Weekly Forex Currency Review 05-06-2009

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The dollar will continue to be unsettled by speculation over underlying central bank reserve diversification away from the US currency. There are likely to be further comments in favour of a strong currency which should help curb heavy selling pressure, especially as there are also very important doubts over the major alternatives to the US currency.        

Key events for the forthcoming week

Dollar:

Underlying confidence in the US fundamentals will remain fragile with continuing fears over the implications of a rising debt burden. There will also be speculation over underlying central bank reserve diversification. Bond yields will remain an important focus as any further increase would risk undermining any economic recovery although rising yields could also attract increased capital inflows which would underpin the currency. Overall, the US currency will find it very difficult to make much headway even if major vulnerabilities in other areas protect the currency from aggressive selling.

The dollar initially remained under pressure, but it managed to find some respite over the second half of the week with the trade-weighted index securing a fragile recovery from 7-month lows even though confidence remained generally fragile.

The dollar failed initially to secure support from comments backing a strong dollar by US Treasury Secretary Geithner. There were comments from a series of Asian central bank officials in support of the US currency. ECB President Trichet also commented that he recognised the importance of US backing for a strong dollar. The remarks continue to suggest some co-ordinated attempt to support the US currency which provided some near-term dollar support.

Pending home sales increased by a stronger than expected 6.7% in May following a 3.2% increase the previous month and this was the third consecutive increase. The evidence of a sales recovery boosted confidence that the housing sector was recovering and this also triggered a renewed surge in risk appetite.

The US ISM index for the manufacturing sector increased to 42.8 in May from 40.1 the previous month and this was slightly above market expectations. Within the data, the orders component pushed above the 50 level while the prices also strengthened, although the employment component remained extremely weak.

The index for the services sector edged higher to 44.0 for May from 43.7 the previous month. In contrast to recent data releases, however, the improvement fell short of market expectations with the overall index of business activity declining over the month. The latest ADP employment report was also slightly weaker than expected with private-sector job losses of 532,000 for May from a revised 545,000 previously.

The US initial jobless claims data was slightly lower than expected with a decline to 621,000 in the latest week from 625,000 previously. The continuing claims data was potentially significant as the number of continuing claims fell to 6.73mn, the first decline since January. This may, however, have reflected the fact that workers are coming to the end of the claims period rather than signalling an improvement.

There were renewed losses in the US bond market which contributed to the underlying fears over central bank reserve diversification. The GM insolvency filing was expected and did not have a major impact, although it did contribute to a softer US dollar tone with underlying sentiment weaker.

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The Euro will gain some support if underlying global risk appetite remains higher, especially if there is any further evidence of regional economic recovery. There are still important vulnerabilities and structural uncertainties which will limit currency support. The situation within the Baltic states will also be watched very closely and a series of forced devaluations would tend to be a negative Euro factor on fears over renewed losses within the banking sector. European officials are also liable to warn over the implications of Euro strength.

The Euro strengthened against the dollar with a peak above the 1.43 level before a retreat. There was a mixed performance on the crosses with a solid underlying tone.

The Euro-zone data continued to suggest a measured recovery with the final PMI index for May registering a further small improvement from the provisional figure while retail sales edged higher.

The ECB left interest rates on hold at 1.00% following the latest council meeting, in line with market expectations. At the press conference following the decision, President Trichet was slightly more optimistic over the economy than in recent comments. The forecasts for 2009 were still downgraded by the bank with an estimate that GDP would decline by 5.1% for 2009 with a marginal return to growth for 2010.

The ECB confirmed that it would by EUR60bn in covered bonds with Trichet refusing to make further comments on the possibility of additional purchases.

Yen:  

The Japanese currency moves will continue to be influenced strongly by degrees of risk appetite and the yen will lose ground if there is a sustained improvement in confidence with an increase in net capital outflows into higher-yielding assets. There will be unease over the US and Euro-zone fundamentals which will tend to provide some yen protection with a reluctance to invest aggressively in overseas funds, especially given the pattern of huge debt issuance.

The dollar continued to find support on dips towards the 94 level against the Japanese currency and jumped higher in mid-week, although it struggled to maintain the gains with uncertainty over underlying yen direction and consolidated above 96.50.

The yen was generally weaker against the Euro. The latest capital account data continued to record an increase in net Japanese outflows into overseas bonds and the increase in outflows will be a negative factor for the Japanese currency.

The latest investment data recorded a 25.3% annual decline in capital spending for the first quarter which was slightly better than expected and maintained hopes of a fragile economic recovery from a low base.
Bank of Japan member Kamezaki stated that there was a high degree of uncertainty over economic direction and that the bank would need to be on guard against the possibility of a stronger than expected recovery even though the most likely outcome was that downside risks would dominate.

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The UK currency will continue to draw some near-term support from the improvement in economic conditions, especially with a stronger services-sector reading. The situation could still be very brittle given the underlying debt fears. Political stresses could continue to undermine the currency in the near term, although the impact should be short-lived. Sterling will gain support if global risk appetite remains firmer while a renewed tone of fear would increase the risk of selling. Overall, it will be difficult to sustain gains much above current levels. 
 
Sterling strengthened sharply over the first half of the week with fresh 7-month highs against the dollar and Euro.  The UK currency then weakened sharply with pressure for a technical correction amplified by increased political tensions.

The UK data remained stronger than expected with a reported 2.6% increase in house prices for May according to the latest Halifax survey. This was the strongest monthly increase since 2002 which maintained recent optimism over the economy. The latest Hometrack survey also reported the first monthly increase in prices for 20 months.

The PMI index for the manufacturing sector rose to 45.4 for May from a revised 43.1 the previous month. The index for the services sector rose to 51.7 in May, the first reading above 50 since March 2008. the construction PMI index rising sharply to 45.9 from 38.1 the previous month which was the strongest level for 12 months.  Mortgage approvals also edged higher, although overall consumer borrowing was still at very depressed levels and dampened expectations for a robust economic recovery.

As expected, the Bank of England left interest rates on hold at 0.50% at the latest MPC meeting. The bank also left the amount of quantitative easing unchanged at GBP125bn with the current schedule of bond buying completed within two months.

The bank decision did not have a significant impact on the currency, but Sterling was undermined temporarily by rumours that Prime Minster Brown had resigned with a drop to near 1.60 against the dollar. Underlying political tensions remained a negative influence for the currency.

Swiss franc:

The Swiss economy is likely to stage a fragile recovery which will not trigger strong support for the currency. The Baltic situation will be watched closely as an increase in fear would tend to support the franc on increased fears over the Euro-zone banking sector. The potential for franc gains will still be severely limited by the threat of National Bank intervention to weaken the Swiss currency and this threat should provide some degree of protection to the US dollar while curbing overall franc gains.

The dollar weakened sharply to lows around 1.06 against the Swiss franc during the first half of the week, but managed to stabilise later in the week. The Euro was unable to hold gains above 1.52 against the franc.

The first-quarter Swiss GDP data recorded a 0.8% quarterly decline which was slightly better than expected, although it was still the worst performance for 15 years. The PMI index rose to 39.8 for May from 34.7 the previous month, maintaining the trend of underlying improvement. Consumer prices fell 1.0% in the year to May.

Continuing fears over the Baltic States should offer some underlying support to the Swiss franc, especially as there will be further speculation over forced currency devaluations in the region.

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The Australian dollar strengthened sharply over the first half of the week with a 7-month peak above the 0.82 level against the US dollar. The Australian currency gained support from a weaker US currency, improved risk appetite and rising commodity prices.

The GDP data was stronger than expected with a 0.4% increase for the first quarter compared with expectations of a contraction and this further boosted confidence in the currency.  The building approvals data was stronger than expected and provided some degree of support.

The Reserve Bank held interest rates at 3.0% following the latest council meeting which was in line with expectations. The bank suggested that rates could be cut again over the next few months. The currency weakened back to the 0.80 region later in the week as the US currency looked to stage a recovery.

The Australian dollar should retain a generally robust tone, although there is certainly the risk of a more substantial downward correction.

Canadian dollar:

The Canadian dollar continued to advance strongly over the first half of the week with a peak close to the 1.08 level against the US dollar. There was a correction back to the 1.1150 region, but underlying Canadian sentiment remained robust

The Bank of Canada left interest rates on hold at 0.25% following the latest central bank meeting. The bank did not announce any move to quantitative easing at this stage. The central bank did warn over the implications of a strong currency advance which triggered some degree of caution over the currency.

The Canadian currency should be able to retain a generally firm tone in the short-term, although there is the threat of a more substantial correction of recent gains.

Indian rupee:

The rupee strengthened towards the 47 level against the US currency during the week, but it was unable to make further progress. There was evidence of central bank intervention to restrain the currency which capped gains.

Underlying sentiment was still firm with rising reserves a further sign of robust capital inflows. Confidence was also boosted by stronger than expected GDP data.

The rupee will continue to gain support from underlying optimism over capital inflows and optimism over a regional recovery. It will be difficult to secure robust gains from current levels, especially with the bank looking to limit gains.

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The Hong Kong dollar was confined to generally narrow ranges over the week and continued to resist pressure for a significant correction weaker with consolidation near 7.7515. There was some evidence of commercial demand for the US currency.

Underlying Hong Kong sentiment was still very firm with capital inflows on optimism over local capital markets and this provided robust underlying support.

Given the improvement in confidence surrounding the regional economy and net capital inflows, the Hong Kong dollar is unlikely to weaken sharply at this stage.   

Chinese yuan:

The yuan was unable to make any headway against the US currency during the week and, significantly, it weakened to six-week lows around 6.833 late in the week. Given the visit of the US Treasury Secretary Geithner, the decision to let the yuan weaken slightly was potentially important with the bank looking to block gains.

There were also cautious comments from Chinese central bank officials over the potential for economic recovery. The Chinese PMI data on Monday recorded little overall change with one edging slightly lower and one higher. Both were above the pivotal 50 level which reinforced market optimism over a recovery.

The most recent evidence suggest that there will be a reluctance to let the yuan strengthen in the short-term despite the potential for medium-term gains.