Weekly Forex Currency Review 03-04-2009

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Overall strategy:  The most recent indicators have suggested that recession conditions could ease slightly while central banks and governments are continuing to provide aggressive support. In this environment, risk appetite is liable to remain stronger in the short-term.  The improvement in sentiment could still prove to be relatively brittle given that there are still very serious underlying stresses in the financial sector. For now, demand for defensive currencies is likely to remain lower which will limit dollar and yen support. 

Key events for the forthcoming week

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The Euro-zone economy will remain under pressure in the short-term as the industrial sector continues to decline.  There will still be underlying fears over internal stresses as credit-rating downgrades continue. The ECB policy will still provide near-term Euro support, especially if the bank continues to resist quantitative easing measures.  The Euro should be able to resist heavy selling pressure in the short-term unless Eastern European fears suddenly intensify.
 
The Euro initially weakened as there were further credit-rating downgrades for European countries with Irish and Hungarian debt ratings both cut during the week. The Euro rallied firmly following the ECB policy meeting, notably against the yen.
The Euro-zone economic data remained generally weak with business confidence weakening to a fresh record low while Spanish inflation turned negative. The flash Euro-zone inflation rate fell sharply to 0.6% in March from 1.2% previously.

German unemployment rose by a further 69,000 for February which was a sharper increase than expected and the Labour Office forecast no improvement during 2009. Euro-zone unemployment rose to a three-year high of 8.5% from a revised 8.3%.

The ECB cut interest rates at the council meeting, but the decision was a surprise as the reduction was held to 0.25% to 1.25% compared with expectations of a 0.50% cut.

In the news conference, President Trichet stated that the inflation outlook was now more balanced. Comments over the economy were still very cautious, but he steered away from an overly-pessimistic stance. Trichet also pointedly stated that the ECB did not rule out further rate cuts.

As far as quantitative easing is concerned, the Trichet stated that a decision on whether to decide on non-standard measures would be taken at next month’s meeting. The decision and policy stance provided near-term Euro support.

Yen:

The very weak Japanese economic data will remain a negative factor for the yen even if there are some hopes that production declines will now ease.  Given weak sentiment, there is still scope for increased capital outflows from Japan which will tend to undermine the yen. These flows will intensify if risk appetite remains stronger and this could push the yen sharply weaker. Risk conditions will still be brittle and the confidence will inevitably falter at times.  Nevertheless, the yen is still liable to remain on the defensive in the short-term.  

The Japanese yen rallied strongly at the beginning of the week with gains to beyond 96 against the dollar, but then weakened steadily over the following few days. The dollar attacked 2009 highs just above the 100 level against the Japanese currency while the Euro also re-challenged six-month highs against the yen.

Capital repatriation flows eased as the new fiscal year started and this undermined the currency. Underlying yen sentiment also remained weak and there was also evidence of increased retail selling as global risk appetite improved.

Domestically, there was a further 9.4% plunge in industrial output for February, but there was some optimism that production would start to recover. Unemployment rose to 4.4% in February from 4.1% while household spending fell 3.5% over the year.

The April Japanese Tankan business confidence survey was even worse than expected with a record decline to -58 from -24 the previous quarter while the index was also at an all-time low. As production and confidence declined sharply, investment was scaled back with expectations that capital spending would decline by over 13%.

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The most recent UK indicators have offered some hope that the downturn is easing and this will provide some support to sentiment.  Unemployment is still set to rise sharply and there will be important underlying fears surrounding the budget outlook. Risk conditions will remain extremely important and Sterling will be in a much stronger position to resist renewed selling pressure if confidence surrounding the global financial sector remains stronger.  Sterling rallies are still liable to fade relatively quickly.

Sterling found support close to 0.94 against the Euro and also bounced from support levels below 1.42 against the dollar. The UK currency rallied firmly to highs above 1.4750 against the US dollar as domestic and international factors provided support.

Sterling gained support from an improvement in global risk appetite and the benchmark FTSE index pushed above the 4000 level for the first time since February.

The PMI index for the manufacturing sector rose to 39.1 in March from 34.7 previously which was the highest level since October. This data was a positive influence as it suggested that there has been significant success in cutting inventories and the services PMI data was also stronger than expected. Mortgage approvals rose to the highest level since May 2008 with a monthly increase to 28,000.

The Nationwide reporting a surprise 0.9% monthly increase in house prices for March compared with expectations of a further decline, although the series is volatile and the Halifax recorded a 1.9% monthly decline in prices.

The latest Bank of England credit conditions survey reported that lenders expected slightly easier conditions during the second quarter which will also help improve confidence surrounding credit availability while consumer confidence improved.

Swiss franc:

The National Bank policies will continue to have a very important impact on the Swiss currency. The bank comments have continued to be very robust over the past week and indicate strongly that the bank will continue to resist franc appreciation with aggressive market intervention if necessary.  With the economy also still very weak, there looks to be little scope for franc gains, especially if global risk appetite remains firmer.

The franc was generally resilient for much of the week and strengthened to highs near 1.5050 against the Euro while it also resisted selling pressure against the dollar

The Swiss PMI data remained at a record low of 32.6 for March which undermined confidence and increased pressure on the central bank to limit franc gains.

National Bank member Hildebrand warned again over the currency. The comments from the central bank were unusually stark as he stated that it will use all measures available to prevent further gains for the Swiss currency and curb the deflation threat.

Following the aggressive central bank rhetoric, the franc weakened to lows around 1.5280 against the Euro and maintained a weaker tone on Friday.

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The Australian dollar retreated to lows below 0.68 against the US currency as commodity process fell and confidence faltered. There was a robust recovery from lows with highs around 0.72, the strongest level since early January.

The currency gained support from rallies in global stock markets while there was evidence of increased carry-trade activity and flows from Japanese investors.

There was a recovery in domestic building approvals according to the latest data, but retail sales recorded a 2.0% monthly fall.  The sales data increased economic fears, although the impact was limited given monetary policy uncertainty. The trade surplus was sharply higher than expected with an AUD2.1bn surplus for February.

The Australian dollar will continue to gain support when there is an improvement in risk appetite and greater confidence in the global economy. Nevertheless, it may prove difficult to extend gains in the short-term given the underlying vulnerabilities.

Canadian dollar:

Canadian dollar volatility increased over the week. From levels close to 1.22, the currency weakened sharply to lows beyond 1.27 before regaining ground.  

The Canadian currency was undermined in the middle of the week by fears that Canadian auto suppliers could face renewed stresses following speculation that General Motors could be pushed into insolvency.

Risk appetite then recovered which provided support. The domestic data failed to have a major impact with the 0.7% GDP decline for February close to expectations.

Canadian dollar volatility is liable to remain higher in the short-term and there appears scope for only limited gains in the short-term even if risk appetite remains firmer.

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The rupee maintained a firm tone, although it struggled to make much further headway against the dollar. Moves were limited in part by a lack of liquidity with two holidays over the period and the rupee edged firmer to 50.35 against the US dollar.

Risk appetite remained stronger as domestic stocks strengthened to a five-month high and there was some optimism that conditions in the global economy could stabilise..

The rupee will continue to gain short-term support if risk appetite remains stronger. It will still be difficult for the currency to make strong gains from current levels even though underlying sentiment should remain firmer for now. 

Hong Kong dollar:

The Hong Kong dollar maintained a firm tone over the week, although it generally stayed slightly away from the band limit of 7.75 against the US dollar.

The currency continued to derive support from the improvement in regional risk appetite with particularly strong sentiment as the Hang Seng index rose by over 7% on Thursday with confidence still firm on Friday. 

The Hong Kong dollar moves will continue to be influenced strongly by trends in risk appetite with the currency likely to maintain a firm tone in the short-term.  

Chinese yuan:

The yuan remained confined to narrow ranges near 6.8350 against the dollar during the week as the central bank continued to exercise tight control of the spot market.

The PMI release were mixed as the CLSA March index recorded a all decline to 44.8 from 45.1 previously, but the official index rose to 52.4 from 49.0 previously. Overall confidence surrounding the economy continued to edge higher.

Calls from US House of Representatives Democrats for increased pressure on China to reform the currency did not have a major impact. China’s increased profile surrounding the G20 talks acted to boost sentiment with the NDF forward yuan rate moving to the strongest level for seven months.

If global economic fears ease, the Chinese authorities may be more willing to allow increased yuan flexibility, but tight control is liable to remain dominant for now.