Market liquidity was sharply lower over the week due to the impact of Christmas and New Year holidays. In this environment, there was a high degree of volatility in the European currency pairs, notably on Wednesday, which was the final trading session of the year. The violent currency moves this year also increased the potential for positioning shifts at the end of the year. Commodity prices were also erratic over the week with crude oil prices rallying from multi-year lows.
The US data remained generally weak, although there were mixed reports. US initial jobless claims fell more sharply than expected to 495,000 in the latest week from 586,000 previously. The weekly data may have been distorted by seasonal considerations and the number of continuing claims increased to a fresh 26-year high.
The Chicago PMI index edged stronger to 34.1 in December from 33.8 the previous month. The orders and employment components were slightly stronger, although they remained trapped below the 40.0 level which still indicated a sharp contraction in activity.
Despite the impact of falling gasoline prices consumer confidence fell to 38.0 in December from a revised 44.7 previously. This was a record low for the index and indicated the depth of pessimism which reinforced fears over near-term spending trends, especially with the Case-Shiller house-price index recording a 18.0% annual decline for October.
The Euro-zone M3 and lending data recorded a significant annual slowdown to 7.8% from 8.5% previously which suggested scope for lower interest rates, although the downturn was controlled which bolstered arguments within the ECB that caution is still required.
ECB Chairman Trichet stated that the growth risks were still on the downside. He also warned that falling commodity prices had an expansionary effect as well as being disinflationary while bond markets may be over estimating risk. The comments continued to suggest that the bank may be reluctant to cut rates very aggressively in January, especially as the impact of substantial interest rate cuts over the past 3 months has not yet been seen.
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The Euro advanced to highs above the 1.42 level against the dollar over the week, but it was unable to sustain the gains with reports of selling from the Middle East and the Euro dipped back to test levels below 1.39 in choppy trading.
Global equity markets generally advanced over the week while credit spreads continued to narrow and Libor rates were also generally lower. Significantly, the Wall Street Vix volatility index dipped to lows just below the 40 level for the first time since the beginning of October which underpinned risk appetite.
In this environment, defensive demand for the yen was weaker while domestic activity was severely curtailed by a series of market holidays. The US currency pushed back above the 90.0 level against the yen over the week. The Australian dollar was also able to take some advantage of the improvement in risk appetite with a test of resistance levels above the 0.70 level against the US currency.
The UK PMI index for the manufacturing sector edged higher to 34.9 from 34.5 previously which was above expectations, but mortgage approvals were weaker than expected with an annual decline of over 60%.
The latest Bank of England credit conditions survey also reported a further tightening in lending standards which maintained expectations of further interest rate cuts while the data also showed that there was a net repayment of equity within the housing sector as debt was repaid.
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Sterling remained under pressure over the first part of the week with a succession of fresh record lows against the Euro and there was a trough just beyond the 0.98 level. It was unable to make any headway against the dollar over the week. Sterling rallied on Wednesday and again in Asian trading on Friday in very volatile trading, but was unable to sustain the advance as underlying sentiment remained extremely weak.
The Swiss KOF business-confidence index weakened to -0.39 in December from -0.04 previously which was a fresh 66-month low for the index and will reinforce fears over the domestic economy, especially with the UBS consumption index also weaker.
The Swiss currency trends were still driven to a large extent by capital flows with some further evidence of repatriation. The franc strengthened to highs near 1.04 against the dollar before a retreat towards 1.0750 while the Euro found support below the 1.48 level.
