Weekly Forex Currency Review 06-03-2009

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Central bank and government policies will remain a very important focus as the authorities continue to battle the very sharp downturn. With interest rates in G7 economies converging close to zero, it will be difficult for currencies to secure a decisive direction with markets focussing more strongly on solvency issues.  The lack of attractive alternatives will continue to underpin the dollar. Nevertheless, with severe fundamental stresses, US currency gains should be limited at best. 

Key events for the forthcoming week

Dollar:

The economic data has not suggested any relief from the steep downturn with particular fears that heavy job losses will undermine consumer spending with the risk of a self-reinforcing downturn.  The financial sector will remain extremely important with the lack of confidence and credit supply still a very important negative influence. The Federal Reserve will have to maintain a very expansionary policy in the short-term . The dollar will continue to gain defensive support from fears over the global economy, especially if risk appetite continues to weaken, but will find it very difficult to make strong headway.    

Confidence surrounding the global economy remained extremely fragile over the week with brief spells of optimism unable to gain any significant traction. In this environment, the dollar regained defensive support and tested 2009 highs beyond 1.25 against the Euro before weakening back towards 1.27 on Friday.

The US ISM manufacturing index edged stronger to 35.8 in February from 35.6 the previous month, in contrast to expectations of a further decline. The individual components were still very weak with a drop in the employment index to a fresh multi-year low of 26.1 from 29.9. The ADP report also recorded a further very sharp employment fall of 697,000 for February after a revised 614,000 decline previously.

The ISM index for the services sector weakened slightly to 41.6 in February from 42.9 the previous month. The main components remained depressed, but there was a slight recovery in the employment index. The US jobless claims data was slightly lower than expected with a decline in initial claims to 639,000 in the latest week from a revised 670,000 previously. The employment evidence overall maintained some hopes that the Friday payroll data may not match the most pessimistic expectations.

Pending home sales falling by a sharper than expected 7.7% for January after a revised 4.8% increase the previous month and mortgage delinquencies rose to record highs near 8% in the fourth quarter of 2008. Construction spending fell by 3.3% in January to the lowest level for close to five years and Fed members warned over deteriorating conditions in the commercial property market.

The Fed’s Beige Book reported that conditions worsened through late February while near-term prospects were poor which certainly tempered any optimism.

Fed Chairman Bernanke again took a generally downbeat stance in testimony on Tuesday with a warning of stagflation if the authorities do not act aggressively to stimulate the economy. The Fed chief was also very critical of the AIG activities and moved towards a political judgement on the banking situation.

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The Euro-zone economy will remain under pressure in the short-term  with a sharp downturn in the industrial sector and there will be demands for additional ECB action.  Markets will also continue to look closely at internal stresses within the Euro-zone, especially if yield spreads continue to widen.  There will also be continuing fears that further deterioration in the Eastern European economies will undermine European banks and have a wider negative impact on the Euro. Overall, losses should be contained from current levels.
       
The Euro attempted to rally at times, but was generally on the defensive as economic fears persisted. Confidence in Eastern European economies remained weak which also continued to have a negative influence on the Euro, especially with underlying fears over the European banking sector.

The ECB cut interest rates by a further 0.50% to a record low 1.50% at the latest council meeting.  There was also a sharp downgrading of economic prospects in the latest staff projections with the economy expected to contract between 2.2% and 3.2% for 2009 with the bank also not expecting significant growth in 2010.

In the press conference following the decision, ECB Chairman Trichet maintained a generally pessimistic stance over the economy. He was careful to note the bank did not decide that 1.50% was the floor for rates which will maintain expectations of further cuts. There was also strong market interest in potential moves towards quantitative measures and Trichet commented that the measures would be discussed.

Provisionally, Euro-zone inflation edged higher to 1.2% in February from 1.1% previously, in contrast to expectations of a further small decline. German retail sales registered a decline for January as the Euro-zone remained under pressure.

Yen:  

The Japanese economy will remain in severe difficulties in the short-term  with a rapid downturn in exports and fears over a wider contraction in the economy. There will be additional pressure on the Bank of Japan to return to a quantitative easing policy. There is still the possibility of capital repatriation over the next few weeks ahead of the fiscal year-end.  Overall, however, the yen will continue to find it much more difficult to gain any defensive support.

The yen remained generally on the defensive over the week as confidence in the Japanese economy continued to deteriorate while there were increased fears over the political situation with a new investigation into alleged illegal party funding.

The dollar pushed to a four-month high above 99.50 before correcting weaker as exporter selling increased. As risk aversion spiked higher again, the yen strengthened back to near 97 against the US currency.

The Bank of Japan announced that currency reserves would be used to help ease the corporate financing stresses which have become an increasing threat to the domestic economy while the government also announced additional support .

The latest capital account data suggested that there had been net capital outflows from Japan during February, but confidence in investment trends remained low.

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The economy will remain in serious difficulties in the short-term. Sterling will also remain vulnerable to selling pressure on the lack of yield support while quantitative easing will pose very important medium-term risks to the currency.  There will still be protection in relative terms given the serious downturn in the US and Europe while the Bank of England has signalled that there will be no further interest rate cuts.  The scope for rallies will be severely constrained unless there is improved confidence towards the financial sector.

Sterling had a slightly softer tone against the dollar over the week, but did find solid buying support below 1.40 with a recovery back towards 1.43 on Friday. The UK currency was also resilient against the Euro with good support close to the 0.90 area.

The UK PMI manufacturing index fell to near-record lows of 34.7 in February from 35.8 the previous month with weak exports despite the improved competitive position. The construction PMI index weakening to a record low of 27.4 in February from 34.5 previously which increased fears over the construction sector. January mortgage lending was only 10% of the levels seen in the same month for 2008.

In contrast, the CIPS index for the services sector edged higher to 43.2 for February from 42.5, edging further away from the record lows seen late in 2008.  The data suggested that the services sector may be holding up better than in the Euro-zone.

The Bank of England interest rate decision was in line with market expectations with a further 0.50% cut in benchmark rates to a fresh record low of 0.50%.

The central bank also announced that it would launch an initial GBP75bn quantitative easing programme by purchasing long-dated government bonds and the total under the scheme could be increased to GBP150bn.

The move to direct money supply expansion was seen as a negative factor for Sterling, although there will also be some hopes that the economy will gain support. Bank of England Governor King also stated that it was very unlikely that interest rates would be cut again which provided some degree of support to the currency.

Swiss franc:

Confidence in the Swiss economy will remain weak in the short-term , especially as the survey evidence has continued to suggest further deterioration, possibly at a faster pace than in the Euro-zone economy.  The franc will still gain some defensive support at times, especially when global risk appetite deteriorates.  The currency will struggle to make any strong headway, especially given the potential for National Bank intervention if there is a rapid advance.     

The franc struggled for direction against the dollar for much of the week, but found  support on losses to beyond the 1.18 level and strengthened to 1.15 on Friday as the US currency came under pressure. The franc had a firm tone against the Euro and strengthened to near 1.46 which was the strongest franc level for 2009.

Despite the domestic weaknesses, the franc still gained defensive support when risk appetite deteriorated and global stock markets were subjected to selling pressure.

The Swiss GDP data was better than expected with the fourth-quarter decline held to 0.3% compared with the consensus estimate of a 0.8% decline while consumer prices rose a slightly stronger than expected 0.2% in the year to February.

The latest Swiss PMI data was weak with a further decline to 32.6 in February from 35.0 the previous month and confidence in the economy remained weak.

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The Australian dollar rallied sharply against the US dollar at times, but was unable to sustain the advances and consolidated around 0.64 late in the week.

The Reserve Bank held interest rates steady at 3.25% following the latest policy meeting, in contrast with market expectations of a cut to 3.0%. The bank stated that conditions had not deteriorated as much as in other major economies.

There was a reported 0.5% contraction for GDP for the fourth quarter which was sharply weaker than expected. The data quickly revived speculation that the Reserve Bank would cut interest rates again, especially as the building approvals also fell. The PMI survey evidence was also weaker than expected.

There is scope for further sharp currency swings as sentiment fluctuates and Australian dollar advances will remain limited until global confidence improves.

Canadian dollar:

The Canadian dollar weakened sharply against the US currency and hit lows beyond 1.2950, the lowest level since early December, before a tentative recovery.

The Bank of Canada interest rate decision was in line with market expectations with a further 0.50% in rates to 0.50%. The statement from the bank was more dovish than expected with the bank suggesting that further policy action may be required.

The economic data provided no support with GDP falling 1.0% for December while building permits also continued to decline sharply. The PMI index did, however, rebound significantly for the February reading

Overall, there is scope for limited Canadian currency gains given that risk appetite could stabilise with the domestic downturn and monetary policy limiting support.
 
Indian rupee:

The rupee remained under pressure over first half of the week and the currency weakened to a fresh all-time low beyond 52 against the US dollar with eight successive daily losses. Global stock markets was subjected to sharp downward pressure which triggered domestic losses and raised fears over capital outflows.

The currency secured some relief later in the week as markets attempted to stabilise while there were also warnings from the central bank. The Reserve Bank announced a further 0.50% cut in interest rates, but risk appetite remained very fragile.

The rupee will remain vulnerable to some further downward pressure given fears over growth trends and the threat of capital outflows, although losses should be contained. 

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The Hong Kong dollar weakened to lows near 7.76 against the US dollar which was a five-week low for the currency as the US currency secured a generally firmer tone.

The local currency was undermined by a general deterioration in risk appetite which lessened demand for the Hong Kong dollar with some fears over net capital outflows. The currency recovered back to around 7.7560 on Friday.

The Hong Kong dollar should be able to maintain a relatively steady tone unless there is evidence of a further substantial deterioration in the Chinese economy. 

Chinese yuan:

The Chinese authorities continued to take a firm stance in stifling currency moves and the yuan settled close to 6.8390 against the US dollar. The economy remained a key focus and Premier Wen stated that he was confident over 8% GDP growth for 2009. The authorities were also confident that February bank lending was CNY800bn

Hopes for a recovery were boosted by a February PMI index gain to 49.0 from 45.3. There were expectations of a further fiscal stimulus, although no announcements were made while there were reports of a weak trade performance for February.

The yuan will remain vulnerable to some limited selling pressure on wider US currency gains in Asia. The impact will be limited while there are hopes for a rebound in the Chinese economy with the central bank also still aiming for stability.