The currency blog

The Deteriorating Situation in Egypt was the over-riding consideration on Friday and remains so today. Risk took a battering, with equities falling sharply on Friday afternoon in the US and bourses in the Far East slipping by the same magnitude this morning. The Dollar has had a reasonable couple of sessions which began with the strong US GDP number. Markets were looking for a rise of 3.3-3.4% in US growth and the actual number was reported at +3.2%, slightly less but still well up on the +2.6% from the previous quarter. The make up of the figure also heartened the market and the overall sentiment became Dollar positive. The trend was cemented by an official statement from the Peoples Bank of China yesterday during which they again expressed concern over inflation and excessive bank lending, warning that the Central Bank may need to tighten reserve requirements again to curb rapid capital inflows.
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After a short rally at the beginning of the year the Greenback has come under increased downward pressure following widening interest rate differentials against many other currencies. The stand out is the difference in view between the hawkish ECB and the somewhat dovish US stance highlighted in the latest FOMC statement has provided a catalyst to differing outlooks from either side of the pond.
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Wednesday saw both the Federal Reserve and Bank of England reveal details from recent meetings. In the Feds case, the meeting was also yesterday, and again the Fed reassured the markets of the continuing economic recovery. Again the Fed expressed concern over the labour market but the key point the markets will take from an otherwise as expected release is the continued lack of dissenters on the FOMC.  We will get the hard data supporting the Feds’ stance on Friday, when US 4th quarter GDP figures are released. Although parts of America also suffered a prolonged cold snap in December, we are not expecting this to be used as an excuse for a disappointing number!
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The single European currency continues to rally against the US Dollar, with the pair trading at two-month highs. The Greenback suffered as President Obama called for a freeze on non-security discretionary spending during his State of the Union speech last night, suggesting a part spending freeze that would save $400 billion from the budget over the next decade and additional cuts of $78 billion in defence. There was a minor reaction in markets to the speech, previously that day a report indicated that US consumers began the year with much more confidence in the economy than expected, seeing a recovery gaining steam and expecting more jobs will be created. The Conference Board said its consumer confidence index, which had slipped in December, rose in January to 60.6, its highest level since May. In contrast US Housing data also released showed a mini double-dip in home prices. Residential real-estate prices dropped in November by the most in a year. According to the S&P/Case-Shiller index, home values in 20 cities fell 1.6 percent from November the prior year, the biggest 12-month decrease since December 2009.

The pound was dealt a severe blow yesterday as the UK economy surprisingly contracted in the fourth quarter of 2010 as the harshest winter in a century hit retail and service sectors. GDP fell by 0.5% in Q4, having increased for the last 4 quarters, according to the Office for National Statistics yesterday morning. The ONS said that growth would have been “flattish” in the fourth quarter without the impact of the weather and that weather-related disruptions accounted for “most” of the 0.5% decline. This view has been echoed by the words from Mervyn King last night who played bad cop / bad cop all on his own. There were no soothing words at all with expectations that rising consumer inflation would remain a problem but that wages in real terms would fall - he warned the UK to expect living standards to fall with the likelihood that things would not improve much for the rest of 2011.

The focus today will now shift to the upcoming FOMC statement with no change in near-term monetary policy expected. However, investors will be focussed on the inflation outlook language and whether any of the new voters on the committee dissent in a hawkish direction. Losses in the dollar were tempered last night on speculation the Federal Reserve will signal the world’s largest economy is improving. The FOMC statement may contain language acknowledging improvement in consumer spending and employment.

The short-term outlook for Sterling looks decidedly dodgy after 4th Quarter UK GDP was released at -0.5%, a contraction! Analysts were penciling in forecasts of +0.3% - +0.4%, but fears are grew that we might see it reported weaker than those especially given comments from the Business Secretary, Vince Cable this morning. He was reported as saying that there is reasonable consensus that Q4 was a ‘pretty bad quarter’ for the UK economy. Now, this could’ve been the Government trying to anchor expectations or it could’ve been the old Tory trick of getting the market to expect horrible news only to be pleasantly surprised when it wasn’t so bad even though the actual number was still weak. The ONS has said that the bad weather was the likely contributor to most or all of the quarterly fall and that without the harsh conditions, GDP would likely have been flat. Sterling has crashed on the back of the number falling over 1% against the board.
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The Euro has started the week on the front foot, pushing through 1.35 in the EURUSD pair and below 1.18 versus Sterling. The recent rally sparked by tougher than expected comments on rising inflation by ECB President Jean Claude Trichet and compounded by short sellers buying back positions, and has probably still got some room to run on the upside given the current divergence between the EURUSD and EUR two year swap rate, but our longer term outlook is still Euro negative. The resignation of the Irish Prime Minister as head of his party and withdrawal of the Green party from the ruling majority has not as yet dealt a fatal blow to the finance bill, key to Irish access to bail out funds, from being approved but it will probably now mean a much earlier than expected general election. Portugal has also re-elected its President for a second term according to reports, hopefully bringing short term stability and calming the market enough for the EFSF reforms to be passed before they inevitably also need to find alternative sources of funding.
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