Weekly Treasury Update
Dollar
Markets overall are continuing to expect a Federal Reserve tapering of bond purchases in September, but a lacklustre set of releases over the next two weeks would increase speculation of over a limited cut in purchases which would undermine yield support and the dollar. For now, yield support will continue to provide support and the dollar will also gain support from underlying stresses in emerging markets. In this context, any relief for emerging currencies would tend to sap dollar strengthen but the overall tone is likely to be firm.
The dollar was able to make headway on a trade-weighted index during the week, but struggled to make any significant impression on major European currencies as the euro maintained a solid underlying tone.
Emerging-market currencies remained under pressure with the Indian and rupee dipping sharply to fresh record lows while the Turkish lira and Indonesian rupiah both falling sharply again as markets fretted over the impact of higher US bond yields with capital outflows from a wide range of emerging markets.
The US economic data was stronger than expected with existing home sales rising to an annual rate of 5.39mn for July from a revised 5.06mn the previous month and this was the highest reading since November 2009 which reinforced a more optimistic tone surrounding the housing sector. Overall action was limited as caution prevailed ahead of the Federal Reserve minutes.
The minutes showed that a majority of members backed Ben Bernanke’s plans for bond tapering. There were some concerns that inflation could stay at levels which would be considered too low and there was a slightly less confident tone surrounding the growth outlook given disappointment over the first-half performance.
There was also still an underlying caution over the merits of tapering bond purchases with some members calling for caution, although others suggested it would soon be time to slow the rate of purchases. The dollar firmed immediately after the minutes, but markets found it difficult to justify strong buying despite underlying expectations that there would be at least a limited September tapering.
Jobless claims increased to 336,000 in the latest reporting week from 323,000 previously and holding close to lows seen at the end of 2007. There was also a further small improvement in the PMI manufacturing index to 53.9 from 53.7 previously.
Fed tapering expectations continued to have an important impact on markets with markets watching both data releases and comments from Fed officials. The net impact was still that the Fed would move to taper bond purchases in September. Yield trends remained important and there was a fresh push higher in US benchmark yields.
Euro
Confidence in the overall eurozone growth outlook will remain stronger in the short-term, especially with a further net improvement in the PMI indices. They will be concerns surrounding the French outlook and there will also be wider concerns surrounding the sustainability of growth. Political tensions will continue in Italy and there will also be growing tensions surrounding Germany’s September Federal election. The European Central Bank is unlikely to cut interest rates in the current environment, but will resist a tightening of conditions and verbal intervention is a growing possibility.
The euro pushed to six-month highs against the dollar and maintained a firm tone, although it did retreat from its best levels. There was a spike higher during European trading following the Bundesbank monthly report. The German central bank stated that forward guidance is not unconditional and does not mark a fundamental change in the ECB’s monetary policy strategy. The bank also stated that the guidance did not rule out the possibility of higher interest rates if greater inflation pressure emerges. The euro pushed higher following the reference to higher interest rates, although the overall comments were more moderate as the bank recognised that rates would need to stay low for now.
The eurozone PMI data was generally stronger than expected with flash manufacturing index rising to a two-year high of 51.3 from 50.3 previously. The services-sector index also moved above the 50 level for the first time in 19 months. Although there was evidence of recovery in peripheral economies, the improvement was again led by Germany and there was some disappointment surrounding the French data which recorded renewed deterioration.
There was further speculation that another Greek bailout package would be required and there were also further concerns surrounding the Italian political situation with potential threats and risk that the government will collapse within the next few weeks.
Range for previous week: $1.3300–$1.3450
Range for this week: $1.3250-$1.3420
Sterling
There will be greater economic confidence in UK growth given the favourable run of data. The Bank of England will be uneasy over the rise in bond yields and there will be further efforts to talk yields down. There is also the possibility of further quantitative easing, especially if credit conditions tighten. The UK will continue to run a current account deficit which will leave the currency more vulnerable to selling pressure if emerging-market tensions intensify. Overall, it will be difficult to make significant Sterling headway from current levels.
Sterling challenged eight-week highs around 1.57 against the dollar during the week, but was unable to break higher and was subjected to a correction as the UK currency also hit resistance close to 0.85 against the euro.
The UK growth-orientated data was again stronger than expected as the CBI (Confederation of British Industry) industrial trends survey registered a reading of zero for August from -12 the previous month, the best reading for two years, which maintained positive sentiment.
The government borrowing data was less favourable with a smaller than expected surplus of £1.3bn for the latest month, the weakest July reading for three years as spending rose sharply. Spending will help support the immediate growth outlook, although there will also be unease surrounding the underlying budget outlook.
There were comments from MPC (Monetary Policy Committee) member Martin Weale that he could imagine the circumstances where further quantitative easing could be introduced, primarily focussing on external risks. The comments had a significant impact given that Weale had dissented against forward guidance and comments from Governor Mark Carney will be watched very closely with a speech due next week.
Range for previous week: $1.5537–$1.5710
Range for this week: $1.5504–$1.5702
Yen
The government remains determined to promote growth through aggressive macro policies and the Bank of Japan has also suggested that it will be quick to relax policy again if there is evidence of downside pressures. These factors will undermine the yen on yield grounds, but there will be pressure for the bank to take a more cautious stance, especially given vulnerability within emerging markets. The yen will also gain some degree of support if global risk conditions deteriorate further.
The dollar continued to gain support on yield grounds during the week and there were reports of importer dollar buying, although exporter selling is also likely to increase at current levels. The US currency peaked just above 99 while the Euro moved above 132 late in the week.
There was further speculation that plans to raise the sales tax would have a damaging impact on the economy and also weaken the yen, at least in the medium term. The complications for the government and yen were illustrated by Moody’s warning that a delay in introducing the sales tax would be damaging and risk further medium-term ratings downgrades. The latest trade data was weaker than expected with an increase in the deficit to a seasonally adjusted ¥0.94tn from ¥0.66tn previously.
BoJ governor Haruhiko Kuroda stated that the bank would not hesitate to act if there was evidence of downside economic risks increasing. The comments maintained expectations that there would be a further expansion of monetary policy on any sign of a downturn in demand.
US 10-year yields moved higher following the FOMC minutes with a peak around 2.93% which pushed the US currency higher. There was a stronger than expected HSBC Chinese PMI index as it moved back above the 50 level which helped improve risk appetite and curbed yen demand.
Range for previous week: ¥96.88–¥99.15
Range for this week: ¥96.12–¥98.34