Weekly Treasury Update
DOLLAR
Economic trends and Federal Reserve policy will continue to dominate market trends in the short-term. The dollar will continue to gain underlying support while there are expectations of bond-purchase tapering during the third quarter. There will still be a risk that growth conditions will deteriorate within the next few months. Global considerations will also be important and, although immediate China credit tensions have eased, the underlying global dynamics are still likely to provide underlying dollar support.
The US currency initially drifted slightly lower before finding strong support as buying interest in other currencies reversed sharply. The dollar gained some support from Middle East tensions as the Egyptian government was ousted by the military.
The US ISM manufacturing index was watched very closely following the dip to below the 50 level last month. There was a recovery to 50.9 for this release, easing immediate fears surrounding the outlook. Individual components were generally stronger with a rebound in orders. Less positively, the employment index was below 50 for the first time since September 2009.
US employment releases came under close scrutiny ahead of Friday’s pivotal payroll release. The headline ADP employment report was stronger than expected at 188,000 for June from a revised 134,000 previously while jobless claims edged down to 343,000 in the latest reporting week from 348,000. The ISM services-sector index dipped to 52.2 from 53.7, although there was a significant improvement in the employment component which provided some relief.
Fed Governor Dudley maintained a generally dovish tone, reiterating that Fed actions were dependent on economic trends. He also stated that quantitative easing could be expanded if there was any sharp economic deterioration. There was a wider than expected trade deficit for May as imports increased sharply and exports were slightly weaker. Although this will help underpin consumer spending, there will tend to be a negative impact on second-quarter GDP growth.
EURO
There have been some further tentative signs of improvement in economic conditions, notably in Spain, as PMI indices move higher. The overall economic situation remains precarious and the ECB remains committed to a policy of extremely low interest rates, as referenced in the latest press conference. Unemployment remains a serious issue which will also have important political ramifications as tensions in Italy and France increase. In this environment, there is also the risk that the overall Eurozone risk premium will intensify. Overall, the Euro will find it very difficult to make any significant progress.
The Euro held steadily for the first half of the week, although it was unable to move above significant technical resistance levels. Currency sentiment was damaged by fresh tensions surrounding Greece and Portugal during the day. The troika warned over Greek reform progress with media reports that there was a Monday deadline for greater reform in order to allow disbursement of the latest €8.1bn loan tranche.
After the resignation of the Portuguese finance minister over austerity measures, the foreign minister also announced his resignation, increasing tensions within the government amid speculation that the administration would collapse and could trigger wider Eurozone instability
There was no surprise with the ECB interest rate decision as the benchmark refinance rate was left on hold at 0.5% with deposit rate unchanged at 0.00%. President Draghi’s press conference was the key focus and volatility sparked sharply higher. Introductory remarks were generally bearish on the Eurozone growth outlook, which had some immediate negative Euro impact as it dipped significantly below 1.3000.
The President reinforced the fact that the ECB was technically prepared for negative deposit rates if required. Draghi also commented that there had been an extensive discussion on whether the refinance rate should be cut with an eventual unanimous vote. There was also a significant shift as the ECB strengthened its forward guidance substantially from recent meetings. In this context, Draghi with the approval of the ECB board, stated that interest rates would be held at current levels or lower for an extended period of time.
This was an important policy shift and a more dovish tone. As far as the Euro is concerned, the ECB stated that it was not a policy target, but it did have an important impact on growth and inflation. The Euro responded sharply to Draghi’s rhetoric and dipped to lows below 1.29.
Range for previous week: $1.2800–$1.3060
Range for this week: $1.2920–$1.3210
STERLING
There has been further evidence of an improving economy, especially in the services sector. This will provide some degree of currency support, but conditions are still liable to be fragile. The Bank of England has also expressed its determination to keep interest rates at extremely low levels over the next few months at least. In this context, yield support will remain extremely limited for Sterling and leave it vulnerable to renewed selling pressure, especially if the Fed remains on track for a tapering of bond purchases. Overall yield considerations will leave Sterling generally vulnerable.
The UK PMI manufacturing report was stronger than expected with an improvement to a 25-month high of 52.5 for the latest release from a revised 51.5 previously. There was also a significantly stronger than expected release for mortgage approvals which maintained expectations of an improvement in the housing sector. The PMI services index rose to 56.9 for June from 54.9, the highest figure for over two years following six consecutive monthly improvements and above expectations.
In contrast to earlier this week, the stronger data provided a much more powerful and sustained currency move higher, peaking around 1.53 against the dollar during US trading on the back of short covering. There may have been some defensive demand for the UK currency in the context of renewed Eurozone stresses.
There were no surprises with the Bank of England policy decision itself with the central bank holding interest rates on hold at 0.5% and the amount of quantitative easing at £375bn. Unusually, however, at Carney’s first meeting, there was a statement which accompanied the decision to leave policy on hold.
The MPC noted that the UK economic recovery was on track, but remained weak by historical standards. There were also concerns surrounding the rise in long-term interest rates seen over the past few weeks which would have a negative impact on the economic outlook. There were also comments that the upward move in market expectations for Bank Rate was not justified.
The bank will also provide more forward guidance in August. There was a very sharp slide in Sterling following the statement as it weakened to lows below 1.51 and recorded the sharpest daily decline for over 18 months with markets focussed on the forward-guidance aspect. The UK currency did find some support weaker than 0.86 against the Euro, but drifted to fresh five-week lows below 1.5050 on Friday.
Range for previous week: $1.4856–$1.5285
Range for this week: $1.4850–$1.5350
YEN
Yield considerations will remain negative for the yen as the Bank of Japan maintains an aggressive monetary policy. The US employment report will be crucial in determining whether there will be any further improvement in rate differentials and the US currency will falter if there is evidence of domestic weakness. Global trends will also be important and the yen will gain some degree of support if risk appetite comes under sustained pressure. Weakness in Chinese markets would also tend to provide net yen support.
The dollar found solid support on dips against the yen while it struggled to gain much above the 100 level. There were continued medium-term expectations surrounding dollar gains on the back of a Federal Reserve policy shift and expectations that the Bank of Japan would maintain a very loose monetary policy. In this context, yield considerations remained favourable for the dollar.
As far as the Japanese data is concerned, the latest weekly report again recorded a net selling of overseas bonds by Japanese investors as has been the case consistently over the past few weeks. The net capital-account trends provided underlying yen support.
Equity-market sentiment was underpinned by the European interest rate decisions with expectations that interest rates would remain extremely low and this was important in providing support to the risk appetite which dampened yen demand.
Range for previous week: ¥99.16–¥101.22
Range for this week: ¥99.00–¥102.00