Direct FX's Weekly Update

The first half of last week's trade on the global financial markets saw limited volatility as investors took a welcomed breather from the previous weeks volatility. The acceptance of a lower global growth profile for the remainder of 2011 and 2012 saw the growth assets drift, and interest rates look to establish themselves at new lower levels. Thursday and Fridays trade again saw nervousness increase. The European Central Bank (ECB) was again active in supporting European debt prices by purchasing Italian debt to somewhat quell investor fears. But an article in the Wall Street Journal describing the close monitoring of US arms of several European banks and their funding situations caused major ripples on equity markets. Banking stocks saw renewed selling pressure and the downside momentum for growth assets once again accelerated. Weaker economic data releases in Europe and the US, coupled with the prospect of central bank intervention by the Swiss and Japanese helped the uncertainty continue. The Australian and New Zealand dollars remained under pressure on most cross rate, and this trend should continue in the short term until equity markets stablise. The coming week's have the added spice of the earning's reporting season for publically listed corporate, and these will no doubt provide a little movement on a daily basis. The Japanese Yen reached a post war high against the US dollar on Friday and this keeps the prospect of further Bank of Japan (BOJ) intervention in play this week.

The unfolding of the events in Libya may offer some risk appetite, with the prospect of a lower oil price with the transfer of power away from Gaddafi being a positive for economic growth.

The release of the Reserve Bank of Australia (RBA) monetary policy meeting minutes highlighted the divergence between the interest rate market pricing, and the rhetoric from the RBA. The fact that wholesale funding rates for Australasian banks will be more expensive as credit markets tighten helps the RBA's cause, and will ease the inflationary pressure as these higher borrowing rates flow through to the mortgage market. The Australian dollar gave up ground against most of its major trading partners in the absence of major domestic economic data releases. This week sees another week light on domestic focus, so the lead will once again be provided by the equity markets for the most part.

The New Zealand dollar traded with a softer tone throughout most of last week, in line with wider decrease in market appetite for risk. There was an absence of top tier domestic data, but this changes this week starting on Tuesday with the quarterly Reserve Bank of New Zealand (RBNZ) Inflation Expectations Survey. Wednesday sees the monthly trade balance numbers, and Thursday the quarterly retail sales numbers, and these will be closely watched. Expect the NZD to remain soft on most cross rates for the most part as the downward revision of growth projections continue with its major trading partners.

In the US economic conditions remain very subdued. The dramatic fall in the "barometer" Philadelphia Fed Manufacturing Index was alarming, and the reading is getting down to levels not seen since the depths of the meltdown in 2008/09. Demand remains very much in place for US Government debt, as safe haven plays remain in place and the potential for further Quantitative Easing (QE) cannot be dismissed. This coming weekends annual central bankers symposium in Jackson Hole provides a forum for US Fed Chairman Bernanke to communicate future policy initiatives, and will be a focus for the coming week.

The Great British Pound performed relatively well over the last week, even as the Bank of England (BOE) Monetary Policy Committee meeting minutes revealed the voting split had moved for 7-2 in favour of keeping the cash rate steady, to 9-0 in favour. The lower growth prospects mean any policy changes are far off in the UK. The GBP is benefitting from flows that may have otherwise have been going into EUR, finding relative stability in the UK. Also adding to the bid tone may have been merger and acquisition flow from Europe, according to well informed sources. Inflationary pressures seem to be easing as forecast, and the Public Sector net borrowing numbers were also lower than expected. This coming week is reasonably light on the economic data front in the UK, with the revised 2nd quarter GDP number on Friday being the focus.

In Europe the outlook remains bleak. Lower than expected growth numbers adding to market sentiment as the debt woes continue unabated. Further speculation about the monetary unions future will remain poignant over the coming years. Increasingly political pressure may dictate the future as unrest increases. The ECB continues to purchase Italian Government bonds to support the debt markets in the short term. Longer term solutions are far more complex. The data focus for the coming week again rests in Germany with economic sentiment and business climate surveys due on Tuesday and Wednesday respectively.

The better than expected Japanese GDP data was a good surprise for the Japanese economy as supply chains continue to recover following their natural disasters. The strength of the YEN remains the primary focus in Japan and will continue to be so in the short term. The BOJ are likely to intervene in some form if this strength continues, and various finance officials are commentating as such on a daily basis. Yen cross rates will see volatility on any such intervention and may provide opportunities for those with interest in YEN money transfers.

In Canada, the strength of the CAD against the USD is compounding the sluggish demand from its largest trading partner. 2nd quarter growth is expected to be close to flat, before accelerating in the 2nd half of 2011 and then again falling in 2013. Expect interest rates to remain on hold in the meantime as inflation remains within Bank of Canada (BOC) forecasts. The focus for the coming week will be the monthly retail sales numbers on Wednesday.

In South Africa the volatility continued in both bond and stock markets and this led to the increased pressure on the RAND again most trading partners. With the increasingly likely odds that there will be no movement higher in the cash rate from the South African Reserve Bank in the next 12 months, expect the RAND to remain under pressure. Inflation numbers are due for release on Thursday this week, but these are likely to be just of passing interest as the global outlook rules sentiment on the RAND.

Sam Coxhead

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