Weekly Forex Currency Review 07-08-2009

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Market confidence towards the dollar will remain weak in the short-termand there are certainly important sources of vulnerability. The US currency is relatively cheap on valuation grounds and there are also still very important vulnerabilities in the other major economies. In this environment, the dollar should be able to resist heavy selling pressure. 

Key events for the forthcoming week

Dollar:

The latest US data has been mixed and optimism that there will be a near-term recovery in the economy will be offset by fears that any improvement in conditions will be fragile and not sustainable. Over the past few months, the dollar has gained support when risk appetite has deteriorated and lost ground on evidence of a firmer economy, but this relationship may start to break down. Dollar confidence is liable to remain fragile on fears over medium-term reserve diversification, although selling pressure should be contained.   

The dollar weakened to 2009 lows over the first half of the week as underlying sentiment remained weak and players looked to break currencies out of recent ranges. The US currency found some support at lower levels as confidence in European currencies faltered and it edged stronger ahead of the US payroll data.

Risk appetite was still firm which tended to curb dollar demand, although there was evidence of greater caution over the second half of the week.

The US ISM manufacturing index was stronger than expected with an increase to 48.9 for July from 44.8 the previous month.  The orders component continued to improve and the pace of job cutting also slowed sharply over the month which will reinforce optimism over a further recovery in the manufacturing sector.

There was also a stronger than expected with a 3.6% increase in pending home sales for June following a revised 0.8% rise the previous month as lower prices continued to attract buyers into the market.

There was a 371,000 decline in private-sector employment according to the latest ADP survey compared with expectations of a 345,000 decline, although this was still a significant improvement from the previous month. The number of planned job cuts also increased for the month.

The headline US jobless claims data was stronger than expected with a dip to 550,000 in the latest week from a revised 588,000 the previous week while continuing claims were higher than expected. The net impact of the data was to trigger a slight revision to estimates for Friday’s payroll data with expectations that fewer jobs will be lost.

The services-sector data was less supportive as the ISM index dipped to 46.4 for July from 47.0 the previous month, contrary to expectations of a monthly recovery. The orders and employment components also declined over the month. There were also some continuing fears over underlying trends in the banking sector.

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The Euro-zone economic data has continued to suggest a slow improvement in conditions and the ECB is likely to maintain a steady approach in the near term. Credit conditions will continue to be watched very closely amid fears that there will be a deterioration in credit availability while confidence in the financial sector will remain extremely fragile. In this environment, the Euro will still find it difficult to make strong headway.  

The Euro strengthened to nine-month highs against the dollar during the week and also pushed to near 2009 highs against the yen before correcting slightly weaker.
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The Euro-zone PMI index for the manufacturing sector was revised up slightly which maintained the sense of optimism towards the Euro-zone

The German factory orders data was sharply stronger than expected with a further 4.5% increase for June following a 4.4% increase the previous month, maintaining optimism over a recovery in the industrial sector, although the Italian output data was weaker than expected.

As expected, the ECB left interest rates on hold at 1.0% following the latest council meeting. Bank chairman Trichet also took a generally neutral stance in the press conference following the meeting with some cautious optimism over a gradual recovery in conditions. Trichet made no significant reference to the Euro’s value.

Yen:  

There will be further domestic fund launches and capital outflows from Japan in search of higher yields will be a persistent feature. Inevitably, it will also be the case that these outflows will be much stronger when international risk appetite is firm. There is likely to be greater caution over the global economy and risk appetite which will provide some degree of yen protection, but the Japanese currency is liable to be blocked close to current levels.    

The yen was again unable to strengthen through the 94 region against the US dollar and had a generally weaker tone with yen consolidation weaker than 95, although selling pressure was controlled for much of the time.

Bank of Japan members commented on the rise in bond yields and there will be some pressure on the bank to curb any further rise in yields. There was also speculation that the Bank will forecast three years of deflation in its October forecasts and this would maintain pressure for a very loose monetary policy.
The latest capital account data also recorded net outflows by Japanese investors into overseas high-yield instruments and these flows will remain an important negative influence for the Japanese currency.

The yen also gained ground after opposition political comments over a possible review to currency reserve management policies as uncertainty increased ahead of the August 30 general election.

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The recent economic data has remained generally encouraging. The Bank of England decision to expand quantitative easing will certainly dampen optimism over the economy and there will continue to be very important fears surrounding the government debt outlook, especially if there is evidence that banking-sector losses will escalate. Sterling will still be in a position to resist heavy losses if global risk appetite remains firm. The net risks still suggest a slightly weaker UK currency over the next few weeks as a whole.
   
Sterling strengthened to 10-month highs against the dollar with a challenge on resistance levels above 1.70 while the UK currency also pushed to near 2009 highs against the Euro before losing ground.

The economic releases were generally favourable which provided initial currency support as confidence in the recovery increased. The Halifax house-price index rose 1.1% for July, maintaining the recent run of favourable housing-sector data.

The manufacturing PMI data was stronger than expected with an increase to 50.8 in July from 47.4 previously. This was the strongest reading and the first above the pivotal 50.0 level since March 2008

The PMI index for the services sector rising to 53.2 in July from 51.6 the previous month while there was a 0.5% increase in industrial output for June as car output recovered from the earlier shutdowns while construction activity fell at a slower rate.

The interest rate decision from the Bank of England was no surprise with rates left on hold at the 0.50% level. The decision on quantitative easing was a surprise, however, as the bank announced an increase in the corporate bond buying programme. A further GBP50bn will be bought over the next three months, taking the total to GBP175bn.

The bank was very cautious over the economic outlook, warning that the financial sector was still extremely fragile while the recession would be deeper than expected. The move to increase quantitative easing was negative for the currency and the bank’s comments also dampened the optimism triggered by recent favourable data releases.

Following the Bank of England move, Sterling weakened sharply to lows near 1.6750 against the dollar with the Euro back above the 0.8550 level

Swiss franc:

The National Bank policy actions will continue to have a very important impact on the Swiss currency.  There will be deflation fears, especially if there is wider US currency appreciation, and the most likely outcome is that the bank will continue to intervene aggressively if necessary to curb renewed currency gains. These risks will increase if the is renewed downward pressure on the US dollar. The franc will, therefore, find it difficult to make much net headway. 
 
The dollar found support below 1.06 against the franc during the week and attempted to rally, but was unable to make strong headway. The Euro hit resistance close to 1.53 against the Swiss currency.

The Swiss PMI index was firmer than expected with an increase to 44.3 for July from 41.8 the previous month, maintaining the recent improving trend.

Swiss consumer prices fell 0.7% in July to give a year-on-year decline of 1.2% which was slightly below expectations and kept the National Bank alert to the deflation threat. Given these deflation fears, there will be increased central bank determination to avoid Swiss currency gains.

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The Australian dollar challenged resistance levels above 0.8450 against the US dollar, but found it difficult to make much headway for the week as a whole.

There was a significant decline in the latest services-sector PMI index which will create some caution over the economy, especially after the weaker than expected retail sales data. A narrower trade deficit did not have a major market impact.

As expected, the Reserve Bank of Australia left interest rates on hold at 3.00% following the latest council meeting and the bank also removed the easing bias while upgrading its assessment of conditions.

The domestic labour-market data was sharply stronger than expected with the unemployment rate holding at 5.8% while there was a surprise 32,200 increase in employment for the month.  The data reinforced expectations that the Reserve Bank will move closer to raising interest rates

The Australian dollar performance will continue to be influenced strongly by degrees of risk appetite and commodity prices. Expectations of a tighter monetary policy should stem any selling pressure.

Canadian dollar:

The Canadian strengthened to highs beyond the 1.07 level against the US currency during the week, but was unable to sustain the gains and weakened back toward the 1.08 level.

The domestic influences remained limited with currency trends still influenced strongly by commodity prices.

The Canadian dollar will find it difficult to make strong headway from current levels even if it proves to be broadly resilient.

Indian rupee:

The rupee secured a generally firmer tone and pushed to 8-week highs against the dollar as the US currency was subjected to further underlying selling pressure

Trading volumes were generally low due to the impact of a strike by state-bank employees with the dollar regaining some ground to 47.80 against the rupee on Friday as there was a mood of greater caution.

Underlying risk appetite was till relatively firm which helped underpin the stock markets and optimism over capital inflows.

The rupee will gain support when global risk appetite improves. Nevertheless, the net risks suggest that the currency will find it difficult to secure more than limited gains. 

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The Hong Kong dollar has again been trapped very close to the 7.75 band limit against the US currency. There have been frequent interventions by the HKMA to stem local currency gains and preserve the bands.

There was some increase in corporate US currency demand, but the Hong Kong dollar still secured wider support on optimism over capital inflows.

The Hong Kong dollar should maintain a firm tone in the short-termwith the potential for further intervention by the HKMA to preserve the band limits.   

Chinese yuan:

The yuan has again been trapped in narrow ranges near 6.83 against the US dollar with the domestic currency still effectively pegged against the dollar. In its latest monetary report, the central bank again pledged that it would maintain a stable yuan

There was some evidence of caution ahead of a batch of economic data next week while volatilities fell to a two-month low as spot activity remained extremely limited.
 
The central bank is likely to maintain the near-term policy of targeting currency stability, especially with persistent doubts over the quality of the economic rebound.