Direct FX Weekly FX Update

Market Overview:

The financial markets have seen wide spread volatility in the last week. Both the EURO and US dollar saw periods of considerable selling pressure. Debt pressures in both the US and Europe remain the concern. The credit rating agencies remain active, with further downgrades on various European debt instruments and the placement of the US Government credit rating on negative watch. The gloss has come off the Australian dollar, as further evidence of the two tiered nature of the domestic economy comes to hand. The New Zealand dollar put in a stellar performance, driven by demand against the Australian dollar and the surprisingly strong first quarter GDP number. Signs of a slowing global growth picture have become more evident, with various Asian countries seeing softer economic numbers, and consumer sentiment falling around the world.

In the US, the Federal Reserve (FED) Open Market Committee meeting minutes revealed that further quantitative easing measures remain a possibility, although the hurdles would be significantly high. This alone would have seen the US dollar under pressure. However coupled with a prolonged Congressional debate about the raising of the US debt ceiling, and the one in two chance of a US credit downgrade, and any chance of a resurgence in the US dollar remains low in the short term. The full ramifications of a credit downgrade for the US are many and widespread. This issue further increases the global growth fears beyond the short term.

The seemingly ever intensifying European debt crisis saw Italian debt and banking stocks under significant pressure ahead of austerity budget votes in parliament, which were passed successfully. The Spanish Government has taken the risky step of guaranteeing Spanish bank debt, in an effort to stop the peripheral contagion from spreading further. In the weekend European bank stress tests results we released. Whilst these were not great reading, they could have been worse, and the perceived integrity of the process is low. This coming Thursday sees yet another hastily organised EU meeting to discuss financial stability and progress in Greece. It is reasonable to expect concerns about this debt crisis to remained elevated for some time yet, and the potential for a full scale "credit event" remains real.

The New Zealand dollar has been in hot demand. There has been a considerable exit of sold NZD positions against the Australian dollar. Momentum was boosted again by the delayed release of the Q1 GDP numbers. These were robust to say the least and amazing considered in context the February earthquake. This opened the way for a track higher by the NZD against almost all trading partners, with the exception of the Japanese YEN. The NZ Q2 CPI inflation number released today showed a 1.0% increase for the quarter, with the usual suspects of fuel, food and transport leading the increase. With the prospect of higher yield in NZ to provide demand for NZ dollars over the short term, this prospect has to be balanced by the slowing global growth outlook. The interest rate market now indicates around a fifty percent chance of an interest rate hike from the Reserve Bank of New Zealand (RBNZ) in October.

The two tiered nature of the Australian economy continues, as consumer and business sentiment surveys weaken, and non mining export sectors continue to struggle with the high value of the Australian dollar. Interestingly, Westpac has formally made the call that the Reserve Bank of Australia (RBA) will cut the cash rate in 2011. This statement caused quite a move lower in the AUD, and lower in Australian interest rates. So tomorrow the RBA Monetary Policy meeting minutes will be closely watched. Their stance of late has been more cautious, and it is easy to imagine that they are watching the global risks closely.

In the UK the economic news was downbeat, but the inflation number released last week was lower than expected and this will be welcomed. This coming Wednesday sees the release of the Bank of England (BoE) Monetary Policy Committee meeting minutes and these will garner attention. Talk of further quantitative easing would likely see the GBP under renewed pressure, especially against the Australasian currencies, although this remains unlikely. Retail sales numbers on Friday will also be closely watched, for further insight into the state of the British consumer. Inflationary pressure is expected to continue to ease in the UK, and this will be welcomed by the consumer. Normalisation of the cash rate from its current low of .5%, has to happen at some stage, therefore the BoE has a balancing act on its hands. Ironically as inflationary pressure starts to ease, this may coincide with the cash rate moving higher, and the fortunes of the GBP will increase with it.

The Canadian economy continues to be patchy. This week will focus on the Bank of Canada (BoC) and their Monetary Policy Report. They are expected to keep the cash rate unchanged at 1.0%. Inflation and retail sales number on Friday will also draw attention.

In Japan the economy remains slow, but indicators on private consumption and capital spending have picked up. The YEN remains in demand, as global fears increase and it benefits from its safe haven status. Also helping demand are reports of increased offshore repatriation flows, as the rebuilding of devastated areas start to gather momentum.

Sam Coxhead

Global Currency Payments & Transfers

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