Weekly Direct FX Update

The sometimes neurotic nature of sentiment in the financial markets was well evidenced through the course of the last week. The Greek debt legislation was focus early in the week. As it became evident that it was likely that the required austerity measures would be passed, there was a rush to cover sold EURO positions and the single currency was in hot demand. Whilst this debt issue is far from over, the markets have reacted with renewed enthusiasm for risk. The NZD reached post float highs against the pound sterling and US dollar, as equity markets pushed higher, with the S&P posting its best weekly performances in two years. The safe haven assets of gold, YEN and Swiss Franc all saw selling pressure. The economic data in the US was relatively strong with the manufacturing numbers much stronger than expected. Interestingly these numbers come as we start to see weaker numbers coming from Europe, the UK and China. The lower than expected growth in Chinese factory output is a sign that their tighter monetary conditions are starting to have an effect, and should see a further tempering of commodity prices in the coming weeks.

The New Zealand dollar remained in short supply, as the risk appetite increased throughout the course of last week. The high demand was backed up by a grinding move higher in the short term interest rates in New Zealand. The focus for this week is tomorrow's New Zealand Institute of Economic Research's Quarterly Survey of Business Opinion (QSBO), and the first quarter GDP number due on Thursday. Expect a rebound in business confidence from the QSBO. With the manufacturing sector leading the way, a .4% expansion is expected by the market for GDP the first quarter.

After a quiet patch for economic data in Australia of late, this week will keep observers busy. Today's building approvals and retails sales numbers were disappointing with building approvals dropping 7.9% and retail sales -.6%. This caused the AUD to drop across the board this morning. Tomorrow, we have the trade balance and cash rate announcement from the Reserve Bank of Australia (RBA). Expect no change in the cash rate, but the accompanying statement will be closely watched, as per usual. Thursday sees the monthly release of employment numbers, with the unemployment rate expected to be unchanged at 4.9%. The two tiered nature of the Australian economy is increasingly coming under the spotlight. This coupled with the international debate on the sustainability of Australian residential property market prices, should see a tempering of enthusiasm for the Australian dollar.

In the US, negotiations continue about the raising of the Federal debt ceiling, by the August 2nd deadline. Last week's stronger than expected housing and manufacturing numbers were encouraging. This shortened week will see the focus primarily on the all important employment numbers due on Friday. The US dollar was under somewhat renewed pressure for much of the last week. The pressure would certainly have been more, had there not been a dramatic move higher in the longer end yield. The benchmark 10 year bond was over 25 pts higher on the week, ending at 3.19%. Longer end yields generally increase as inflationary pressure build, and this would be in line with the improvement in the economic data, and the scheduled ending of the 2nd quantitative easing program (QE- essentially the printing of money to keep longer end interest rates artificially low, in order to stimulate the economy).

In the UK the economic indicators remain weak. The pound sterling has been underperforming, as various Bank of England Monetary Policy Committee members give lip service to the possibility of further QE. Whilst the prospect of further QE exists, expect the GBP to continue to underperform. There is a raft of economic data in the UK this week, with various construction, housing, services and manufacturing data releases due. The Bank of England (BoE) cash rate decision on Thursday will be watched. Whilst there is little chance of a change in the cash rate, a change to the QE profile will see the GBP under renewed pressure.

In the Euro zone, with the Greek debt situation stablised for the time being, focus could well now move to other peripheral states. The magnitude of the issues in Europe mean some kind of level of default risk will be present for the medium term. Of focus this week will be the European Central Bank (ECB) decision on the cash rate. The market expects the cash rate to increase from 1.25% to 1.5%, as persistent inflationary pressure pushes the ECB into action. Short term price action for the EURO is likely to be driven by sentiment in the equity markets. If the appetite for risk continues, so should that for the EURO.

The Canadian dollar performed relatively well last week, in the face of lowering oil prices. Support for the CAD came in the form of higher than expected inflation numbers, that should see the pressure come back on the Bank of Canada (BoC). The monthly GDP number was flat against an expectation of a +.1% rise. This week has a quiet start, building permits on Thursday and the employment numbers on Friday. If further pressure comes onto the BoC with regards to the cash rate, expect to see further demand for CAD across the board. Current levels represent good value buying of CAD with New Zealand and Australian dollars.

In Japan the picture remains mixed. The YEN gave up ground during last week, which will be welcomed by Japanese exports, as they work through supply chain issues after the earthquake and tsunami. Economic data was mixed with the retails sales number beating expectations, but manufacturing remaining depressed. If last week's appetite for risk continues, the YEN will test further support levels against a host of currencies.

Sam Coxhead

Global Currency Payments & Transfers

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