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Market Overview: By Sam Coxhead of Direct FX

Market Overview: By Sam Coxhead of Direct FX (www.directfx.co.nz)

Foreign exchange markets finally broke out of their recent sideways trading range last week. Increased uncertainty stemming from various political and economic forces have driven the moves. Risk aversion has increased as economic indicators again point towards lower than previously forecast growth in Europe, the US and Australasia. Elections in France and Greece have increased the risk aversion. Adding to the mix a sharp correction in the oil price, and the way has opened for a materially stronger US dollar, and Japanese YEN.

In Australia the Reserve Bank (RBA) surprised the market with the larger than expected 50 point reduction in the cash rate to 3.75%. The move may have been a result of the RBA not wanting to change the cash rate at its next meeting, following the Federal Budget, so there may have been an element of “front loading”, to last week’s reduction. But they were clear on their reasons for easing monetary conditions. A benign inflationary environment and weaker than expected domestic activity provided the environment for the decisive cut. Following today’s relatively buoyant retail sales and building approvals numbers, the remainder of the week’s sees the focus on Thursdays employment numbers. A higher than expected unemployment rate would see further pressure on recently maligned Australian dollar.

In New Zealand last week’s higher than expected unemployment rate increased pressure on the already fragile New Zealand dollar. The NZD saw selling pressure across the board, and it was a strangely weak performance. The downward trend of the Fonterra Diary auction prices will not be helping investor sentiment. This week will see the lead mainly come from offshore, and the wider market appetite (or lack thereof), for risk. The Reserve Bank of New Zealand (RBNZ) Financial Stability Report will be followed but should not be of material impact to the price action this week

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The US dollar saw good demand across the board last week, apart from against the Japanese Yen. The numbers were again mixed heading into the all important employment report on Friday. Manufacturing numbers were stronger than expected, whilst services data lagged. A weaker crude oil price was certainly US dollar supportive, as a lower oil price directly impacts on productivity and personal spending habits in the US. The employment numbers were a mixed bag at best, with the participation rate (number of people engaged in the labour market) at the lowest level since 1981. This indicates people have simply given up looking for employment. The low participation rate makes the unemployment rate naturally fall, and this caused the unemployment rate to come in at 8.1%. This week FED Chairman Bernanke speaks Thursday, and consumer sentiment numbers on Friday will garner most attention. The oil price will also be a factor, with lower oil pricing supporting the US dollar.

In Europe the debt crisis is currently getting a political injection. French President Sarkozy has lost his bid to remain in charge, with Socialist Leader Hollande winning a tight election battle. In Greece the pro-bailout parties saw higher than expected pressure in the polls. No party achieved a majority and now the negotiations start. The rise of anti-bailout party Syriza into second place in the polls questions how long Greece will remain in the Euro-zone. The back lash of voters across Europe makes the drive for austerity harder as well as adding to the uncertainty. Pressure builds on the ECB to become more active in trying to stimulate growth. The EURO has seen a dramatic fall in demand following the two election results. This week will see further focus on the ECB as ECB President Draghi speaks, and the ECB release their monthly report on Thursday.

In the UK last week mixed economic indicators were seen. Manufacturing and services sectors slightly underperformed market expectations, whilst the construction sectors saw better than expected growth. This week sees the focus return to monetary policy and the Bank of England (BOE). Interestingly, Citibank released a note to investors late last week calling for 50-75 billion of further quantitative easing from the BOE at this week’s meeting. The probability of extra stimulation is not high, but given the rapidly changing environment, nothing would surprise. The GBP has remained in demand on most pairings, but did give up ground to the resurgent US dollar.

In Japan tension will again be rising at the Bank of Japan. Global risk aversion has again seen demand for YEN increase. This has been added to in the last few sessions by a dramatically lower oil price. Lower oil prices naturally support YEN. The focus for the week coming will be the current account on Thursday.

Weaker than expected monthly GDP numbers were shrugged off by the Canadian dollar for the most part last week. Manufacturing numbers on Friday also underperformed, but given the volatile nature of that data, they also were of limited impact. The fact that the Bank of Canada have openly talk of hiking the cash rate, has provided strong demand for CAD in recent times. The focus this week is undoubtedly the employment numbers on Friday, with an unemployment rate of 7.3% expected in the report.

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