Weekly Forex Currency Review 05-12-2008

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Overall strategy: 

The global economy will continue to weaken in the short-term with all the major regions under pressure and particular fears surrounding the industrial sector. Further aggressive monetary and fiscal policy action, allied with direct action to underpin the financial sector, should still lead to some very cautious expectations over an improvement in conditions during 2009 which would help stabilise sentiment. 

Key events for the forthcoming week

Dollar:

The US economy will continue to weaken in the short-term with a particular focus on a sharp deterioration in the labour market. Close attention will also be paid to the business confidence and consumer spending surveys as these will be very important forward - looking indicators.  The Fed will be under pressure to cut interest rates further, although the focus is liable to switch more towards direct measures such as the buying of securities and bonds. The US currency will continue to gain some defensive support in the short-term with strong demand for Treasuries. These supportive flows are liable to fade which will increase underlying dollar vulnerability, especially given the huge Fed credit expansion.

The US currency was confined to relatively narrow ranges over the week as markets fretted over the global economic outlook. The dollar pushed to highs beyond 1.26 against the Euro before losing ground and settling around 1.2750.

The PMI data for the US economy remained at depressed levels with the manufacturing index falling to 36.2 in November from 38.9 previously. The prices component also weakened to the lowest level for over 50 years as commodity prices continued to weaken sharply. The services-sector weakened sharply to a record low of 37.3 for the month from 44.4 previously with all the components deteriorating rapidly while the employment index weakened to below 35.

There was a further decline in auto sales for the month, illustrating the stresses within the manufacturing sector, while factory orders also continued to decline. Retail sales evidence remained weak and there were fears that consumer credit lines would be cut.

As far as employment is concerned, there was a sharp decline in private-sector payrolls according to the latest ADP report with a 250,000 decline in employment. There was some slight degree of relief in the latest initial jobless claims data with a decline to 509,000, although continuing claims were at a 26-year high.

Fed Chairman Bernanke stated that the Fed would consider lowering interest rates further while he also suggested that it would look to intervene in the market to buy Treasury bonds in order to keep long-term interest rates down. Bernanke also suggested that public funds could be used to stem foreclosures.

In addition, the Fed also announced that the measures to boost liquidity will be extended until the end of April as money-market stresses remained high.

The impact of lower bond yields was illustrated by the latest mortgage application data with the weekly total rising by over 100% as re-mortgaging activity surged in response to a decline in Treasury yields to 50-year lows.

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The Euro-zone economy will continue to weaken in the short-term, especially with exports deteriorating. Following sharp interest rate cuts over the past three months, the bank is likely to be more cautious over the next few months, especially as it will need to maintain medium-term monetary credibility. There will be further fiscal support measures which will help underpin confidence and the Euro-zone is still less vulnerable to underlying credit stresses which should protect the currency from selling pressure. 
       
The Euro was mixed over the week as a whole with an advance against Sterling while it struggled to maintain gains against the other main currencies.

The final PMI data for November recorded a further decline from the flash estimates which reinforced fears over the outlook. The data for Spain was particularly depressed. Elsewhere, retail sales continued to decline according to the October data.

At the latest council meeting, the ECB cut interest rates by a larger than expected 0.75% to 2.75%, pushing the total easing to 1.75% in less than 3 months. ECB Chairman Trichet stated that growth risks were to the downside with the risk of a protracted slowdown while the staff projections for 2009 were downgraded sharply.

Trichet was still anxious to point out the need for discipline and the importance of medium-term perspective for policy while suggesting that it may be possible for the bank to make asset purchases outright.

Yen:  

The economy will remain weak in the short-term with domestic spending still under pressure while export conditions are also liable to deteriorate. There is likely to be particular unease over the implications of a sharp slowdown in China. There will be the threat of capital repatriation to underpin corporate balance sheets while there will be a reduced flow of funds overseas and both these factors will support the yen. The Finance Ministry is likely to discourage strong yen gains from current levels.     

The yen retained a firm tone and pushed to highs near 92 against the dollar while there were gains against most major currencies. The Japanese currency continued to gain support from elevated risk aversion and global economic fears.

The Bank of Japan held an unscheduled meeting over the week. Interest rates were unchanged at 0.30% with the main emphasis on easing stresses within the corporate finance market by accepting a wider range of collateral. The Bank also announced that it would provide unlimited liquidity to ease year-end funding pressures.

The economic data remained weak with the monthly Tankan business sentiment index weakening to a 7-year low, although the data was slightly better than in the other major economies. Capital spending also fell by 13.3% in the year to the third quarter.

The reports that the Japanese postal savings fund was buying dollars heavily at lower levels, but the US currency struggled to make any headway.

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The economy will continue to weaken in the short-term with unemployment continuing to rise sharply. There is the potential for short-term relief for consumer spending as tax changes and the rapid cuts in interest rates will have a positive impact. Yield support has been severely eroded and the speculation over further interest rate cuts will limit any Sterling support. There will also be fears over the financial sector. There should still be some protection from the grim outlook in the US and Euro-zone. In the current environment, Sterling rallies are likely to remain very fragile and vulnerable to a rapid reversal.
 
Sterling remained under pressure over the week with the trade-weighted index dipping to an all-time low. The UK currency also weakened to record lows against the Euro beyond 0.87 and tested support below 1.45 against the dollar.

The economic data remained extremely weak with the PMI index for the manufacturing sector dipping to 34.4 from a revised 40.7 previously while the services sector index declined to a record low of 40.1 from 42.4 previously. Consumer lending remained at a depressed level while the Halifax house-price index recorded a further 2.6% decline in November prices to give an annual decline of close to 15%.

The Bank of England cut interest rates by a further 1.0% at the latest monetary policy meeting. This took rates down to 2.0% which was the lowest level since 1951. In the statement following the decision, the bank stated further concerns over the economic outlook with financial-sector stresses while inflation was set to decline further. The voting breakdown was not released following the meeting.

There was some speculation that the UK could look to join the Euro zone at a depressed Sterling rate against the Euro which also unsettled the currency.

Swiss franc:

The economy will continue to weaken in the short-term with a strong probability that GDP will contract for the fourth quarter. The National Bank will also consider a further interest rate cut at next week’s policy meeting. The recent trends still suggest that the franc will gain some defensive support when risk aversion rises. Given the domestic economic vulnerability, the currency will struggle to secure strong support.   

The franc weakened to lows near 1.22 against the dollar over the week before finding some renewed support and consolidating near the 1.20 level. The Swiss currency also resisted a decline through 1.55 against the Euro.

The Swiss PMI index for November weakened sharply to 35.2 in November from 47.0 the previous month, maintaining the sharp deterioration seen over the past two months, while GDP was unchanged for the third quarter.

Consumer prices fell a sharper than expected 0.7% for November which cut the annual inflation rate to 1.5% and reinforced expectations of a further cut in interest rates. The National Bank was more cautious in comments over the week.

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The Australian dollar was unable to gain any momentum against the US currency over the week, but there was some buying support on dips. The global environment remained tough with declines in commodity prices and fears over the global economy.

The Reserve Bank of Australia cut interest rates by a larger than expected 1.0% with rates now down to 4.25%. There was some speculation over a pause in the rate-cutting process, especially with the bank not due to meet again until February.

The latest trade account data was stronger than expected with a AUD2.95bn surplus, but the evidence on the domestic economy was weaker with a sharp decline in building approvals. The PMI data remained weak in the latest monthly releases while there was a 0.1% GDP increase for the third quarter.

The Australian dollar has scope for a limited recovery, but is unlikely to make much headway unless there is evidence of stabilisation in the global economy.

Canadian dollar:

The Canadian dollar was generally weaker and tested levels beyond 1.26 against the US currency. Commodity prices generally remained under pressure which underlined the local currency as crude prices dipped to levels near US$45 per barrel. Metals prices were also generally on the defensive which was a negative influence.

The Canadian monthly GDP data was slightly weaker than expected with a 0.1% increase for October while the third-quarter estimates was revised up slightly.

The currency was undermined to some extent by an increase in political tensions as the opposition parties looked to block government legislation and force an election with the government suspending the parliamentary session until January.

The Canadian dollar will need a recovery in sentiment towards the global economy to make much headway against the US currency.
 
Indian rupee:

The rupee tested levels beyond 50.0 against the US currency before securing some relief over the second half of the week with a move back towards 49.80.

There was some evidence that the capital account was stabilising which helped underpin the currency. The rupee gained some support from the decline in oil prices, especially with hopes that the trade account could stabilise and offset the impact of weaker exports. Markets were expecting a further interest rate cut over the weekend.

Volatility levels are liable to remain highly elevated in the short-term. Overall, there is scope for a limited rupee advance despite the persistent growth fears. 

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The Hong Kong dollar was trapped in relatively narrow ranges, consolidating around the 7.7520 region. There was some evidence of corporate US dollar demand over the week while local inter-bank rates drifted lower on high liquidity.

There were concerns over the regional economy while the Chinese yuan depreciation was also an unsettling influence. Risk appetite was also still generally fragile.

The Hong Kong dollar should retain a firm tone for now, but there is scope for upward pressure to remain slightly weaker which will limit currency support.

Chinese yuan:

There was a significant shift in the yuan over the week with the currency dipping significantly over the week after weeks of stability. There appeared to be particular unease over the implications of reduced competitiveness within Europe.

There was a shortage of dollars in the market which triggered losses for the yuan even though the central bank provided additional liquidity. There was a slightly firmer tone on Friday although the Chinese currency still near 6.88 against the dollar.

The cabinet stated that the government will take economic stimulus steps including improvements to currency management, although it declined to provide details

Following the yuan move and government comments, there was increased speculation of a policy change and promotion of a weaker yuan to help support the economy.

There will be further speculation over a shift in central bank policy, although the bank is still likely to aim for relative stability in the near term.

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