Weekly Forex Currency Review 06-11-2009

The dollar will continue to find it very difficult to gain support on yield grounds and this will certainly curtail overall buying support. Nevertheless, confidence in the 2010 global outlook is likely to fade over the next few weeks and this should stem use of the dollar as a funding currency while high-yield instruments and commodities will find it more difficult to secure further buying support.

Dollar

The latest services-related data will tend to maintain fears that the current rebound in activity will be very fragile. Although the Federal Reserve has edged slightly closer to withdrawing some policy stimulus, there is very little chance of a near-term increase in interest rates and yield support will therefore remain weak. Underlying confidence in the dollar is also likely to remain very fragile on expectations of reserve diversification. Given these vulnerabilities, the US currency will find it difficult to gain any strong support even if losses from current levels are limited.

The dollar was unable to extend or sustain the correction seen the previous week and dipped lower to test support levels beyond 1.49 against the Euro later in the week as defensive dollar demand was weaker.

The US ISM index for the manufacturing sector was stronger than expected with an increase to 55.7 for October from 52.6 the previous month and this was the strongest figure since 2006. The pending home sales data was also robust with a further 6.1% increase for September after a 6.4% increase the previous month.

The services-sector index edged lower to 50.6 from 50.9 the previous month compared with expectations of a small increase. The data will reinforce fears over underlying vulnerability in the economy, especially as services are much larger that the manufacturing sector.

The ADP report recorded a private-sector employment decline of 203,000 for October which was slightly worse than expected, although it was an improvement from the previous month. The US economic data was slightly stronger than expected with jobless claims falling to 512,000 in the latest week from a revised 532,000 previously. There was a further strong gain in productivity for the third quarter and a sharp drop in unit labour costs as companies cut employment aggressively.

As expected, the Federal Reserve left the Fed funds rate on hold in the 0.0 – 0.5% range following the latest FOMC meeting. The Fed maintained that the economy was improving while the declines in employment and business investment had slowed.

There were still important areas of vulnerability and, critically, the Fed maintained the commitment to maintain interest rates at exceptionally low levels for an extended period. There was some reduction in agency debt purchases, primarily due to a lack of securities, with the Fed moving very slowly towards lessening the degree of stimulus.

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The ECB will maintain a steady policy in the short - term and there will be expectations that the extraordinary liquidity-support measures will be gradually withdrawn during 2010. There will still be important structural vulnerabilities within the Euro-zone, especially in countries such as Ireland and Spain and fears over the outlook is liable to increase. There is still the risk that confidence in the Euro will deteriorate suddenly, especially if credit conditions deteriorate further.

The Euro was able to resist further selling pressure during the week with a net advance against the dollar and yen, although ranges were relatively narrow.

There were increased fears over the European banking sector which undermined confidence and also reminded investors of the underlying Euro-zone structural vulnerabilities. Fitch also downgraded its credit rating for Ireland.

The Euro-zone retail sales data was weaker than expected with a further 0.7% decline for September to give a 3.6% annual decline, maintaining fears over the outlook for consumer spending.

There were no policy surprises from the ECB with interest rates left on hold at 1.00% following the latest council meeting. Bank President Trichet maintained a tone of cautious optimism over the economy, repeating his expectations for a very slow recovery while he drew attention to falling money supply and private loans. Trichet suggested that extreme liquidity measures would be gradually withdrawn during 2010. There were no substantive comments on the Euro from the bank head.

Yen:

Confidence in Japan’s economy is likely to remain weaker in the short - term with particular fears surrounding the fiscal position as government debt remains at unsustainable levels. Degrees of risk appetite will remain important in the short - term and the Japanese currency will continue to gain some defensive support when international risk deteriorates. Institutional yen selling is likely to remain a key feature at lower levels which will make it difficult for the Japanese currency to make strong headway.
The dollar was unable to break above 91.50 against the Japanese yen and dipped to re-test support levels below 90. The was very choppy yen trading on the European crosses with net yen losses later in the week as equity markets rallied.
Bank of Japan Governor Shirakawa stated in comments on Wednesday that downward pressure on prices would continue, maintaining pressure for the central bank to maintain a very loose monetary policy. The Finance Ministry has also pledged additional policy measures next fiscal year to curb the budget deficit.
The latest Chinese PMI data was broadly encouraging which curbed defensive yen demand with hopes that the global was economy was still rebounding.

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The latest survey evidence has been generally encouraging for the economy. The GDP data, however, still appears very depressed which will maintain unease over the fundamental outlook. The Bank of England decision to expand quantitative easing will also increase fears over medium-term currency depreciation. Sterling trends will still be correlated to an important extent with risk appetite and weakness in global banking stocks would undermine the currency. Even with initial potential support, Sterling is still liable to come under renewed selling pressure.

Sterling strengthened to above 1.66 against the dollar following the decision, supported in part by a fragile dollar, and was able to consolidate above 1.65. Sterling held stronger than 0.90 against the Euro.
The PMI index for the manufacturing sector was significantly stronger than expected at a two-year high of 53.7 from a revised 49.9 figure the previous month. The services-sector index was also stronger than expected with a rise to a 56.9 from 55.3 and this was the highest figure since September 2007. The construction PMI index weakened to 46.2 for October from 46.7, maintaining unease over the sector.
The government announced a further support package for the UK banks as part of a wider restructuring scheme and the additional support could be close to GBP40bn.  
At the Bank of England MPC meeting, interest rates were left on hold at 0.50% as expected. The MPC also announced a further GBP25bn increase in the quantitative easing target to GBP200bn.

The bank was slightly more confident of a recovery in the economy, but still very concerned that the economy is facing a shortage of credit as the banks work to repair their balance sheets. The bank recognised that this is a difficult balancing act and there were concerns over potential policy errors over the next few months.

The latest NIESR data recorded an estimated 0.4% GDP decline in the three months to October which was weaker than expected. The data maintained fears that the UK recovery will lag behind other major economies.
There will be increased fears over the government debt position, especially as confidence is already very fragile. There will also be unease over underlying financial-sector vulnerability which will tend to be a negative factor for the currency.

Swiss franc:

The Swiss franc is likely to gain some degree of support if there is a sustained deterioration in international risk appetite. There will still be the important threat of National Bank intervention to curb excessive franc gains, especially against the Euro, and this will deter franc buying support. The net risks suggest that there is little scope for sustained franc gains from current levels even if there is a limited near-term advance.
 
The dollar stalled above 1.03 against the Swiss franc during the week and retreated to lows below 1.0150. The Euro was unable to make any significant progress away from the 1.51 level against the Swiss currency.

The Swiss PMI index weakened to 54.0 from 54.3 previously which was slightly disappointing given the recent run of robust data, although the impact was limited.

Consumer prices rose 0.6% for October which was in line with market expectations for a 0.8% annual decline. The data will keep the National Bank on alert, but should not intensify pressure for action to curb franc gains at this stage.

The latest UBS results were weaker than expected which had a mixed franc influence. Support on wider risk aversion was offset  by fears over further underlying weakness in the Swiss financial sector.

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The Australian dollar continued to find strong support below the 0.90 level against the US currency and, despite a rally later in the week, it struggled to break resistance levels as there was a slightly more cautious tone.

The Australian Reserve Bank interest rate decision was in line with market expectations with a 0.25% rate increase. The statement from the bank was slightly more cautious than expected and there was reduced speculation that the bank would increase rates again at the December meeting.

The domestic data was weaker than expected with a 0.5% decline for retail sales compared with expectations of a small rise which curbed currency support, although the building approvals data was robust.

Australian dollar sentiment will remain strong in the short - term with expectations of higher interest rates. Resistance levels are still likely to be tougher to break.

Canadian dollar:

The Canadian dollar again hit lows beyond 1.08 against the US currency before rebounding to the 1.06 area. Risk appetite managed to stabilise with a rebound in equity markets which helped underpin the local currency while strength in gold prices was also a positive influence for the Canadian dollar.

There were no major domestic influences during the week as global developments tended to dominate, although the PMI index remained firm for October.

Trading conditions are liable to remain choppy in the short - term. The net risks suggest that Canadian dollar gains are likely to be limited from current levels.

Indian rupee:

The rupee was generally stronger during the week and pushed to around 46.80 during Friday’s trading with the US currency significantly weaker on the NDF market.

The US currency was generally fragile which helped underpin rupee confidence while there was also measured optimism over further capital inflows. The government announced that it would maintain the fiscal stimulus to help support the economy.

The rupee will still gain support on a fundamental lack of US dollar confidence. It will be difficult to sustain any initial rupee gains as caution surrounding the global economy is liable to prevail.

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The Hong Kong dollar maintained a position very close to the 7.75 limit against the US dollar during the week and the HKMA was again forced to add additional liquidity to maintain the permitted band

US currency sentiment remained generally weak which supported the Hong Kong dollar and there was further evidence of capital inflows.

Any sharp deterioration in risk appetite would trigger some limited Hong Kong dollar weakness, although the overall risks suggest that any selling pressure will be limited.

Chinese yuan:

There was no sign of the yuan being granted additional freedom during the week with the Bank of China maintaining tight control of the market with a spot rate around 6.827 against the dollar. There was some dollar vulnerability in the NDF market as US-China trade tensions increased.

The economic data maintained a generally firm tone with the PMI indices edging higher for October while the World Bank upgraded its GDP forecasts.

Officials were still cautious over an tightening of monetary policy while the Commerce Minister stated that a stable yuan was required to support exports.

The central bank is likely to resist pressure for substantial yuan appreciation in the short - term, especially with doubts over the economy persisting. The underlying pressure for appreciation will continue.