Dollar in demand against Eurozone vulnerability

Defensive considerations will remain extremely important in the short-term as markets continue to focus on the Eurozone crisis and global vulnerabilities. There is likely to be further defensive demand for the US currency as the US Treasury market continues to attract support.

The dollar advanced firmly against European currencies during the week, but a slide against the yen held back the overall dollar index. Risk considerations tended to dominate and there was a decline in US Treasury yields to 2012 lows on defensive demand.

The US retail sales data was slightly weaker than expected with a 0.1 per cent gain for the headline and underlying increase for April. There was a much weaker than expected reading for the Philadelphia Fed index as it dipped to -5.8 from 8.5 the previous month while there was a substantial deterioration in most of the major components which raised some doubts over the US outlook.

The Fed minutes confirmed that the FOMC was more optimistic surrounding the growth outlook with the probability of a slow decline in unemployment. Several members indicated that further monetary accommodation could be required if the economy lost momentum. The Fed also expressed concerns surrounding the fiscal outlook.

Euro

The euro was subjected to heavy selling as political and economic fears increased with four-month lows near 1.2650 against the dollar and it weakened very sharply against the yen as Greek euro-exit and contagion fears intensified.

There were further fears surrounding Spain with major doubts surrounding the banking sector. There was an increase in benchmark Spanish bond yields to above the 6.3 per cent level while the spread over German bunds widened to a record high. Moody's also announced a credit-rating downgrade of 26 Italian banks and 16 Spanish banks which reinforced fears surrounding the European banking sector given the sovereign-debt default risk. Fitch downgraded Greece's sovereign rating to CCC from B-.

Germany secured a stronger than expected first-quarter GDP gain of 0.5 per cent, allowing a Eurozone figure of 0.0 per cent which technically avoided a recession. Sentiment was undermined quickly by the fact that it was only the German performance which provided support as Italy for example contracted by 0.8 per cent for the quarter.

There were further fears surrounding the European banking sector which had a negative impact on the currency. There were reports of substantial capital withdrawals from the Greek banking sector and there were also reports of substantial outflows from Spanish bank Bankia.

There was intense pressure for the ECB to take additional action to stabilise markets while the political pressure for additional measures was also intense. German Finance Minister Schaeuble called for a rapid move to political union.

Range for previous week: $1.2670-$1.2870 (Dh4.6540 -Dh4.7271). Range for this week: $1.2610-$1.2900 (Dh4.6316-Dh4.7381)

Pound

As growth conditions will be undermined by Eurozone vulnerability and there will also be a high degree of unease surrounding the domestic conditions, especially with income levels under pressure. There will be speculation over additional Bank of England quantitative easing particularly if Euro fears intensify. The pound has gained important support on defensive grounds, although it may prove difficult to sustain buying support given the lack of confidence in the domestic fundamentals.

The pound was unable to hold gains through the 0.80 level against the euro during the week and dipped sharply to two-month lows around 1.5750 against the dollar.

The latest UK unemployment data was stronger than expected with a decline in the claimant count of 13,700 for April following a revised decline the previous month while the unemployment rate declined to 8.2 per cent from 8.3 per cent previously, although the drop was fuelled primarily by an increase in part-time employment.

In its quarterly inflation report, the Bank of England lowered its growth and inflation forecasts for the two-year outlook.

Range for previous week: $1.5730-$1.6120 (Dh5.7776 -Dh5.9208). Range for this week: $1.5700-$1.6200 (Dh5.7666-Dh5.9502)

— HSBC Global Markets Middle East