November 2013 Monthly Report: US dollar stages a comeback

Sterling has remained on the sidelines for the majority of October. With some economic figures coming in below estimates, investors have adjusted their expectations accordingly, encouraging them to unwind sterling long positions. The pound is likely to remain on the back foot this month and we doubt economic figures can provide enough surprise to lure investors back into sterling. However, the latest Bank of England monetary policy minutes revealed a less dovish tone from the central bank, and if this continues, could help sterling resist a buoyant euro.

The market has been taking every opportunity to support a stronger euro, and despite some weak economic data, the single currency doesn’t seem to have run out of steam just yet. Even though the ECB outlined the importance of the exchange rate to the recovery, members haven’t displayed much concern towards euro strength. As excess liquidity in the eurozone declines, attention turns to the policy tools the central bank will use in order to support European banks.
Dollar weakness has continued into the new month despite managing to pare back some losses against both sterling and the euro. The US government standoff gave investors an excuse to sell dollars after the Federal Reserve kept monetary Policy unchanged in September. We should see the dollar begin to get back on its feet this month, as clearer data allows investors to get a better picture of the likely timing of tapering.

Not looking great for sterling in the month ahead 
It seems like the period of sterling superiority has faded, and now it is time for sterling strength to take a back seat. The market now views previous sterling strength as excessive, and with last month producing softer economic data, investors have been encouraged to reduce sterling holdings. Nevertheless the outlook on the UK economy hasn’t changed. Optimism regarding the UK recovery remains and strategists have begun to raise their forecasts for GBP/EUR. We expect solid data figures to continue in November, however in order to witness some significant sterling momentum, economic data will have to provide some significant upside surprise.
Last month we saw a slight shift in the Bank of England’s stance, and although there were no policy adjustments the central bank highlighted that unemployment has improved marginally faster than forecasted. The monetary policy minutes from the last meeting noted that it was now possible that unemployment will be lower, and growth faster in the second half of the year, than predicted at the time of the August Inflation Report. This less dovish language may be what is needed to keep sterling competitive especially against the euro this month. If the central bank continues to display a more positive tone about the UK economy (especially unemployment), it could reignite speculation about when the BoE will consider raising rates. Next week the BoE’s monetary policy committee will meet and it is unlikely that we will see any change in policy. Eyes will then await the release of the monetary policy minutes to identify whether this rhetoric has continued into November.

GBP/EUR

Euro domination
There has been a big shift in momentum in the last month, and the demand we had seen for sterling has now moved to the euro. Euro strength has become a hot topic, and although the ECB have remained dovish, their lack of concern about euro momentum has given investors the green light to buy euros. In the press conference after the last ECB rate announcement, President Draghi highlighted the importance of the exchange rate to the eurozone recovery but didn’t signal any immediate concern about the single currency’s recent strength. It was only this week that ECB member Nowotny said he doesn’t see any tool the ECB could use against the strong euro, and it is something that we will just have to deal with. With comments like that it is no surprise investors are bullish on the euro, and this against bearish behaviour towards sterling set the tone last month. Investors have disregarded some more disappointing releases from the eurozone, and penalised sterling for some poor UK numbers. However, this week eurozone unemployment data was released and showed unemployment rose to 12.2% allowing sterling to rally through 1.17 and close at 1.18. Inflation is also becoming an increasing problem, and with CPI now at 0.7% y/y, the pressure is mounting for the ECB to take action, and possibly cut rates. This may be an indication that not everything can be ignored, and some euro weakness is in sight.

European banks are running out of excess capital and the ECB has said that there are a number of tools available in order to support banks, sparking talk of another round of LTROs. In an interview, governing council member Nowotny said that it is clear that there would be a liquidity provision but refrained from outlining what measures the ECB would use. As the month unfolds, there will be more focus on this, and if one is announced, it is likely to dampen recent euro strength and edge GBPEUR higher.

The ECB has scheduled a comprehensive assessment of 124 of the most significant Eurozone banks between November 2013 and October 2014. This includes a Supervisory risk assessment, asset quality review and stress test. It is possible that banks will begin to reduce the amount of foreign currency dominated assets held, to purchase euros in an effort to clean up their balance sheet. This could begin to influence the rate also.

GBP/USD

Is the storm over?
Neither currency in this pairing had it easy last month, however the problems just kept piling on for the dollar. After more than two weeks in partial shutdown, the US government managed to raise the debt ceiling in time to avoid default, but this was only raised till February 2014. Whilst this decision removed the immediate threat of default, it was by no means a solution, and this set the dollar up for weakness. The influence the shutdown had on the economy has also affected the Federal Reserve’s decision on whether to taper their asset purchases this year.

As we enter the new month the greenback is under a little less pressure than it was in October. This week the Federal Reserve kept interest rates and asset purchases on hold for another month, as expected. In the accompanying statement, the Fed seemed optimistic, but said more evidence is needed in order to pare back stimulus. The less dovish language provided the greenback with some momentum, edging the GBP/USD rate lower. Whether we can see this trend continue is dependent upon the performance of US figures. The shutdown has given the central bank more time to assess economic conditions, and as distorted data clears the way for more accurate releases, evidence should begin to build in favour of tapering.

The September employment report revealed 148k additional workers and a decline in the unemployment rate to 7.2%, the lowest level since November 2008. October’s payroll reading is expected to be show a modest increase, highlighting the slowing trend in payrolls. The market will pay particular attention to employment figures and any indication of an improving labour market will encourage more bullish behaviour, as well as increased speculation about the timing of tapering.

In the month ahead we feel the dollar will stabilise but will remain vulnerable to some weaker data releases. This may provide sterling with pockets of opportunity to push the GBPUSD rate higher but there is a fair possibility we could see this rate marginally trend downwards this month.

GBP/EUR: 1.1875
GBP/USD: 1.5920
EUR/USD: 1.3460

Sasha Nugent
Currency Analyst
Caxton FX

Caxton FX Weekly Report: Final Countdown for the US government

Sterling weakness continues as UK data shocks market
After sterling fell victim to a sell-off recently, last week’s manufacturing production figure surprised the market and gave investors another reason to get rid of some of their sterling holdings. Hopefully this week will be a better one for the pound with some significant releases due. Inflation figures will be released on Tuesday, and employment figures on Wednesday. If inflation meets the market’s expectation of 2.6%y/y, it will further justify the central bank’s position outlined in forward guidance. Employment figures will also be
watched carefully, and although no change in the unemployment rate is expected, lower claimant count figures will point to an improving economy. The last retail sales release disappointed, and this week we should see a much better number allowing sterling to make a decent comeback, to finish the week in a better position. It is likely that the euro will put up a fight, but provided UK figures can meet expectations, we should see the familiar upward trend return.

The Euro rides on
The euro has started this week still looking fairly robust, however the days ahead are looking more challenging for the single currency. ECB President Draghi has continued to shed a negative light on the progress of the eurozone, describing the recovery as fragile and uneven. Investors, as usual, seem to be drawing their own conclusions about the eurozone recovery as demand for the single currency remains fairly strong. This week sterling has ample opportunities to reverse the euro’s gains, although figures such as German ZEW Economic Sentiment may attempt to limit sterling’s potential. A number of ECB members have highlighted the problem of subdued inflation, and although the market is expecting an LTRO as the ECB’s next move, a less-than-forecast inflation figure would suggest a rate cut cannot be ruled out.
The US government has still failed to come to an agreement to lift the debt ceiling and although this continues to weigh on the dollar, some strong US figures this week will make it more difficult for the EUR/USD rate to reach 1.36 again.

A few days left, will the dollar default or overcome?
The deadline for the US government to raise the debt ceiling is fast approaching, with only four days to go. The markets may not be too worried just yet, however if an agreement is not reached soon we could begin to see the dollar re-emerge as a safe haven currency of choice. Until investors begin to park their funds in the dollar the greenback will be looking towards US data to provide the currency with some momentum. Considering US data has some catching up to do, it would be a good week for the little US releases we have to deliver some upside surprise. Until fears of a default really hit the market dollar weakness is likely to remain, with positive data only providing some short-term relief for the greenback.

End of week forecast

GBP / EUR	1.1825
GBP / USD	1.5925
EUR / USD	1.3575
GBP / AUD	1.6920

Sasha Nugent

Currency Analyst

Caxton FX

Caxton FX Weekly Report: Investors unwind sterling long positions

Investors profit-take as rate hike speculation eases
Sterling ended the week experiencing sharp declines as investors realise they may have gotten ahead of themselves on UK optimism. Bank of England Governor Mark Carney stated that the central bank will not consider “raising rates or tightening monetary policy until we see the conditions in the economy where the economy is really growing”. This, alongside economic figures that have come in below expectations, have highlighted the fact the UK still has a long way to go before the economy is perceived as “really growing”. The Bank of England is likely to maintain their dovish bias when they meet to discuss monetary policy this week, and we expect both the base rate and asset purchase programme to remain on hold for another month. After weeks of being the frontrunner sterling begins the week in a more vulnerable position and we doubt much is going to boost the GBP/EUR and GBP/USD rate back to the highs we have seen recently. Manufacturing Production figures could provide sterling with some support, however with a more euro-focused week sterling gains will be limited for a while yet.

Stellar performance from the euro, but can it continue?
The euro definitely made a strong comeback towards the end of last week, and with a more euro-focused week the single currency could possibly extend these gains further. Sentiment has improved towards the eurozone after Italian Prime Minister Letta won the confidence vote and ECB President Draghi stressed the bank’s commitment to use all policy tools available if the recovery falters. The central bank didn’t signal any concern about the current strength of the euro but did emphasize the exchange rate’s significance to the recovery of the euro area. President Draghi is due to speak on Wednesday and Thursday and it is unlikely that rhetoric will differ much from what we heard last week. German factory orders, industrial production figures and German trade balance will all be numbers to watch, and considering the ECB doesn’t view a strong euro as a threat just yet, we doubt investors will hesitate if data provides upside surprise.

How close will we get to a US default?
The dollar has suffered the consequences of a US government clash, and it will most likely get worse before it gets better for the currency. Last week we witnessed some good US economic figures provide the currency with some relief, but with the shutdown preventing the all-important US jobs release, there is only so much US data can do. The FOMC meeting minutes on Thursday will be of some interest, however with Fed tapering talk on hold for now it is unlikely to have a big influence with the partial shutdown still in place. Last week’s unemployment claims provided upside surprise and if this week follows suit it could support dollar weakness in the short term. For now the market is just playing the waiting game, and investors are not yet convinced the US government will risk a US default. As the days left to reach a decision diminish and risk aversion increases, we may see the dollar return as the safe haven once again. We believe the dollar could remain on the back foot for most of the week and don’t expect to see the risk aversion play for a few sessions yet.

End of week forecast

GBP / EUR	1.1850
GBP / USD	1.61
EUR / USD	1.3610
GBP / AUD	1.71

Sasha Nugent

Currency Analyst

Caxton FX

Caxton FX Weekly Report: PMI Galore

Can the UK do it again?

It all begins again for the UK. Can sterling continue to produce such impressive figures to kick start the month on a good note? This week will most likely set a good tone for the majority of the month with a number of economic figures due. The main focus will be on PMI figures, and after last month’s golden performance, investors will definitely be waiting to see if it was just a one off. Last week, BoE Governor Mark Carney displayed a more hawkish tone. Carney explained that although the central bank would consider further QE if the recovery falters, his personal view is the recovery is strengthening and therefore more QE isn’t needed just yet. This allowed the pound to dominate, however with various economic figures and speeches out of the eurozone and the US, sterling will be under pressure to keep both the GBP/EUR and GBP/USD rates under tight grip.

Euro aims to be seen

Dovish statements from ECB members weakened the euro towards the end of last week and this is likely to continue in the days ahead. The monthly ECB rate announcement is on Thursday and in the following ECB press conference, President Draghi is most likely to reiterate points he has made in earlier speeches. Considering recent eurozone performance, we do not expect the ECB to adjust their current interest rate. A slew of economic data will be published this week including Spanish and Italian manufacturing and services PMI figures. Unemployment data for Germany, Spain and the eurozone aggregate will also be released and will attract at lot of attention considering the regions struggle with unemployment. A surprise improvement in the labour market will definitely be welcomed by the market and if this occurs, we should see the euro gain. German and eurozone aggregate retail sales numbers are also due and the single currency is likely to remain vulnerable against sterling if UK PMI data exceeds expectations. If the US government can come to a solution for its fiscal problems in time, it would also be big week for the dollar, where positive US employment figures could overshadow improvements in the euro area. Although UK and US developments could cloud euro strength, we believe that the euro will be able to pare back some of its losses during the course of the week.

Non-farm payrolls and Bernanke to direct dollar movement

Recently US economic figures have been missing expectations, and this has caused the dollar to remain weak against both the euro and sterling. The GBPUSD rate revisited levels of 1.61 on Friday, while the EURUSD rate sat comfortably above 1.35. The September 18th Fed meeting which saw the asset purchase programme remain on hold, triggered a downward spiral for the dollar, and this week, greenback will aim to start the month more positively. Provided the US government can come to an agreement regarding fiscal policy, non-farm payrolls and the employment rate are significant data releases which are most likely to set the tone for the month. ISM manufacturing and non-manufacturing figures will also be major drivers of the dollar this week. Fed chairman Ben Bernanke is due to make a speech on Wednesday evening and investors will be eager to hear from the horse’s mouth what is required in order to give tapering the go ahead. Comments made in this speech are likely to dominate dollar momentum at least until non-farm employment data and the unemployment rate are released. This will be a make or break week for greenback, and as much as the dollar could strengthen this week, failure to produce decent results could see it weaken. We maintain our view that the dollar will make another attempt to reduce recent losses yet we expect to see volatility as the week end approaches.

End of week forecast

GBP / EUR	1.1970
GBP / USD	1.6050
EUR / USD	1.3475
GBP / AUD	1.74

Sasha Nugent

Currency Analyst

Caxton FX 

Caxton FX Weekly Report: US dollar attempts to recover

Sterling aims to hold on tight

Last week’s main market driver was the decision by the Federal Reserve to keep the asset purchase program unchanged for at least another month. The shocking decision allowed sterling to run away with the trophy, and it is with that trophy that sterling begins the week. With fewer UK releases, the pound could come under pressure after recent strength. Current account figures due on Thursday (09:30) will be the main release, although CBI realised sales on Wednesday (11.00) and the Final GDP q/q reading on Thursday (09:30) could possibly provide sterling with more support. Despite poor retail sales figures, the pound has remained resilient hanging on to some good levels against both the euro and the dollar. Some MPC members are due to speak and it will definitely be interesting what they have to say about the UK economy. The PMI figures for France, Germany and the Eurozone aggregate number provided mixed results keeping sterling in charge, however good German IFO business climate numbers could attempt to push the GBP/EUR rate lower. The GBP/USD rate could also adjust downwards provided US data releases provide upside surprise.

The euro’s chance to surprise markets
Angela Merkel managed to secure her position as the German Chancellor for her third consecutive term, a historic victory. Eurozone PMI figures showed uneven development with manufacturing sectors coming in below expectations, while the services sector figures beat estimates, dampening euro momentum. These figures highlight uneven progress in the eurozone economies. German IFO data tomorrow provides another opportunity for the euro to gain. ECB President Mario Draghi is due to make a speech on this afternoon and on Friday, which will most likely have an effect on the euro, possibly providing more insight on his perspective on the Eurozone economies. Although we expect the ECB President to display some positive light on the development of the euro area, Draghi may also remind the markets that the recovery is still extremely vulnerable limiting euro upside. We could potentially see a slight reversal in the EUR/USD rate this week, however this is dependent on the performance of US indicators.

A fresh start for greenback
This week the dollar has a chance to put its nightmares of last week behind. A slew of US data releases are due which could allow the dollar to pare back some of its losses against euro and sterling. Many Fed members are due to speak this week and hopefully this will help shed some light on the central bank’s thinking behind last week’s decision to hold QE3 constant. Fed member of St Louis James Bullard has already made a statement claiming that small tapering of quantitative easing is possible next month. After the cloud the Fed pulled over the US recovery last week, this week should see evidence begin to build once again in order to warrant tapering to begin in October. Upside surprise from CB consumer confidence figures as well as strong core durable goods orders and new homes sales, would contribute to putting the dollar on the right path to rebuilding earlier strength. We expect to see the GBP/USD and EUR/USD rate retract a marginally as the week progresses.

End of week forecast

GBP / EUR	1.1830
GBP / USD	1.5970
EUR / USD	1.3480
GBP / AUD	1.7050

Sasha Nugent

Currency Analyst

Caxton FX

Caxton FX Weekly Report: Fed tapering decision weighs on greenback

Employment data was all Sterling needed

Although last week was a quiet week for UK data, claimant count figures gave sterling the boost it needed
to see the GBP/EUR rate touch the 1.19 mark. This week is a bit more eventful as Tuesday sees the release
of inflation figures at 09:30. This will be of particular interest as economic data has continuously pointed towards a stronger UK recovery, which has spurred doubt as to whether the timeframe given under forward guidance is appropriate. In a meeting with the Treasury committee, the central bank reinforced that if inflation breached the knockout condition of 2.5% in the medium-term, it would simply cause the monetary policy committee to assess why and then consider what action to take. A high inflation number may encourage speculation that the BoE will re-examine policy and ultimately raise rates earlier than the 2016 benchmark. The BoE monetary policy minutes due on Wednesday morning (09:30) will also be of interest, especially since the central bank didn't provide an accompanying statement following the announcement of the official bank rate. Retail sales figures released on Thursday are expected to follow the trend of recent UK figures and provide upside surprise. This should see sterling remain in control of the GBP/EUR rate, maintaining levels of 1.19 during the week. The GBP/USD rate will see a lot of volatility ahead of the all-important Federal Reserve meeting on Wednesday. The increasing likelihood that the Fed will delay tapering until at least the October meeting, creates a possibility sterling could maintain momentum against the US dollar.

Euro strength falters
Euro strength seen towards the end of August now seems like a distant memory. Since the start of September some eurozone fundamentals have been disappointing, allowing sterling to take advantage. This week sees the German ZEW Economic Sentiment due on Tuesday at 10:00, which is expected to improve to 45.3 from 42.0. Better eurozone figures are unlikely to provide the euro with much momentum, especially as negotiations regarding Portugal’s fiscal target are underway. Despite more disappointing US figures, the euro failed to capitalise and we doubt any eurozone releases will see the euro gain much ground. While we predict the single currency will remain on the back foot against sterling, it may stand more of a chance against the dollar if tapering doesn't begin this month. 

US dollar gets a battering 

The dollar took a beating last week, with sterling finishing off the job on Friday, pushing the GBP/USD rate to 1.5876. Poor US figures including non-farm payrolls figures and retail sales has contributed to the dollar’s downfall. The major driver of the greenback this week will be the outcome of the Federal Reserve meeting on Wednesday evening (7pm). A decision to reduce stimulus would see the US dollar rebound, while one to keep the asset purchase program on hold for at least another month could keep the currency vulnerable at least for this week. Dollar strength is mostly dependent on the Federal Reserve’s comments and actions. Even if the Fed decide not to go ahead with tapering this month it is still on the cards, and data from Wednesday onwards could be seen as another opportunity to warrant a reduction in stimulus to begin in October. For this reason we see the dollar remaining vulnerable for the earlier part of this week, with a slight window for strength as the weekend approaches.

End of week forecast

GBP / EUR	1.1950
GBP / USD	1.5855
EUR / USD	1.3275
GBP / AUD	1.7175

Sasha Nugent

Currency Analyst

Caxton FX 

Weekly round-up: Greek talks in focus

Markets are nervy ahead of Greek talks

There is a distinctive air of déjà-vu surrounding today’s meeting of the eurozone finance ministers, who for the third meeting in the space of two weeks are grappling with the IMF over Greece’s debt-reduction package, which should unlock the country’s next aid tranche. Talk has emerged this morning that a deal could be delayed until December 3, which would surely weaken the euro. There has been plenty of comment today from eurozone officials, from assertions that a deal today is “probable” to the less convincing “fully possible.” If an agreement does emerge, we expect the euro to benefit further but as it stands the situation remains highly uncertain.

Market confidence that EU officials will do what is necessary to avert a Greek disaster has helped the euro in the past week. Eurozone growth figures were also improved last week, whilst a key gauge of German business climate also impressed and lifted sentiment towards the single currency.

The weekend brought some mixed news from Spain, where in the Catalonian regional elections the separatist parties won but none failed to secure a majority. On balance, PM Rajoy will be relieved that Catalan President Mas’ party failed to secure the mandate to drive for a referendum on independence in the near-term, though with so much support for independence across separatist parties, the story will drag on.

US dollar hurt by positive headlines from across the world

As well as broadly encouraging news from the eurozone (Spain aside), there has been plenty to cheer about globally. A ceasefire in Israel has relieved geopolitical tensions, while the latest positive figures from the US and China have also improved trading conditions. This has seen global equities rally, an environment in which the greenback never trades positively.

The market will surely refocus on the issue of the US fiscal cliff once we can put the Greek negotiations behind us. The latest reports from the fiscal cliff talks have not been positive, so the uncertainty related to this is likely to be the trigger if the USD is to bounce back before the end of the year.   

GBP out of favour as fears of a UK ratings downgrade build

Last week’s public sector net borrowing figure was very disappointing. This, combined with ongoing indications from members of the MPC that we can expect a weak end to the year in terms of GDP, has sparked speculation that the UK’s prized AAA credit rating could fall foul of a cut from the likes of Moody’s. Much of sterling’ demand is down to its safe-haven profile, which is reliant on the UK’s top credit rating. However, the UK deficit is growing, despite ongoing austerity measures and UK growth remains extremely flimsy. Tuesday’s revised UK GDP number for Q3 will be closely watched.

There has been some rather better news for sterling in the form of the MPC minutes, which revealed only one policymaker voted in favour of more QE, whilst a cut to the BoE’s 0.5% base rate was viewed as unlikely in the foreseeable future.

End of week forecast

GBP / EUR	1.2300
GBP / USD	1.6050
EUR / USD	1.3050
GBP / AUD	1.5225

At €1.2350, GBP/EUR is trading at one-month low and we could see further weakness in the short-term. Losses should be limited to around a further cent however. Longer term, we remain confident of a bounce. Sterling has regained the $1.60 level but we do still favour the US dollar moving forward and would view the current level as a strong opportunity to sell the pound.

What the fiscal cliff could mean for the US and global economy

With the US fiscal cliff less than three months away, the International Monetary Fund has chimed in this week with its concerns for both the US and the global economy as a whole. The US is edging towards an enormous fiscal tightening the like of which we haven’t seen since 1947. The nerves, pressure and speculation surrounding the issue will only going to intensify as US politicians argue and stall their way through the final quarter of the year.

The IMF has estimated that if a deal isn’t reached to avoid a full-blown fiscal cliff, then the US could well plunge into recession next year. The organisation estimates that the US economy will grow by 2.1% in 2013, while the impact of the fiscal cliff would weigh on GDP by 2.2%.

While the fiscal cliff does not appear to threaten a global recession next year, it would certainly have a significant impact; rating agency Fitch has estimated that it would cut global growth in half. As far as eurozone growth is concerned, developments from within the region could easily tip the IMF’s 2013 eurozone GDP forecast of 0.2% well and truly into recession territory regardless of the fiscal cliff. However, the organisation sees the failure to reach a compromise on the fiscal cliff knocking 0.4% off growth, which would seal the deal regardless.

If an agreement between the Republican controlled Congress and Democrat controlled Senate, it is highly unlikely that the payroll tax cut will be extended - there appears to be consensus on this issue. The expiration of this tax cut then will likely shave 1.0% off US GDP, which is nearly half the amount that the IMF is estimating of a full-blown fiscal cliff. This would leave global growth down around 2.6% in 2013, instead of the 3.6% the IMF is anticipating on the assumption a deal is reached. Unless US politicians pull a rabbit out of their collective hat, the fiscal cliff issue is likely to end in pain for all concerned, just how much pain is the real question.

Richard Driver

Currency Analyst

Caxton FX 

US fiscal cliff a major danger to the US dollar

The most immediate danger to the US dollar is quite clearly posed by QE3. The US Federal Reserve’s monetary policy outlook should be a little clearer after Bernanke’s speech in Jackson Hole this afternoon. If it is not, then the Fed’s meeting and press conference on September 13^th should yield plenty of clues.

Whilst data over the past month or two suggests that US economic growth is recovering from its slumber in the first half of 2012, there is plenty of uncertainty ahead with the US ‘fiscal cliff’ drawing closer.

What is the fiscal cliff? The end of 2012 will see tax cuts come to an end and spending cuts dramatically, which are expected to weigh on US GDP dramatically. Tax cuts that will expire include a 2% payroll cut for workers and tax breaks for businesses, while tax hikes related to President Obama’s healthcare law will also kick in. The Congressional Budget Office estimates that the effects of all this could be a reduction in US GDP by a staggering 4.0% in 2013, while two million jobs could be lost resulting in a 1.0% rise in unemployment. So with the fiscal cliff capable of plunging the US economy back into recession, the stakes are extremely high.

                                                                                                                              

The US economy is faced with taking the pain and addressing its fiscal position in an early but huge hit, or spreading the pain over a longer period in order to safeguard a still fragile recovery (a familiar debate to followers of the UK political approach to austerity). As last year’s ‘debt ceiling’ debacle demonstrated, deadlock in the US political system can cause huge delays to major policy decisions.

In addition, this fiscal cliff issue comes in the context of an election year, so there will be no decision made on how to approach tax and spending moving forward until the leadership is determined in early November. A stop-gap measure to delay the tax rises may well come before the end of the year but you can be confident that any decision that is made will come right down to the wire.

What are the implications for the US dollar? Well, as ever there are two sides of the coin. The concerns over the US economy and the fears of recession could drive the dollar down in line with its deteriorating economic fundamentals. Contrastingly, the threat to the world’s largest economy could see the market flood back into the safe-haven US dollar. Inevitably, both strategies will be adopted but which truly prevails is uncertain.

Our bet is that the US dollar will be hurt by the fiscal cliff issue. This will likely be the case whether the US ‘goes over the cliff’ or whether delaying tactics are adopted. The can-kicking that has been evident in the eurozone has been a major weight on the euro over the last couple of years and the market response to more of the same from US policymakers will be the same.

However, the fiscal cliff is by no means the sole point of focus for the financial markets in the second half of 2012. Of course, this all comes as the eurozone debt crisis reaches new levels of seriousness. Indeed, we doubt that the fiscal cliff issue will be enough to stop the EUR/USD pair dropping significantly below $1.20 by the end of the year. The fiscal cliff will weigh on the dollar, but not to the same extent that the debt crisis will weigh on the euro.   

Richard Driver

Currency Analyst

Caxton FX

The aussie dollar is flying high but where does it go from here?

Australian dollar has gained by over 6.5% over the pound in the past two months, strengthened by nearly 7.5% against the USD in the past six weeks, and hit fresh record highs against the euro only this afternoon. The Reserve Bank of Australia cut its interest rate to 3.50% in early June and its key trading partner China continues to slowdown, so what is driving this latest rally in the aussie dollar?

One major factor fuelling the current positivity towards the AUD is the development that the German central bank, the Bundesbank, is set expand its portfolio of Australian assets. The eurozone crisis has caused central banks all over the world to review their reserve allocations and among others who are set to invest in Australian assets is the Czech central bank. This factor has completely overshadowed any dampening effects you might have expected as a result of the collapse of risk appetite that saw many higher-yielding currencies and equities decline since early May.

In addition, Australian economic data has in general held up remarkably well given the decline being seen in the Chinese economy (Chinese GDP has slowed down from a pace of 9.5% to 7.6% in the past year). Recent data revealed that Australian GDP expanded by an impressive 1.3% in Q1 of this year, well up from Q4 2011’s figure of 0.6%. This domestic economic strength gave the Reserve Bank of Australia the confidence not to cut its interest rate again in July.

However, we are seeing considerable risks of a rate cut in August as this domestic performance looks unlikely to persist. Recent Australian data has taken a downturn, particularly in terms of the domestic labour market. As well as July’s weak labour numbers, forward-looking indicators point to further softness.

Importantly, data revealed a sharp drop in Chinese imports from Australia in June and weekly New South Wales coal shipments have also fallen off this month. Equally, Chinese steel production has declined and its iron ore inventories have climbed, suggesting waning demand for aussie exports in the months ahead. As well as further deterioration in Chinese growth, we take a gloomy view as to the outlook for global growth and financial conditions, driven not least by eurozone risks. If a rate cut doesn’t come in August, we would be very surprised if it didn’t come in September.

For these domestic and international reasons, we see the AUD rally halting soon. AUD/USD should fail to sustain any breach of 1.05 and we should see this rate head back down toward and below parity in the coming months. In terms of GBP/AUD, downside scope is looking increasingly limited. The aussie is deep in overbought territory and we expect 1.55 will be seen once again before long. In addition, when the aussie dollar does endure its downward correction, it could well be quite a brutal move.

Richard Driver
Analyst – Caxton FX
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MPC minutes reveal no extra doves but QE risks remain prominent

Wednesday’s MPC minutes revealed that David Miles remained the one and only policymaker in favour of an additional round of quantitative easing (£25bn) at the rate-setting committee’s May meeting. We have to admit that we expected one or two other policymakers to give Miles some company in the dovish camp, but we maintain that he won’t be the lone dove for long.

This much has been indicated by Adam Posen, who has been expressing second thoughts with regard to his decision to abandon his calls for QE, pointing to a potential overestimation of UK growth over Q1. We’d be surprised if Posen fall back to his dovish tendencies in June. Though it may take more than Posen to worry holders of sterling, given that a 7-2 split on the QE vote still keeps the dovish very much in the minority.

One major point that could dissuade several policymakers to vote for QE is the fact that they believe UK inflation is equally likely to be above target as below it in the medium term without more monetary stimulus. In addition, current CPI levels, regardless of the recent fall from 3.5% to 3.0%, are high.

Nonetheless, it was stressed that for several members of the committee, the decision was finely balanced and the option remains well and truly on the table. The latest figure from the UK retail sector, combined with the softer start we saw to Q2 in the form of some weak UK PMI surveys, will increase speculation that the UK’s struggling economy is in need of some extra monetary help.

The key factor that could well have the final say on the BoE QE debate is of course the eurozone debt crisis. The situation in Greece has taken a severe turn for the worse since the failure of the ruling coalition to secure sufficient support at its recent general election. A new round of elections is due on June 17th, which could well produce an anti-bailout collation and lead to a Greek euro-exit. Meanwhile, fault lines within the EU leadership have been highlighted this week in Germany’s rejection of French and Italian plans to introduce a common eurozone bond (a Eurobond).

As shown by the euro’s recent slide, confidence in the euro project is waning. We expect the euro-region to return to negative growth this year and the financial shockwaves from a probable Greek exit are expected to be worse than those of Lehman’s. Consequently, we bet we haven’t seen the last of UK quantitative easing in 2012.

Richard Driver
Analyst – Caxton FX

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EUR/JPY Overview: Japanese yen to continue weakening

The yen has weakened off by around 11.5% against the euro in the past two months. This is largely attributable to the convergence of performance between the US and Japan economies and monetary easing from the Bank of Japan.

The Japanese economy remains a key underperformer among the major global economies; it contracted by 0.2% in the final quarter of 2012 (though this was revised up from an initial estimate of a 0.6% contraction). Reduced exports, caused by the yen’s excessive strength and weakening global demand, are a key factor weighing on Japanese growth. However, industrial production and the post-earthquake reconstruction project is gaining pace, which should take Japanese back into positive territory this quarter.

The market was recently dealt a scare by January’s Japanese current account data, which revealed a record deficit of $5.41bn. The yen suffered as a result - Japan’s current account surplus has been a cornerstone of the JPY’s safe-haven status. Nonetheless, it remains likely that this deficit will prove a temporary blip, though it did the yen no favours in the short-term.

The US economy, by contrast, is outperforming. It grew at an annualised pace of 3.0% in the final quarter of 2011. As shown by the Non-Farm payrolls figures so far this year, the US labour market is making some real improvements. Crucially, this has seen the US Federal Reserve remove any reference to QE3 from its messages and in a statement this week, it upgraded its economic outlook from “modest growth” to “moderate growth.” With China slowing down, the eurozone entering a recession and Japanese growth likely to be fairly flat this year; the US economy is the real outperformer at present and we are seeing considerable yen to dollar flows as a result.

Another key factor weighing on the JPY is the Bank of Japan’s commitment to yen-depreciation. The strong yen has been a huge downside factor on Japanese exports. The Bank of Japan has repeatedly failed in its attempt s to directly intervene in the currency markets but monetary easing is still a weapon that the market is wary of.

February saw the BoJ boost its quantitative easing programme by 10 trillion yen, which has fuelled much of EUR/JPY’s gains in the past month. Whilst the BoJ took no further major action at its March meeting, the dissent within the committee highlights the scope for further easing. The Bank of Japan is highly concerned with the country’s deflation problem and is likely to continue monetary easing this year in order to achieve its 1.00% inflation target.

There are a plethora of reasons why not to invest in the euro this year. Having contracted by 0.2% last quarter, the eurozone’s growth figures in the year so far are pointing quite clearly to a recession. Nonetheless, there have been some broadly positive developments out of the eurozone in recent weeks, with the Greek debt-swap deal going through and paving the way for what is likely to be a second Greek bailout. However, sentiment towards the euro has been hit hard, as shown news by the 13.5% decline in the EUR/USD pair from last summer’s high.

Greece will be granted aid for now but it is widely expected to return to bailout territory by next year. Market sentiment remains suspicious that Portugal and more alarmingly Spain and Italy may be forced to follow a similar path in having to restructure their debt. The only real factor seemingly supporting the euro at present is the constant need of Asian and Middle Eastern central banks to diversify their FX reserves away from the US dollar.

Regardless of the eurozone’s poor growth and debt dynamics, monetary policy in Japan is likely to be the dominant driver of this pair in 2012 and EUR/JPY’s rise will not be a symptom of euro strength but of yen weakness. Long positions in the yen have fallen back considerably from January’s highs and we do not view the weakening bias we have seen in the yen in the past few to be temporary.

Developments in the eurozone and the US economy have provided a boost to global stocks, including the Nikkei, and in these risk-on conditions the safe-haven yen will always weaken. Events in the eurozone are likely to put plenty of pressure on market risk appetite this year but our bet is that the BoJ will successfully demonstrate its resolve in weakening the yen through monetary easing, something it failed to do through direct intervention.

We can see the EUR/JPY rate continuing its uptrend from the current 109.00 level in the coming months. This should see April 2011’s highs above the 120.00 level revisited at some point in the second half of this year.

Richard Driver
Currency Analyst
Caxton FX

Swedish Krona March Outlook

The Swedish krona and other risky currencies finished 2011 strongly and made an impressive start to 2012. Risk appetite has been spurred on by the ongoing impact of the European Central Bank’s (ECB) mid-December LTRO (cheap loan offering), further improvements to the US economic recovery and the emergence of a Greek bailout agreement.

However, huge uncertainties surround both the Greek and wider eurozone debt situation. In addition, data this year clearly points to the onset of a recession in the euro-area. The risks to a downturn in market sentiment, which will inevitably weigh on the krona, are all too apparent.

In terms of the Swedish economy, growth has deteriorated and the prospects for this year have weakened. Amid diminishing internal and external demand and rising unemployment, the Swedish economy contracted by 1.1% in the final quarter of 2012. Accordingly, the Riksbank is forecasting growth of just 0.7% for 2012.

The Riksbank cut the Swedish interest rate by 25 basis points to 1.50% in February, following the rate cut we saw in December. Further monetary easing this year cannot be discounted if conditions continue to worsen. In addition, after an impressive surplus last year, the Swedish National Debt Office has recently announced that it expects a budget deficit of 11bn krona this year.

We hold a pessimistic view for Greek and eurozone developments this year, on both the growth and the debt front. This should weigh on risk appetite and combined with the Swedish economy’s downtrend, the outlook for the Swedish krona is decidedly vulnerable.

GBP/SEK

Interest rate developments have gone against the Swedish krona in recent months, with the Riskbank reducing its yield from 2.00% to 1.50%. The moves were down to both diminishing global and domestic growth. With the eurozone accounting for more than half of Swedish exports, the recession that the region is heading into is likely to weaken Swedish growth to an even greater degree. The Swedish inflation outlook is also distinctly tame, so there is little scope for a Riksbank rate hike this year, while a further cut will certainly be considered if conditions both internally and externally deteriorate.  

This Swedish downturn contrasts with the good news that has emanated from the UK economy in the past few weeks. UK retail sales figures have been excellent; the services sector continues to show decent growth and the construction sector also bounced back in February. These firmer figures have made a return to positive growth (after last quarter’s -0.2% GDP figure) highly likely in Q1 2012. This in turn should dissuade the MPC from deciding on further UK quantitative easing this year. It also increases the likelihood of the UK hanging onto its prized AAA credit rating, which is a major pillar of support for sterling.

The ECB’s cheap loans have fuelled a rally in risky assets in the past three months, as shown by the FTSE 100’s recent climb to a seven month high. However, an improved outlook for the UK economy (and therefore sterling), a deteriorating Swedish economy and a fairly sharp decline in risk appetite have seen GBP/SEK show signs of resuming last year’s uptrend. In line with a pessimistic view towards the overall eurozone situation, we see GBP/SEK consolidating on its recent bounce in the 10.7-10.8 area over the next few weeks. In the medium and longer-term, the risks are skewed towards a further upside move towards 11.00.

EUR/SEK

There have been some positive developments in the eurozone in recent months. The ECB’s cheap loans have ensured that credit conditions in Europe have eased this year and have fuelled a rally in eurozone equities and brought key peripheral bond yields in Italy and Spain down to more sustainable levels. A long-awaited Greek bailout agreement finally arrived in February, quelling fears of a messy Greek default in mid-March (albeit temporarily).

However, the market also remains incredibly tense about the Greek situation. A Greek bailout is by no means assured, which means we may yet see a messy Greek default this month. Greece has until the evening of Thursday 8^th March to convince enough private bondholders to sign up to the debt-swap arrangement, failure to do so could result in a credit event in which credit default swaps are triggered.

The potential Greek scenarios that are currently on the table are many and varied and this lack of certainty is what is weighing on risk appetite at present. Even in a best case scenario in which Greece gets its second bailout and avoids a default without triggering a credit event, there are strong arguments that suggest this is simply an exercise in buying time and we could be back in bailout and default territory before long.

In addition, eurozone growth remains a key concern. The region contracted by 0.3% in the fourth quarter of 2011 and judging by growth figures out of Germany and the region as a whole, a slide back into a prolonged recession is now looking somewhat inevitable.

By virtue of the Swedish krona’s negative correlation with low levels of risk appetite and in line with our view that we are entering a period of damper market confidence in which safer assets than the krona will be turned to, we are confident that EUR/SEK will continue to climb. We have seen a sharp spike from 8.80 to over 8.90 in the past week and we are looking for a push towards 9.00 in March.

USD/SEK

To buck the global trend of weakening global growth, the US recovery has really gathered pace in recent months. The US economy grew at an impressive annualised pace of 3.0% in the fourth quarter of last year and there have been significant improvements to America’s chronic unemployment problem. This upturn seems to have caused US Federal Reserve Chairman (Ben Bernanke) to indicate that QE3 will not be utilised, which is a real positive for the US dollar.

By contrast, the US dollar made a very weak start to 2012 but we believe the greenback will be a major outperformer this year. With intervention doubts surrounding the other traditional safe-haven currencies (the yen and the swiss franc) and with the EUR/USD pairing looking increasingly vulnerable to a collapse, the USD is set for major gains in what will surely be a highly uncertain, dollar-friendly environment this year.

The bounce in the USD/SEK rate (from 6.55 to 6.80) in the past week should represent the start of a major reversal of dollar weakness. We see the USD strengthening in excess of 7.00 krona level in coming months, though over the next few weeks gains will probably be limited by the 6.90 level.  

NOK/SEK

The Norwegian krone has made an extremely impressive start to 2012. It is the top performing currency over the past month thanks to a combination of domestic economic strength and soaring oil prices.  Norwegian manufacturing and retail sector growth and declining unemployment has improved sentiment towards the NOK, while a widening trade surplus shows that exports are not being hit as they are in neighbouring Sweden.  The Norwegian economy outperformed the Swedish economy in the fourth quarter of 2011 by growing 0.6% (versus Sweden’s 1.1% contraction) and is almost certain to continue outshining this year.

Oil prices have risen by 15% already in 2012 amid worrying developments in Iran; Brent crude is currently trading just off a multi-month high above $125 per barrel.  As a major producer of oil, the Norwegian economy stands to benefit and so too does its currency.

The only real question mark hanging over the Norwegian krone is the monetary policy of the Norges Bank. The state of Norwegian economic growth wouldn’t suggest another cut to the Norwegian base rate, which currently stands at 1.75% (slightly higher than the Swedish 1.50% rate). However, Governor Olsen has reiterated that the Norges Bank will consider the strength of the krone when evaluating its interest rate policy. Another rate cut may well come if the NOK continues to appreciate but the krone is likely to remain in demand regardless.

With the NOK/SEK rate having bounced from just above 1.14 to just below 1.20, the Norwegian krone is the clear outperformer here. NOK/SEK is actually trading only marginally below a 25-month high. However, the current pace of appreciation is unlikely to persist for another month as Norges Bank intervention concerns will inevitably temper progress. Still, we should not see too much of a downward correction away from the current 1.20 trading level.

Caxton FX Weekly Round-Up: GBP/EUR/USD

ECB loans fail to deter euro reversal

The European Central Bank’s second LTRO, in which it offered more three-year loans at 1.00% to the eurozone’s struggling banking sector, failed to give the euro the impetus to build on gains it has made in the year to date. The cheap loans have been crucial in avoiding a credit crunch and bringing down peripheral bond yields in recent weeks. Risk appetite has been booming in as a result but it seems unlikely that this second LTRO, of which demand was similar to last December’s, will have the same impact. The market saw fit to use the event as an opportunity to take profit on the euro’s strong start to 2012 and the single currency sold off across board.

The Greek issue continues to peg the euro back. A debt-swap deal must emerge by Thursday evening. Failure to persuade enough private bondholders to accept losses of at least 53.5% on their holdings could result in credit default swaps being triggered and a whole wave of financial turmoil. In addition, Greece’s second bailout still hasn’t been signed off and a U-turn remains possible. Greek nerves are likely to steadily build this week.

Concerns outside of Greece have also added to the weight being felt by the euro. Spain has defied the EU by setting a softer deficit target than that agreed under the recent fiscal compact (5.8% rather than 4.4% of GDP).

Economic growth is at the heart of this problem – these countries are struggling to cut their debt because austerity measures are strangling output. Recent data revealed that the pace of contraction in the eurozone services sector quickened in February, while unemployment increased.

February’s growth data suggests firm Q1

The pace of growth in the UK manufacturing sector slowed in February. The same is true of the UK services sector, while in the construction sector we saw the best monthly posting since April 2011. Still, the market’s key concerns focus on whether the UK will head back into recession, whether the MPC will announce further quantitative easing, and whether the UK will lose its AAA credit rating. The growth data from January and February has balanced the risks in favour of a ‘no’ to all of these questions. As such they should give sterling some underlying support in the coming weeks.

Ben Bernanke indicates QE3 is off the table

A speech from US Federal Reserve Chairman brightened the prospects of the US dollar last week. Bernanke failed to a make any reference to “QE3” – a third programme of quantitative easing. The market took this as a ‘clear’ indication that the upturn in the US economy in recent months has caused the Fed to step away from the option of more QE. Bernanke’s ‘signal’ could well turn out to be the catalyst for the US dollar to reverse the weakness we have seen in the greenback in the first couple of months of this year. Data last week confirmed the reason for optimism with regard to the US, revealing that its economy grew at an impressive annualized pace of 3.0% in Q4 2011.

Sterling is trading back up at €1.20 now, thanks to the euro’s poor end to last week. Risks remain to upside ahead of the tensions that will inevitably build as a result of the ongoing Greek debt-swap negotiations. We continue to hold the view that with GBP/USD up at $1.5850, this is a strong level at which to sell sterling and buy USD.

End of week forecast
GBP / EUR 1.2075
GBP / USD 1.58
EUR / USD 1.31
GBP / AUD 1.49

Richard Driver
Analyst – Caxton FX

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Weekly Analysis: Euro still looking vulnerable

Early year optimism disappears very quickly

There were signs of a rally in confidence and risk appetite in the session or so of 2012 but sentiment quickly deteriorated due to all the familiar eurozone-related concerns. Poor demand at eurozone bond auctions (including that of Germany, much to the market’s concern) and widening yield spreads saw the euro resume its downtrend almost across the board. Linked to this are ongoing concerns of blanket downgrades throughout the eurozone when Standard & Poor’s decides to take action. There are plenty of bond auctions this week to keep the euro under pressure; Greece will look to the market on Tuesday, while Italy and Spain will do so on Thursday.

Also in the headlines in recent sessions has been the worsening economic picture in the eurozone. EU leaders finally appear to be willing to address the issue of eurozone growth. The debt crisis is having such as impact on confidence that the region is spiralling into recession and EU leaders have earmarked the Jan 30th meeting as an opportunity to look at eurozone growth and the region’s soaring unemployment levels (10.3% for the eurozone).

Figures last week revealed a eurozone services sector contraction, as well as negative monthly growth in both German and eurozone retail sales. Forward looking data such as German factory and eurozone industrial orders also undershot expectations last week. It seems businesses on the continent are preparing for the worst and sitting on their capital. With the lack of leadership we have seen on the debt issue, it is difficult to question why.

Merkel and Sarkozy’s meeting produced little of real note; they remain committed to the progress made on introducing greater budgetary discipline in the eurozone and continue to urge Greece to reach an agreement with private bondholders on haircuts before the country is given its 2nd bailout.

The ECB will have its monthly meeting and press conference on Thursday, which will surely overshadow the BoE’s Monetary Policy Committee meeting. We think there is a greater chance of another ECB rate cut than the market is currently appreciating. Eurozone data is only going one way and with inflation also beginning to ease, Draghi could well pull the trigger for the third consecutive month. That said, we are still betting that the ECB will keep its powder dry for this month, though another cut in Q1 is almost a dead cert.

UK growth takes a more positive turn, but for how long?

Last week’s monthly set of UK growth data take a turn for the better, with each of the services, manufacturing and construction sector figures beating expectations. The services sector was particularly impressive in December.

The outlook for the UK recovery remains highly uncertain and risks are firmly fixed to the downside. Sterling should benefit nonetheless, with hopes being raised that the Bank of England may be convinced that further quantitative easing may not be necessary after all. High demand for UK debt continues to support the pound; gilts were the top performing government bond for 2011 and are starting 2012 where they spent the last.

Sterling is trading up at a sixteen month high of 1.21 against the euro and the outlook is looking very strong for GBP/EUR. Less so against the dollar, the US recovery is gathering pace at an impressive rate, which is only adding to the safe-haven appeal of the greenback. GBP/USD is trading just above a four month low of $1.54.

End of week forecast:

GBP / EUR 1.2150
GBP / USD 1.54
EUR / USD 1.27
GBP / AUD 1.51

Richard Driver
Analyst – Caxton FX
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Caxton FX January Outlook: GBP/EUR/USD

December was an awful month for the single currency; the crucial EU Summit failed to satisfy market expectations and the euro was punished accordingly. Preceding the Summit, hopes for a holistic, assertive and credible plan to deal with the region’s debt profile were elevated higher than ever. Unfortunately the fiscal compact on budgetary discipline and various other commitments that were made did little to convince the market that EU leaders are on the right track. The region’s debt dynamics are finally taking their toll on the euro in a very material way.

Sentiment towards the UK economy has been at a particularly low ebb in recent weeks; growth figures have been disappointing and sights have been set very low for 2012 growth. Nonetheless, with the UK government remaining committed to its deficit reduction plan, there continues to be strong (and sterling-supportive) demand for UK gilts and there remains minimal scope for Bank of England intervention.

The focal points for this month are inevitably eurozone-related. Investors will be looking to the EU Summit on 30th of January with hopes for major decisions to deal with the debt situation. Growth will also be discussed and this has up until now remained a largely unaddressed problem. The eurozone looks likely to head back into a technical recession this year, and it goes without saying that the region cannot solve this crisis without economic growth.

Sterling/Euro

Slow progress and poor leadership are hurting the euro almost across the board at present. Sterling has climbed to a sixteen-month high of €1.2150 against the euro, which says far more about waning confidence levels towards the single currency than it does about the UK’s economic growth prospects.
Out of last month’s EU Summit came an agreement to top up the eurozone’s bailout resources by €200bn in IMF loans. Typically, and almost symbolic of EU leaders’ inability to take action, this figure was later revised down to €150bn. Agreements to bring forward the introduction of the European Stability Mechanism (the permanent bailout fund) by a year to the middle of 2012 and to enforce stricter budget discipline are valuable long-term developments, but they do little to deal with the region’s very pressing short-term issues. The market is short-termist by nature; investors are far less concerned with avoiding future crises, they are preoccupied with the threat that the current crisis poses to the very existence of the euro.

Rating agency action (or the threat of it) is worrying the market at present. The bodies responded to the latest EU Summit inaction by downgrading the ratings of eurozone states such as Belgium and put several key nations such as Spain and Italy on ‘negative watch.’ Fitch’s even came to the damning conclusion that a comprehensive solution to the debt problem is “technically and politically beyond reach.” Standard & Poor’s are yet to wield their axe but are likely to do so in coming weeks, and this represents a major threat to the euro and risk appetite more generally.

Bond auctions in the eurozone are also in sharp contrast. Debt sales have been attracting diminishing demand and, alarmingly, this even applies to the core countries of France and Germany. Bond spreads are widening throughout the eurozone (Germany excepted) and further bond auctions this month will keep the pressure on the euro.

Greece remains the first head on the chopping block and its government has already stated this week that they will be forced to exit the euro in the event that they do not receive a second bailout by March. We can expect nerves to build steadily ahead of this deadline.

The prospects for the UK economy, despite a couple of encouraging growth figures from the UK services and construction sectors this week, are distinctly gloomy. Flat to minimal (around 0.5%) growth seems likely this year, and the risks of a recession are very significant. However in truth, developments in the eurozone will have a greater say over the UK’s recovery prospects than domestic policy.

Risks for this pair are quite clearly to the upside from our standpoint; the uptrend may be stalled by bouts of profit-taking on sterling’s rallies, but we see this pair climbing a further cent towards €1.22.

Sterling/US dollar

Sterling has been trading within a three cent range of $1.54 - $1.57 since late November and although this pair has threatened a move to the downside several times, sterling has managed to maintain sufficient support.
The US recovery is finding some real transaction at present, we haven’t seen such consistently positive economic data flow in almost a year. US manufacturing, consumer confidence and employment gauges are all on the up. The labour market, which remains both the US government and the US Federal Reserve’s number one concern, in particular appears to be making some progress, with January’s key monthly employment change figure hitting an eight month high.

In comparison to slowdowns in economies such as the UK, the eurozone, China and many others, the upturn in the US is attracting plenty of investment besides safe-haven flows. Often strong US data will weaken the dollar but at present, the opposite is true. In addition, the upturn in the US is diminishing the case for further quantitative easing from the Fed, which again is a positive for the US dollar.

Safe-haven flows are still the number one driver of the greenback’s strength however. The eurozone situation continues to peg back risk appetite and we are confident it will do so for many months to come. With fears of central bank intervention hanging over the yen and particularly the swiss franc, demand for the US dollar is high.

With market confidence on a noticeable downtrend, we see this pair breaking its current range to the downside in coming weeks. A move towards $1.53 is our bet.

Caxton FX one month forecast:
GBP / EUR 1.22
GBP / USD 1.53
EUR / USD 1.26

Richard Driver
Senior Analyst – Caxton FX


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Monthly Report: US dollar goes from strength to strength

September failed to bring the bounce in global investor confidence and risk appetite that we were anticipating. We have a revised our longer-term forecast for euro strength and dollar weakness due to a sharp deterioration of the global financial environment. Market fears have gone from bad to worse in recent weeks; faith in eurozone officials’ ability to make any real progress on the debt issue is waning and economic data is pointing evermore towards a global economic slowdown. As a result, the equity markets have consolidated early August’s sharp sell-off and the dollar has strengthened significantly. The outlook has probably not looked this gloomy since the last global recession, which favours safe-haven assets considerably.

Perpetual weakness in the US economy, Standard & Poor’s downgrade of US debt and the certainty of ultra-loose Fed monetary policy for the foreseeable future has failed to hold the US dollar back. More pressing global matters have ensured major dollar gains. Added to this, the Swiss National Bank has intervened in the strength of the swiss franc, and the Bank of Japan has been posturing for a similar move, leaving the greenback as the safe haven currency of choice. Sterling is suffering against the dollar accordingly, but has made gains against riskier currencies such as the euro and the commodity currencies.

The euro has really suffered a downward correction over the past five weeks. A Greek default looks inevitable, the European banking system looks vulnerable to a major crisis and a concrete plan to ensure Italy and Spain are not sucked into the eurozone’s bailout cycle remains elusive. On top of this, eurozone growth has slowed to such an extent that a rate cut from the ECB looks is looking increasingly likely at coming meetings.

GBP/EUR

On its own merits, sterling remains an unappealing currency. This is unlikely to change any time soon; economic growth is only teetering above negative territory, which has caused investors to scale back Bank of England interest rate bets to 2013. Indeed, far from tightening monetary policy, the Monetary Policy Committee has pulled the trigger on further quantitative easing (QE2). £75bn in extra asset purchases has been announced in order to boost the UK economy and safeguard it from heightened volatility in the financial markets.

Nonetheless, the eurozone is suffering a comparable slowdown to that of the UK and although the ECB held interest rates at 1.50% this month, there is still a very significant risk of a rate cut in 2011. The debt crisis is clearly impacting activity in the region, as shown by two consecutive months of contraction in the eurozone’s services sector.

Importantly, the UK has maintained its AAA credit rating and is being seen to be ‘doing the right thing’ with regard to reducing its debt. Debt concerns have surrounded the euro all year, with Portugal, Ireland and Greece (for the second time) all seeking aid. However, concerns have reached such heights that the euro has finally borne the brunt of the market’s frustration. There is now a near certainty of some form of Greek default and growing speculation that private investors are going to have to accept a substantial hair cut on their Greek holdings. This has seen the EUR/USD pair decline by over twelve cents from late August’s rate of $1.45.

A key factor weighing on the euro is the inability of EU officials to convince the market that they have any genuine handle on the debt crisis consuming other, larger eurozone states such as Spain and Italy. There is quite clearly lack of any real consensus on any long-term solution, which has brought about the realisation that progress is likely to take months, not weeks. Crucially, Asian sovereign funds seem to be losing their appetite for the euro and have reduced their previously reliable support for the single currency.

Sterling has made some decent gains over the euro in recent weeks then, climbing from a low of €1.13 to trade at its current level two cents higher. We foresee little progress on the debt issue in the near-term, giving the GBP/EUR rate further upside potential. Indeed, the muted market responses to what were anticipated to be significant relief stories, such as the recent German ‘yes’ vote for the expansion of the bailout fund, suggest market sentiment is going to require a really major development to bounce back. Sterling could well edge up by one or two cents from its current trading level of €1.15 in the month ahead.

GBP/USD

The dollar has gone from strength to strength over the past month or so. Safe haven flows have increased as a result of the worsening global economic picture and in addition, the dollar has taken the lion’s share of these safe-haven flows due to the deteriorating appeal of the alternatives (the yen and the swiss franc).

The Fed decided against introducing a QE3 programme last month, instead opting for ‘Operation Twist,’ where by it sells short-term debt and buys long-term debt. The market was unimpressed and thus the dollar remained strong. Still, QE3 remains a possibility in coming months, though it is unlikely that Bernanke will pull the trigger just yet given the slight upturn in the growth data coming out of the US of late. If and when there is further quantitative easing in the US, expect the dollar to weaken off considerably. For this month at least, this looks unlikely.

Sterling has broken out of its long-term trading range against the dollar to the downside. In late August this pair was trading at $1.65, it is now trading at a thirteen month low of $1.53. Sterling has fallen a long way very fast against the dollar, but it is looking vulnerable to a further decline. The pound will continue to struggle against the dollar as long as funds continue to be redirected from the euro to the greenback, which is exactly what we foresee in the coming weeks.


Caxton FX one month forecast:
GBP / EUR: 1.17
GBP / USD: 1.51
EUR / USD: 1.29

Richard Driver
Senior Analyst – Caxton FX


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A Weekly Round-Up: Sterling, Euro, Dollar

Stocks tumble but the major pairings remain in range

Attention last week was very much centred on activities in the stock market. The US debt downgrade, combined with ongoing concerns surrounding global growth and the absence of a long-term solution to the eurozone debt situation, triggered major declines in global equities. Market confidence was as low as we have seen it all year. Nonetheless, the US dollar failed to capitalise from heightened demand for safe-haven assets.

However, there have not been major moves amongst the major currency pairings; sterling remains fairly unchanged against both the euro and the dollar. The truth remains that the US, UK and eurozone economies have such serious economic problems that they cannot muster the support to sustain a rally.

The main event this week as far as the euro is concerned is tomorrow’s meeting between Merkel and Sarkozy. The two heavyweights will be looking at a long-term solution to the euro-regions debt situation which is now threatening major eurozone nations such as Spain, Italy and France.

The Fed promises record-low rates until mid-2013

Last week’s US Federal Reserve meeting was highly significant. Chairman Ben Bernanke announced that the US interest rate will remain at its current record-low level of <0.25% for the next two years, in a bid to nurture the US economy’s struggling recovery. The removal of any rate hike bets weakens the US dollar’s prospects in the long-term. However, prevailing concerns surrounding another global recession are likely to keep the greenback supported via its safe-haven demand.

In terms of the US economy, we had more mixed data last week. Monthly US retail sales figures showed an encouraging uptick, but some awful US consumer sentiment data suggests future figures could disappoint. This week’s data calendar is a quiet one from the US economy, we have had some awful manufacturing data out this afternoon which will only cement pessimistic bets for growth.

MPC minutes in focus

This week brings some important UK-related news. The UK consumer price index (headline inflation) is announced tomorrow. This is forecast to show an uptick but last week’s BoE quarterly inflation report was distinctly dovish on this issue. It suggested that inflation will still spike up to 5.0% in coming months, before falling fairly rapidly back down towards the official 2.0% target next year.

The MPC minutes are released on Wednesday and it will be very interesting to see whether quantitative easing gained further air-time, and whether one of the two remaining MPC hawks defected to the dovish camp. One thing can be safely assumed, there will be no UK interest rate hike for many months to come. Thursday sees the release of the monthly UK retail sales figure, which is expected to show some further modest growth.

End of week forecast

GBP / EUR 1.13

GBP / USD 1.6330

EUR / USD 1.4450

GBP / AUD 1.55

Richard Driver
Currency Analyst
Caxton FX


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