Weekly Forex Currency Review 01-05-2009

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The net evidence suggest that markets still want to take a more optimistic tone towards the global economy with stock markets pushing to 2009 highs. In this environment, there will be reduced defensive demand for the dollar. The US currency could be in a position to gain some cyclical support, especially with little confidence in the other major currencies. There is also an important risk that confidence will unravel again during the summer period.     

Key events for the forthcoming week

Dollar:

There will be further cautious optimism that the US economy will continue to improve slowly over the next few months.  There will continue to be fears over the employment trends, especially with jobless claims still at an extremely high level. In this environment, there is still the risk that weak consumer spending will have a further negative impact on the banking sector through credit-card defaults. There is reduced scope for defensive dollar demand in the short-term , especially with credit spreads continuing to narrow slightly. Degrees of risk appetite continued to have an important market impact. Confidence initially faltered with fears over the impact of a flu pandemic, but economic sentiment was generally resilient as equity markets were generally firmer and this lessened dollar demand. There were also no major global negative data surprises

The US GDP data was weaker than expected with a headline 6.1% annualised contraction for the first quarter of 2009 following a 6.3% decline the previous quarter. Inventories continued to decline sharply during the three-month period while trade volumes also fell rapidly in response to the global downturn. The sharp drop in inventories should lessen the risk of a further very sharp GDP contraction, although that was also the case following the fourth-quarter data.

The latest US initial jobless claims data was close to market expectations with a decline to 631,000 from a revised 645,000 the previous month while continuing claims were at a fresh record high at 6.27mn. In contrast, the Chicago PMI index was stronger than expected at 40.1 from 31.4 the previous month as orders recovered. The Chicago data should act as a leading indicator and the firmer data maintained some cautious optimism that the economy was ain a position to recover, although the employment component remained very weak

The other more forward - looking data maintained the recent pattern of being stronger than expected with consumer confidence rising to 39.2 in April from a revised 26.9 previously, although this is still at an historically very weak level. In addition, the Richmond Fed index rose to -9 from -20 the previous month while the Case-Shiller index reported that house prices fell 18.6% in the year to February.

The dollar weakened ahead of the FOMC interest rate decision on expectations that the Fed would expand the quantitative bond buying to help support the economy. With risk appetite also firmer on higher equity markets, the dollar weakened to lows near 1.3340 against the Euro.

As expected the Fed left the target range for Fed funds at the 0.00 – 0.25% range following the latest FOMC meeting. The Fed also decided not to adjust the amount of bond buying at this time. In the statement, there was a commitment to keep interest rates at a very low level for an extended period. There was, however, some cautious optimism that the rate of contraction in the economy was slowing. Despite recovering back towards the 1.32 level later in the week, the dollar maintained a generally weaker tone against European currencies.

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The evidence continues to suggest that the rate of GDP decline is slowing while business sentiment has improved significantly. In this environment, the ECB may be more cautious over adopting non-standard policy measures and a decision not to implement quantitative measures at the May meeting would tend to support the Euro. The currency will also gain some backing if there is a continuing improvement in risk appetite.  Underlying structural fears will still limit the scope for Euro gains.
          
The Euro secured solid buying support on retreats, although it was unable to make strong headway as resistance levels remained tough to break down.

The Euro-zone employment data was weaker than expected with the unemployment rate rising to 8.9% from 8.7% the previous month. The flash inflation estimate for April was also slightly lower than expected at 0.6%. German unemployment rose by a further 58,000 in the latest month from a revised 71,000 increase the previous month. There was speculation that the Irish economy could contract by at least 10% for 2009.

There were further comments from ECB officials during the week with Bini-Smaghi, for example, casting doubts whether there had been an agreement on quantitative easing methods. The Euro remained very sensitive to policy comments ahead of the council meeting next week and suggestions that the bank would not pursue quantitative easing underpinned the Euro. Late in the week there was an agreement that ECB members would not make public comments over policy measures.

Yen:  

The latest industrial data has continued to suggest that conditions are starting to stabilise with the regional economy also showing some significant signs of improvement.  The economy will still be very weak in the short-term  which will curb yen support. Any sustained improvement in risk appetite would tend to weaken the Japanese currency and international confidence is liable to remain firmer in the very short-term . The shift in sentiment could still prove to be very brittle give that there are still important stresses with some yen support beyond the 100 level against the dollar.

The Japanese currency gained ground early in the week as economic uncertainties combined with fears over the flu outbreak undermined risk appetite. The Japanese currency strengthened to highs beyond 96 against the dollar and 125 against the Euro before weakening sharply later in the week with lows beyond 99 against the dollar.

Domestically, the retail sales data was slightly better than expected with a 3.9% decline in the year to March. In contrast, the unemployment rate rose to a four-year high of 4.8% while core consumer prices fell 0.1% in the year to March which maintained unease over the deflation threat.

The Japanese industrial data was stronger than expected with a 1.6% increase in industrial production, the first rise for eight months, which boosted confidence in the domestic and regional economy.

The Bank of Japan held interest rates at 0.10% following the latest council meeting and also decided against implementing any further quantitative policy measures.

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The evidence continues to suggest that the economy is stabilising at a weak level and is also performing favourably in comparison with the Euro-zone.  The debt situation will remain a very important focus and there are still very serious risks associated with the very high borrowing requirement. While risk appetite remains firmer, the UK currency can retain a firm tone, but will be much more vulnerable to selling pressure if there is a sustained deterioration in risk appetite. Overall, Sterling will find it very difficult to make sustained gains.  
 
Sterling prove generally resilient over the weak as underlying UK economic fears were offset by optimism over risk appetite. The UK currency consolidated near 0.8950 against the Euro and hit tough resistance above 1.49 against the dollar.

The currency was unsettled initially by some renewed fears over the UK banks with media reports that the sector would need to raise substantial additional capital to secure adequate protection against another economic downturn.

The UK economic data was stronger than expected with the CBI retail survey rising to +3 from -44 previously, although this figure is likely to have been distorted by seasonal considerations and the CBI was still generally downbeat over prospects. The data still provided some degree of net relief and alleviate fears over a further substantial deterioration in retail spending.

Hometrack reported the slowest decline in house prices for close to 12 months with a 0.3% April monthly drop, but was not confident that any recovery would be sustained. There was a small decline in BBA mortgage approvals for March which caused some disappointment given that the recent housing-sector evidence has suggested a very tentative recovery in lending levels while mortgage lending was also weak.

The Nationwide Bank reported a smaller than expected 0.4% decline in house prices for April. The PMI index for manufacturing rose to 42.9 in April from a revised 39.5 which was an 8-month high.

Swiss franc:

The Swiss economy is likely to secure only a limited recovery in the short-term  with an improvement in domestic demand. The economy is still liable to under-perform the Euro-zone as exports remain under heavy pressure. The National Bank will continue to intervene to prevent franc gains and fears over the implications of franc strength will increase if there is also general dollar weakness. In this environment, the franc is unlikely to make much headway.

The franc was generally resilient over the week and tested important levels near 1.50 against the Euro before a measured retreat. The dollar weakened to lows below 1.13 before finding significant support.

The Swiss KOF index weakened to a record low of -1.79 in April from a revised -1.65 the previous month, although the previous figure had originally been reported as even weaker. Underlying confidence in the economy will remain weak, especially with exports remaining under heavy pressure.

There were also fears that the Swiss economy will under-perform other major economies which will curb franc support.

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The Australian currency found firm buying support below the 0.70 level against the US dollar and pushed sharply stronger during the middle of the week with a peak above the 0.7350 level before a period of consolidation.

The domestic influences remained limited as the currency moves were dominated by trends in risk appetite while the latest manufacturing PMI index weakened to a record low. Global equity markets were generally stronger and this provided important support to the Australian currency over the week.

The Australian dollar should maintain a firm tone in the short-term  on improved risk appetite, although resistance levels will be tough to break down.

Canadian dollar:

The Canadian dollar remained volatile over the week following last week’s interest rate decision. The currency drew important support from an improvement in risk appetite and a weaker US currency which pushed the Canadian dollar to highs beyond 1.19, the strongest level since early 2009.

The Bank of Canada repeated comments that there was no need for an early move to quantitative easing and this provided further support to the local currency. The GDP data was broadly in line with expectations and did not have a major impact

The Canadian dollar will remain vulnerable to higher volatility and there is likely to be scope for only limited near-term gains after the recent advance.
 
Indian rupee:

The rupee was unable to sustain levels stronger than 50 against the US currency during the week, although ranges were generally narrow. Market activity was limited by holidays on Thursday and Friday.

The rupee gained some support from a firmer tone in global risk appetite while the equity market was firm. There was stronger month-end dollar demand which stifled the potential for any currency appreciation.

The rupee trends will remain correlated strongly with degrees of global risk appetite. Overall, there is likely to be scope for only limited net gains given that improved conditions have been priced in.  

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The Hong Kong dollar continued to trade near the 7.75 strongest limit of the currency band against the US dollar as underlying confidence remained firmer and there was further HKMA intervention to prevent the band limit being breached.

The currency continued to gain support from an improvement in risk appetite and sentiment towards the regional economy also improved.

The Hong Kong dollar should be able to maintain a firm tone in the short-term  on improved risk appetite with further intervention required to keep the band intact.  

Chinese yuan:

The yuan remained firmer over the week with a further small advance to 6.8230 against the US dollar. There was also a shift in the NDF market with forward yuan rates at the strongest for 8 months

The yuan continued to gain support from expectations of an improvement in the domestic and regional economy, especially with a further small improvement in the official PMI data for April.

Chinese official comments on the plans to secure a greater role for the Chinese financial sector also provided a significant boost to the yuan.

The yuan will continue to be in a stronger position to advance if the authorities are more confident over the domestic and international growth outlook. Confidence could still falter very quickly if there is evidence of the economy stalling again.