a slowdown in the economy, especially if there is a weaker than expected payroll report. The Federal Reserve will maintain a policy of extremely low interest rates, but it is likely to hold off from fresh quantitative easing for now and there should still be expectations that the US economy will out-perform in the short-term. Global growth trends will be important and the US currency will gain some important support if global growth conditions deteriorate with a generally firm tone likely.

The dollar found support at lower levels during the week and was able to make some headway during the week as a whole with EUR/USD weakening towards 1.31 although gains were measured as there were mixed US data releases.

The latest US ISM manufacturing index was stronger than expected with an increase to a 10-month high of 54.8 for April from 53.4 previously, contrary to expectations of a modest decline. All the main components showed healthy gains for the month which helped alleviate immediate concerns surrounding the US outlook, especially as markets were braced for a more subdued report.

There was a decline in jobless claims to 365,000 in the latest week from 392,000 the previous week which provided some relief to economic sentiment. In contrast, there was a decline in the latest ISM services-sector report to 53.5 from 56.0 previously. There was a decline in the export and employment components for the index, although they were still comfortably above the 50 level. The latest ADP employment report was weaker than expected with a 119,000 increase for April following a revised 201,000 gain previously. Federal Reserve speakers during the week continued to indicate that policy was on hold in the short-term.

Unease surrounding the global economic outlook also had some influence n triggering defensive dollar demand, especially given the Euro-zone stresses.

Euro

There will be major concerns surrounding the economic outlook in the short-term, especially with a notable deterioration in the April PMI data. There will be further concerns surrounding the peripheral growth outlook and this will inevitably intensify stresses within the banking sector, especially as bad debts will continue to increase. There will be strong pressure for the ECB to take a more aggressive policy and political factors will be extremely important, especially if there is a change in President for France. Evidence of a policy shift could provide some Euro support, although there is still likely to be underlying depreciation with the potential for sharp losses.

The Euro was subjected to heavy selling pressure in Europe on Wednesday due to a combination of fundamental and technical factors, although there was solid support at lower levels with no major support levels broken.

The final Euro-zone PMI manufacturing index edged lower to 45.9 from a flash estimate of 46.0, although principal attention focussed on the peripheral economies as the Italian index deteriorated sharply for April. There were also depressed readings for the Spanish and Greek economies which maintained fears over the outlook with the Spanish economy confirmed as in recession.

The German unemployment data was weaker than expected with an increase of 19,000 for April. There were further defensive inflows into German bonds as yields dipped to record lows on capital flight from peripheral economies.

As expected, the ECB left interest rates on hold and the press conference was the main focus. Although President Draghi continued to reference downside growth risks he also stated that there were some signs of stabilisation during the first quarter. These remarks were somewhat surprising given very weak surveys for April. Draghi also stated that there had been no discussion surrounding specific interest rate cuts.

The net impact was to dampen expectations of a further near-term cut in interest rates which helped underpin the Euro, especially with a covering of short positions following the inability to break 1.31 support. There will still be major concerns surrounding the economic outlook and the overall impression was that the ECB was looking to shift the focus back onto political action to boost the growth outlook.

There were political uncertainties surrounding the French and Greece elections this weekend with fears that the pro-austerity Greek parties would not be able to secure a majority. There were also uncertainties over the French-German relationship if Holland wins in France.

Sterling

There will be further UK economic uncertainty as the business surveys have been generally optimistic and in contrast to the official data. Monetary policy will remain an important focus and there will continue to be a high degree of uncertainty. There should be reduced expectations of further quantitative easing which will provide some Sterling support. Safe-haven considerations will remain important and there will be further defensive Sterling demand given Euro-zone fears. There will, however, be unease surrounding the banking sector and a wider deterioration in risk conditions could trigger rapid capital outflows.

Sterling held firm against the dollar during the week and pushed to 22-month highs against the Euro as there was further evidence of defensive demand for the currency.

The latest PMI manufacturing survey was weaker than expected with a decline to 50.5 for April from a revised 51.9. The latest PMI services-sector index was weaker than expected with a decline to 53.5 from 55.3 the previous month. Although this was significantly worse than expected, the impact was offset by a rise in the business expectations component to a 25-month high as hiring intentions strengthened.

There was a solid rise in UK lending for March, but there was a further decline in money supply which will increase fears surrounding the growth outlook as credit conditions remained extremely tight. Although there has been speculation over defensive inflows, official data recorded net capital outflows of gilts for February and March. The Nationwide reported a 0.2% decline in house prices for April with a sharper decline reported in the Halifax survey.

Although there was still a high degree of uncertainty, the net result from this week’s surveys was reduced expectations surrounding further Bank of England quantitative easing which helped underpin sentiment.

Weekly Market analysis

The Euro-zone structural vulnerabilities will remain a very important short-term focus. There will be major concerns surrounding the Greek situation given the risk of fresh elections. Uncertainty surrounding France’s policies and the Spanish banking sector will also cause major concerns. With reduced confidence surrounding the global growth outlook, risk appetite is likely to remain generally fragile in the short-term.

Dollar

The recent economic data releases have generally been slightly weaker than expected and there will be concerns surrounding an underlying slowdown. International considerations will be extremely important in the short-term and there is scope for dollar demand on defensive grounds, especially as there will be a lack of confidence in the global growth outlook. Global intervention policies will also tend to support the US currency as reserve diversification away from the dollar will decline. There will be speculation that the Federal Reserve will sanction additional quantitative easing if demand falters and this will be important in curbing dollar demand on yield grounds.

There was a weaker than expected US payroll report on Friday with an employment increase of 115,000 for April from a revised 154,000 for March. The dollar was still resilient both following the payroll data and during the week as the Euro lost wider support. There was a sharp drop in oil and gold prices which undermined commodity currencies and was instrumental in pushing the dollar higher as risk appetite remained generally very fragile and the Euro lost ground.

The latest US jobless claims recorded a slight decline to 367,000 in the latest week from 368,000 previously which maintained some degree of relief surrounding US labour-market trends. The latest US trade account recorded a sharp increase in the deficit to US$51.8bn from a revised US$45.4bn previously as imports rose sharply. There will be optimism that consumer spending remains firm, but the impact of the deficit is likely to trigger a downward revision to US first-quarter GDP estimates.

Regional Fed President Kocherlakota stated that monetary policy should start to be tightened within the next 6-9 months, but the impact was limited as he is not an FOMC voting member this year. Fed Chairman Bernanke remained generally cautious, although with no substantive comments.

Euro

Structural fears will be very important in the short-term given the severe stresses within Greece as it attempts to form a government and find a way to maintain its Euro-zone position while relaxing austerity. There will also be major concerns surrounding the economic outlook in the short-term, especially with a notable deterioration in recent indicators. In this context, fears surrounding Spain are liable to increase with the banking sector under heavy pressure. There will be speculation over a policy shift towards a growth strategy, which may underpin confidence, but net vulnerabilities are likely to push the currency weaker.

The Euro was unable to gain any significant support from the US payroll data as selling pressure on the currency resumed. Political comments dominated with the French presidential election and Greek parliamentary election. There was no surprise in the French ballot with Socialist Party’s Hollande winning against Sarkozy gaining around 52% of the vote.

There were uncertainties surrounding domestic economic policies given resistance to austerity measures and proposals to increase taxes. There were also important Euro-zone uncertainties given that the Franco-German relationship under Merkel and Sarkozy was a key influence on policy. There will be calls for Germany to reverse course and France will also put additional pressure for more aggressive ECB action.

The governing Greek coalition parties lost substantial support at the election with particularly heavy losses for Pasok. New Democracy won the most number of seats and won first chance at forming a government, but was unable to gain sufficient backing. The majority of Greeks still want to retain the Euro, but there is also strong opposition to austerity measures and there will be major difficulties resolving this contradiction. Prolonged uncertainty will increase fears surrounding a forced exit from the Euro and wider Euro-zone uncertainty.

After New Democracy and the SYRIZA coalition both failed to form a government, the baton was handed to Pasok who came third in the election. There were some rumours of a coalition deal with Democratic Left which had some impact in lifting market sentiment, although there was no evidence of a deal and caution prevailed.

Within the wider Euro-zone, the Spanish government took a majority stake in Bankia with further capital injections into the banking sector as a whole and confidence in the Euro-zone remained extremely fragile. There were further capital flows into the German fixed-interest market as bund yields hit record lows.

Sterling

The underlying economic data releases have remained mixed which will create further policy uncertainties. Growth conditions will be undermined by Euro-zone vulnerability and there will be speculation over additional Bank of England quantitative easing if growth fails to respond. These factors will tend to undermine Sterling, but defensive considerations will also remain very important and there will be underlying support as a refuge from Euro fears. Sterling will find it difficult to gain sustained support if there is a sustained deterioration in international risk conditions.

Sterling maintained a generally firm tone over the week as it pushed towards the 0.80 level against the Euro. Technical considerations remained important with an important option barrier at 0.80 and failure to break through this level triggered some profit taking on Sterling positions as the UK currency also retreated from highs near 1.62 against the dollar.

The latest manufacturing data recorded a rebound of 0.9% for March following a revised 1.1% decline previously while the wider industrial production data registered a 0.3% decline. There was also a weaker than expected BRC retail sales report with a 3.3% annual decline for April.

As expected the Bank of England left interest rates on hold at 0.50% at the latest policy meeting while quantitative easing was also held steady at GBP325bn. There had been some speculation that the MPC could expand the amount of bond purchases given that the current programme has been completed and the decision to hold policy boosted Sterling demand.

The latest NIESR GDP growth estimate remained very subdued with a reading of 0.1% for April following a revised 0.2% decline the previous month. There was still evidence of defensive Sterling demand which helped cushion the currency as bond yields remained at historically extremely low levels.

Weekly Market analysis

The Euro-zone structural vulnerabilities will remain a very important short-term focus, especially as confidence in the banking sector has deteriorated sharply. Any sustained run on the banks or substantial capital outflows would substantially increase the risk of a destabilising break-up in the Euro-zone as a whole. In this appetite, risk appetite is likely to remain generally vulnerable in the short-term.

Dollar

Defensive considerations will remain extremely important in the short-term as markets continue to focus on the Euro-zone crisis and global vulnerabilities. There is likely to be further defensive demand for the US currency as the US Treasury market continues to attract support. The Federal Reserve policies will also be important, especially as there will be further speculation that the Fed will sanction further quantitative easing if there is any fresh deterioration in the economy. The dollar will, therefore, find it difficult to gain further strong support, especially if forthcoming indicators are weaker than expected.

The dollar advanced firmly against European currencies during the week as Euro-zone fears booted the dollar’s relative appeal, but a slide against the yen held back the overall dollar index. Risk considerations tended to dominate and there was a decline in US Treasury yields to 2012 lows on defensive demand.

The US retail sales data was slightly weaker than expected with a 0.1% gain for the headline and underlying increase for April. The US housing starts data was stronger than expected with an increase to an annual rate of 0.72mn for April from 0.70mn previously while permits fell to 0.72mn from 0.77mn, but they were still at the highest level since 2008. A stronger than expected increase in industrial production was offset by a downward revision for the previous month.

There was a much weaker than expected reading for the Philadelphia Fed index as it dipped to -5.8 from 8.5 the previous month while there was a substantial deterioration in most of the major components which raised some doubts over the US outlook.

The Fed minutes confirmed that the FOMC was more optimistic surrounding the growth outlook with the probability of a slow decline in unemployment. Several members did indicate that further monetary accommodation could be required if the economy lost momentum. The Fed also expressed concerns surrounding the fiscal outlook which reminded markets over the underlying risks and there will be increased speculation over quantitative easing.

Euro

There will be further fears surrounding the Euro-zone in the short-term. Failure to form a government and the necessity for a second Greek election will increase fears that Greece will be forced out of the Euro area. There will be fears surrounding any contagion effect if Greece did exit the Euro area and substantial unease surrounding the financial sector as a whole which will increase the risk of capital flight and a further loss of market confidence. There will be strong pressure for additional ECB support in the form of a third LTRO and political tensions will intensify. In this context, the Euro is likely to remain generally vulnerable initially, but with the possibility of a sharp rebound.

The Euro was subjected to heavy selling as political and economic fears increased with 4-month lows near 1.2650 against the dollar and it weakened very sharply against the yen as Greek Euro-exit and contagion fears intensified.

There were further fears surrounding Spain with major doubts surrounding the banking sector. There was an increase in benchmark Spanish bond yields to above the 6.3% level while the spread over German bunds widened to a record high. Moody’s also announced a credit-rating downgrade of 26 Italian banks and 16 Spanish banks which reinforced fears surrounding the European banking sector given the sovereign-debt default risk. Fitch downgraded Greece’s sovereign rating to CCC from B-.

Germany secured a stronger than expected first-quarter GDP gain of 0.5%, allowing a Euro-zone figure of 0.0% which technically avoided a recession. Sentiment was undermined quickly by the fact that it was only the German performance which provided support as Italy for example contracted by 0.8% for the quarter.

Greece was inevitably a very important focus as political negotiations continued with the President holding talks with all major political parties. After protracted discussion, there was an announcement that no government had been formed. A caretaker government was formed and fresh elections will be held on June 17th.

The SYRIZA party remained strongly opposed to the bailout agreement and will campaign for the bailout deal to be abandoned. Failure to form a government increased fears that Greece would be forced to leave the Euro-zone if no concessions are forthcoming. This had an important negative impact on the European banking sector as the lack of collateral continued to create additional stresses.

There were further fears surrounding the European banking sector which had an important negative impact on the currency. There were reports of substantial capital withdrawals from the Greek banking sector and there were also reports of substantial outflows from Spanish bank Bankia.

There was intense pressure for the ECB to take additional action to stabilise markets while the political pressure for additional measures was also intense. German Finance Minister Schauble called for a rapid move to political union.

Sterling

Growth conditions will be undermined by Euro-zone vulnerability and there will also be a high degree of unease surrounding the domestic conditions, especially with income levels under pressure. There will be speculation over additional Bank of England quantitative easing particularly if Euro fears intensify. Sterling has gained important support on defensive grounds, although it may prove difficult to sustain buying support given the lack of confidence in the domestic fundamentals. A wider deterioration in risk appetite would increase the risk of international Sterling selling.

Sterling was unable to hold gains through the 0.80 level against the Euro during the week and dipped sharply to 2-month lows around 1.5750 against the dollar.

The latest UK unemployment data was stronger than expected with a decline in the claimant count of 13,700 for April following a revised decline the previous month while the unemployment rate declined to 8.2% from 8.3% previously, although the drop was fuelled primarily by an increase in part-time employment.

In its quarterly inflation report, the Bank of England lowered its growth and inflation forecasts for the two-year outlook. The main focus on the report tended to be the bank’s news conference with Governor King stating that there were substantial uncertainties and risks resulting from the Euro-zone crisis. With a lowering of inflation forecasts and warning over the Euro area, there was additional speculation that the central bank would sanction additional quantitative easing.

The scope for defensive UK demand was illustrated by the latest two-year bond auction as yields fell sharply to 0.35% as bidding interest remained strong and benchmark bond yields also fell to record lows.

There was increased unease surrounding the UK economy given the fears over weak European demand. Wider risk conditions remained very important and an increase in global fear put Sterling under pressure despite Euro-zone defensive inflows.