Foreign Exchange Market Overview

Mon, March 21, 2011

Last week the market was dominated by the terrible events that unfolded in Japan. Earthquakes, followed by a tsunami dealt a devastating blow to the nation's economy and also lead to a possible nuclear crisis when the Fukushima nuclear plant suffered damage. The Japanese Nikkei 225 fell by 6.2% when the markets opened on Monday, and in a bid to support the economy the Bank of Japan pumped an equivalent of $183 billion in Yen into the economy. As technicians working at the Fukushima plant struggled to prevent radiation leaks and reactor melt downs, the Nikkei plunged further and more stimulus from the BoJ was needed. By Thursday the Yen had reached an exchange rate of 76.25 against the US Dollar, the highest exchange rate since World War 2. It was only until Friday when G7 nations jointly agreed to intervene in the currency markets did conditions improve, economically speaking, for Japan as the decision saw an immediate decline in the Yen and the Nikkei closed the day 2.7% up.

As a result the of the Japanese turmoil the foreign exchange markets saw a huge shift towards safe haven currencies such as the US Dollar, the Swiss Franc and even the Japanese Yen itself, leaving the Pound to trade at a weekly low of 1.5969 against the Dollar. The exchange rate began to improve towards the end of the week as risk aversion began to fade and the GBP/USD exchange rate closed the week at 1.6230. On the data front Wednesday's employment reports showed that jobless claims fell to their lowest level in two years in the month of February when claims fell by 10,200. This came as a surprise to economists who had forecast that claims would increase by 1,300. Despite this the ILO unemployment rate rose in the 3 months to January from 7.9% to 8.0% providing a cloudy picture of the UK's labour market.

In stark contrast to the previous week, the UK's economic calendar is looking much busier with Wednesday's scheduled release of the Chancellor of the Exchequer's budget report and the Bank of England minutes taking the spot light. Traders will be interested in the division of the MPC vote, as more policy members turning hawkish will signify that an interest rate hike may occur in the near future. Tuesday's inflation figures will also be closely watched as rising inflation will add further weight to an eventual increase. As expectations for a rate hike build, the Pound may gather support and rally against the other currencies.

Despite the goings on in Japan the Euro remained fairly resilient, as against the US Dollar, the exchange rate pushed up to a high of 1.4170 on Friday as markets relaxed and traders became less risk aversive, and against the British Pound, the Euro appreciated to see the pair trade to a low of 1.1411 by the end of the week. Despite Portugal receiving a downgrade to it's sovereign credit rating by Moody's Investor services, the Euro was supported by an encouraging economic docket. Euro-zone Consumer Prices and Producer Prices from Germany added to interest rate hikes expectations in April and much of the Euro's advance can be attributed to these expectations, although there has been some debate as to whether the crisis in Japan will make the ECB hold off on a rate hike as the global outlook worsens.

Over the next week, as long as risk sentiment doesn't take too much of a hold on price action, the Euro could continue to appreciate of the back of rate hike expectations. Still the economic figures could prove to be the currency's down fall, as Thursday's Purchasing Manager's Index (PMI) for both Germany and the Euro-zone are expected to report slower growth across manufacturing and services based industries. Further to this Friday's GfK consumer confidence survey is expected to report weaker consumer sentiment and should Germany's IFO business sentiment gauges fall from February then the Euro could lose ground against the other majors.

Risk sentiment directed the majority of the Dollar's movements last week. Initial reactions to Japan's natural disaster saw the Dollar benefit form its safe-haven status. Were it not for the gains made from risk aversive trading, the Dollar may have well ended the week much lower, as the economic docket was less than supportive. Indeed the Dollar would have weakened following the disappointing drop in housing starts and building permits in February by 22.5% and 8.2% respectively. Further to this weekly jobless claims rose and February's industrial production fell despite forecast calling for an increase. On a positive note the Fed, following their announcement to maintain their current monetary policy, announced that information received since January has shown that economic conditions are improving and so too are labour market conditions, albeit gradually. The Fed also said that the elevated unemployment rate and low inflation did not warrant any interest rate hikes in the near future, this despite in February's Producer and Consumer Price Indexes reporting better than expected growth.

For the upcoming week, risk sentiment will most likely remain as the most influential force behind the Dollar's movements. With problems still persisting in Libya and other Middle Eastern Nations, as well as the aftermath of Japan's earthquake the Dollar could easily retrace some of the losses it incurred during the closing days of last week. On the data front, Monday could see the Dollar trade lower if existing homes sales support a negative outlook for the US housing market, although conversely Wednesday's New Home sales are expected to rise by 2.1% in February following January's decline. Friday's 4th Quarter GDP rounds the week off and could push the Dollar higher as forecasts call for the US economy to expand at a rate of 3.0%.

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