Weekly Forex Currency Review 06-02-2009

All the major central banks and government will be looking to maintain highly expansionary policies in the short-term to help combat the serious global downturn.  There will also tend to be resistance to currency appreciation while there will be a temptation for more aggressive trade policies. Any increased evidence of protectionism would risk renewed tensions and volatility in the currency markets. There would be a risk of a wider loss of dollar confidence if the Obama Administration adopts a tough stance.

Key events for the forthcoming week

Dollar:

The economic data will remain very weak in the short-term with unemployment continuing to rise strongly. The Federal Reserve will maintain a highly expansionary policy, although the short-term focus is likely to remain on fiscal policy as the fiscal stimulus package makes its way though Congress. The dollar will tend to lose some defensive support if there is greater confidence that the US and global economy will recover, but sentiment towards the financial sector will remain extremely fragile. Overall, the dollar will struggle to secure sustained gains given the massive financing burden.  

Major currencies again struggled for direction during much of the week. There were, however, some signs that recent trading patterns were breaking down as the Euro and yen tended to weaken together. The dollar gained some support on hopes that the economic deterioration was slowing with the Euro dipping to below 1.28.

The US ISM index for the manufacturing sector was slightly stronger than expected with an increase to 35.6 in January from 32.9 the previous month, the first increase since June. The orders component improved, but the employment index was unchanged at an extremely weak 29.9. Similarly, the services-sector index recovered slightly to 42.9 from 40.1, with the employment component weakening.

There was significant US labour-market data with the latest ADP employment report recording a further 522,000 decline in employment for January following a revised 659,000 drop the previous month. The Challenger group data also reported that layoffs were at a 7-year high.  Jobless claims rose to 626,000 in the latest week from a revised 591,000 increase the previous week and this was a fresh 26-year high.  The string of weak releases maintained expectations of a very weak monthly payroll report. Auto sales also declined to the lowest level since 1982.

US pending home sales rose by 6.3% in December following a revised 3.8% decline the previous month and this had some positive impact on market confidence. There was also some optimism that a further round of government-backed policy action would help stabilise conditions in the global economy. The fiscal stimulus package was approved in the House of Representatives, but there were difficulties in the Senate with demands for the spending commitments to be scaled back.

The Federal Reserve announced that the emergency swap facilities would be extended for a further six months while there was a small increase in Libor rates which suggested that there were still important underlying tensions in the credit markets.

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The ECB comments continue to suggest strongly that interest rates will be cut further at the March meeting which will undermine Euro yield support. The economy will also remain very weak in the short-term and the currency will be unsettled by fears over the Eastern Europe outlook. The ECB is still the most likely central bank to resist currency debasement as the bank focuses on medium-term price stability. In this environment, the Euro should be able to avoid heavy selling pressure even if there are near-term losses.       
       
The Euro was unable to make significant headway during the week and had a generally weaker tone, notably against Sterling. The currency was undermined by Fitch’s downgrading of Russia’s credit rating while there were wider fears over Eastern European economies which had a negative impact on the Euro.

German retail sales fell 0.2% December in December while Euro-zone sales were unchanged over the month to give a 1.6% annual decline. The German industrial data remained extremely weak with a 6.9% decline for December.

The ECB left interest rates on hold at 2.0% following the latest ECB council meeting which was in line with market expectations. In the press conference, Chairman Trichet was generally downbeat over the economic outlook with a warning over an extended downturn while he also stated that inflation pressures had weakened further.

Trichet gave a very clear hint that rates were likely to be cut again at the March meeting, but there was some confusion as he appeared to retract comments which suggested that rates would be cut by 0.50%. Nevertheless, markets expected a cut in rates to a record low of 1.50% and confidence remained weaker.

Yen:  

The Japanese economy will continue to weaken in the short-term and there will be major fears over the industrial sector as production volumes are cut sharply. There will be additional pressure on the Bank of Japan to engage in more quantitative easing and there will also be intense pressure for intervention to weaken the Japanese currency unless there are clear signs of recovery.  The Japanese currency will still gain support when financial-market fears increase, but substantial gains are likely to be resisted by the authorities. 
         
The yen was trapped in narrow rages against the dollar for much of the week before weakening sharply on Thursday with lows beyond 92.0. There was no evidence of speculation despite pressure for action and the yen consolidated around 91.20.

Severe weakness in the domestic economy was illustrated by a 27.9% annual decline in car sales for January while Hitachi issued a profit warning. The relatively new services-sector index declining to 34.1 in January from 37 the previous month. The current state of uncertainty was illustrated by the markets focus on more forward - looking indicators A rise in the Chinese PMI indices for January, allied with further government support measures, underpinned confidence and the Nikkei index rallied.

The Bank of Japan announced that it would buy bank shares in a package worth US$11bn. The move underpinned risk appetite to some extent and weakened the yen, although the impact was still measured as confidence remained extremely fragile.

Bank of Japan member Mizuno stated that the bank must be prepared to act promptly and take unorthodox measures if necessary, although there were no specific policy measures. Governor Shirakawa voiced concerns over any plans to print money to support the economy, especially as it would risk undermining yen confidence.

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Confidence in the economy will remain very fragile in the short-term with a further sharp contraction in prospect for the first quarter. Yield support will remain very low, but there will be speculation that interest rates will now be held steady which will temper selling pressure. Sterling moves will also be influenced strongly by the trends in risk appetite and developments in the banking sector. In this context, Sterling volatility is liable to remain high with some further respite in selling likely to be seen in the short-term. 

Sterling maintained a generally firmer tone over the week. There was further evidence of a correction from over-sold conditions while the there was also some reassessment of Sterling’s prospects given the European stresses. Selling pressure on the UK banking sector also eased which boosted sentiment. The UK currency pushed to highs above 1.47 against the dollar and a two-month high beyond 0.87 against the Euro.

The UK PMI index for manufacturing rose to 35.8 from 34.9 the previous month which provided some slight relief, although it still indicates a sharp contraction for the sector. The other PMI indices posted similar results with the services sector index rising to 42.5 from 40.2. There was also a surprise increase in the Halifax house-price index for January, the first increase for 13 months.

The Bank of England cut interest rates by a further 0.50% to 1.00% at the latest MPC meeting, in line with market expectations, and took rates down to a fresh record low.

In the statement following the decision, the bank referred to the risks of inflation substantially undershooting the 2.0% target while the outlook for consumer spending was weak and the global economy faced a major slowdown. The bank, however, also pointed to the stimulatory effect of substantial interest rate cuts while warning that Sterling weakness would push import costs higher.

Swiss franc:

Confidence in the Swiss economy will remain relatively weak, especially with exports remaining under pressure as the European economy suffers. The National Bank will also be very reluctant to tolerate substantial franc appreciation. The Swiss currency will still gain some defensive support when risk appetite falters, although the net risks suggest that appreciation will be limited.  

The Swiss franc struggled for direction for much of the time, but had a slightly weaker underlying trend with lows beyond 1.17 against the dollar while it also weakened back to just beyond 1.50 against the Euro.

The Swiss PMI index weakened to a record low of 35.0 in January from a revised 36.5 the previous month which reinforced fears over the industrial sector. The trade surplus fell sharply for December with a 13% annual decline in exports which illustrated the substantial difficulties in the trade sector.

The franc moves were again influenced strongly by official comments. The Finance Minister stated that it would support the National Bank if it decided to intervene to weaken the currency which initially triggered renewed selling pressure on the franc.

Bank Chairman Roth commented that he was comfortable with developments, but Hildebrand repeated comments that the bank could intervene in the markets.

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The Australian currency weakened to lows near 0.6250 against the US currency early in the week, but then recovered back towards 0.66 as Asian market fears subsided following a recovery in the Chinese PMI data..

The Australian Reserve Bank cut interest rates aggressively by 1.00% to 3.25% which was in line with market expectations. The bank was slightly more cautious than expected over the prospects for further cuts in rates which underpinned confidence. The government also announced a further AUD42bn fiscal stimulus package.

The domestic data on Wednesday recorded a further downturn in building approvals. In contrast, the retail sales data was much stronger than expected with a 3.8% monthly increase with some support from the previous stimulus, although the data is erratic.

Although trading conditions will remain erratic, there is scope for a limited Australian dollar advance on hopes for global economic stabilisation.

Canadian dollar:

The Canadian dollar found support weaker than the 1.25 level against the US dollar, but was unable to make strong headway. The currency was still hampered by fears over the global economy while firm gold prices provided some degree of support. It consolidated in a 1.23 – 1.24 band amid uncertain trading conditions

Building permits continued to decline for December while the PMI index was also weak, but the domestic data failed to have  major impact as markets concentrated on global risk conditions.

Overall, there is scope for a limited Canadian dollar advance as markets look to regain some degree of confidence with the currency struggling to make strong headway.
 
Indian rupee:

The rupee was again confined to relatively narrow ranges, although there was a slightly firmer tone. The dollar was undermined to some extent by exporter selling with the rupee pushing towards the 48.75 region on Friday.

Trends in the domestic and global stock markets remained extremely important with the currency gaining some ground as equity markets looked to rally. There was further speculation that borrowing costs would be cut further in the near term.

Overall, there is the potential for limited rupee gains, although it will be difficult o secure a strong advance as confidence in the global economy will remain very fragile.  

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The Hong Kong dollar was confined to a narrow band over the week as activity remained at lower levels while there was evidence of two-way business.

There was a decline in local inter-bank rates, but this did not have a substantial negative impact on the currency. Some easing of fears surrounding the Chinese economy allowed the Hong Kong dollar to strengthen towards 7.7540 on Friday.

The Hong Kong dollar should be able to maintain a steady tone in the near term unless there are renewed fears over the Chinese economy and fresh capital outflows . 

Chinese yuan:

The Chinese yuan was again confined to narrow ranges in the spot market as the bank retained tight control of the market with the yuan settling close to 6.8350 against the dollar. There were sharper moves in the NDF market amid uncertainty over longer-term trends in the Chinese economy.

The latest PMI data triggered some optimism that the economy was stabilising as the composite index rose to 42.2 in January from 41.2 the previous month. There was also evidence that the government efforts to stimulate the economy were having an impact as loan issuance expanded strongly to a record monthly high.

Political considerations remained important as there was further speculation that G7 members would exert pressure on the Chinese authorities to accept a stronger yuan.

The economic and political trends will continue to be monitored very closely in the short-term.  Any escalation in trade and currency tensions would risk a spike in volatility, but the central bank will maintain very tight control of the spot rate.

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