Weekly Forex Currency Review 09-04-2010

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Confidence in the Euro-zone area will remain generally weak in the short-term and this will remain a negative factor for the currency as investor sentiment remains very fragile towards the debt situation. There is certainly some risk of a much more serious deterioration in confidence surrounding the Euro given the underlying stresses, especially if the economic recovery appears to be faltering.             

Key events for the forthcoming week

Dollar:

There will be further optimism over a sustained rebound in the economy and the dollar should continue to gain some degree of support from higher bond yields. There will still be major doubts whether the Federal Reserve will move to increase short-term rates within the next few months which will curb support Underlying confidence in the US fundamentals will remain fragile with debt fears still an important underlying negative factor.  In this environment, the dollar will find it difficult to secure strong, independent support.

The dollar maintained a firm tone against the Euro and tested levels close to March’s high, but it was unable to break through and there was a more defensive tone on a trade-weighted basis. Firm risk appetite and high commodity prices curbed underlying demand for the US currency.

The headline US payroll increase was slightly weaker than expected with a gain of 162,000 for March following a revised 14,000 decline the previous month while unemployment was unchanged at 9.7%. There were mixed elements within the report, but there was a gain in weekly hours which will provide some degree of confidence surrounding the economy.

There was speculation that the Federal Reserve would increase the discount rate on Monday and this helped support the dollar, but there was no move to adjust rates by the Fed. The trend in long-term interest rates remained under scrutiny and the US currency was still able to secure underlying support from the recent rise in yields relative to German bunds.

The US economic data on Monday was stronger than expected with the ISM non-manufacturing index rising to 55.4 for March from 53.0 the previous month and this was the strongest figure since May 2006 while the employment index pushed to near the 50 level. There was a rise in pending home sales of 8.2% for February and the data overall maintained confidence in the economy.
The US jobless claims were higher than expected at 460,000 in the latest week from  a revised 442,000 the previous week which may have been distorted by the Easter weekend. Markets will wait for further evidence over the next few weeks before assessing whether there is a new trend developing.

Within the FOMC minutes released on Tuesday, there were comments indicating that there was no fixed time for the extended period language and the members were broadly confident that the Fed could react and tighten policy quickly if required. There were concerns over the contraction seen in bank lending seen during the first two months of the year. Overall, the minutes did not provide additional dollar support

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Sentiment surrounding the Greek budget and debt situation will remain very fragile and reassurance from central bank officials may provide only temporary relief. There will also be unease over the Euro-zone economic outlook with fears that there will be further credit-rating downgrades. There is certainly the risk of further medium-term selling pressure on the Euro given the structural vulnerabilities, although there may be some scope for a near-term reprieve. 

The Euro remained on the defensive during the week losing ground on most crosses as underlying sentiment remained weak. There was a corrective recovery late in the week as support near the 10-month low of 1.3450 held.

There were further concerns over the Greek situation as yield spreads over German bunds continued to widen to record levels since the Euro’s introduction. There were increased fears that Greece would face a vicious circle with rising debt costs making it even more difficult to meet deficit targets. This, in turn, further undermined sentiment and maintain Euro selling pressure, especially with speculation over a debt default.

Fourth-quarter Euro-zone GDP was revised to show no change from 0.1% previously which also hampered sentiment. The Euro-zone Sentix investor index strengthened to 2.5 for April from -7.5 the previous month.

As expected, the ECB left interest rates on hold at 1.00% following the latest council meeting. In the press conference following the meeting, President Trichet stated that monetary policy remained appropriate and he maintained a neutral policy stance.

Trichet also stated that default was not an option for Greece while the deal was described as a workable framework as he looked to foster a greater sense of confidence surrounding the Euro area. Underlying confidence was still extremely fragile, but Trichet’s comments did help to stabilise Euro sentiment.

Yen:  

The yen will remain vulnerable to carry-related selling, especially if confidence in the global economy holds relatively firm. The trend in yields will also be important and higher global interest rates will tend to attract funds away from the yen. A Chinese yuan revaluation would provide near-term support for the yen and any renewed deterioration in risk appetite would also tend to undermine confidence. The yen will find it difficult to sustain any significant gains.

The yen weakened to lows beyond 94.50 against the dollar during the week, but then found support and regained some ground. The yen was also able to recover from losses against the Euro in choppy trading conditions.

The domestic economic data was mixed with a weaker than expected figure for machinery orders as core orders declined by 5.4% over the month which will maintain some fears over the investment outlook. In contrast, the latest consumer confidence data was stronger than expected which could help underpin spending levels.

There was renewed speculation over a Chinese revaluation during the week following a batch of media comments with some expectations that a move was imminent. This speculation also helped underpin the yen to some extent.

The Bank of Japan held interest rates at 0.10% following the latest monetary policy meeting which was in line with market expectations. The bank also expressed confidence that the economy was picking up in its latest report.

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There will be a high degree of uncertainty over the budget outlook and underlying confidence in the debt situation will remain weak. Markets will be looking for decisive and credible action on the deficit following the election. In the near term, Sterling will, therefore, tend to weaken if opinion polls suggest no party will have a majority. Given the amount of bad news priced in and the very high number of short speculative positions, Sterling may still be able to avoid further selling pressure ahead of the May 6th vote.

Sterling remained under selling pressure at times, but did find support on dips below the 1.51 level against the US currency before rallying back to above 1.53. Euro vulnerability allowed Sterling to strengthen to 7-week highs beyond 0.8750.

Confirmation that a General Election would be called on Tuesday for May 6th was not a surprise, but the UK currency was pushed lower by one opinion poll which suggested an increased risk of an indecisive outcome. There was also a weaker UK gilt auction which tended to undermine slightly

The construction PMI index rose to 53.1 for March from 48.5 the previous month and this was the first figure above the 50.0 benchmark for over two years. The services-sector PMI index weakened to 56.5 for March from 58.4 the previous month and, although the index was still at healthy levels in historic terms, there were fears over a slowdown. In contrast, the OECD was relatively optimistic in its latest report.

The Halifax bank reported a 1.1% increase in house prices for March following a revised 1.6% decline the previous month while there was also a larger than expected 1.0% increase in February industrial production after the 0.5% decline previously.

As expected, the Bank of England left interest rates at 0.5% following the latest Monetary Policy meeting and the amount of quantitative easing was also left on hold at GBP200bn. The Bank will be very reluctant to get involved in the political debate and comments are, therefore, likely to remain very limited in the short-term. The May meeting will be much more important both for the bank and for Sterling.

Swiss franc:

The Swiss currency will continue to gain some defensive support from a general lack of confidence in the Euro. The National Bank will remain an important focus and there will be further pressure on the central bank to prevent further gains against the Euro which will also tend to curb the scope for franc appreciation. The franc should be able to resist heavy selling pressure give a lack of confidence in the Euro area.

The dollar pushed to a high above 1.08 against the franc on Thursday before edging moving lower and back to 1.0695. The Euro held above the 1.43 level against the Swiss currency with Euro selling pressure curbed by fears over National Bank intervention with some further franc sales reported.

Swiss consumer prices rose 0.1% in March to give a 1.4% annual increase. This was in line with market expectations and should not have a substantial impact on monetary policy expectations. Retail sales rose 3.1% in the year to February which should maintain cautious optimism towards the economy.

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The Australian dollar maintained a firm tone against the US dollar during the week and tested resistance levels close to 0.93.

The Reserve Bank of Australia increased interest rates to 4.25% from 4.00% at the latest policy meeting. Given that there had been some doubts over the potential for a rate increase, the decision provided some Australian dollar support, especially with a relatively hawkish statement.

The employment data was close to expectations with an increase of close to 20,000 for March which maintained confidence in the Australian economy.

Australian dollar sentiment should remain generally firm for now with expectations of further carry-related inflows. The currency may still find it difficult to extend gains, especially if there is a further tightening of Chinese monetary policy.

Canadian dollar:

The Canadian dollar strengthened to test US dollar support levels close to parity and pushed to a high around 0.9980. After a correction weaker the currency was again close to parity late in the week.

The currency drew support from high oil prices and wider gains in commodity prices while risk appetite also remained generally strong.

The Canadian dollar should remain generally firm in the short-term given expectations of higher interest rates and firm risk appetite. It will remain difficult to extend gains on valuation grounds.

Indian rupee:

The rupee again had a stronger tone over the week and strengthened to test 19-month highs beyond the 44.50 level against the US dollar. There was increased speculation over a Chinese yuan revaluation during the week and this helped strengthen the rupee on expectations of firmer emerging-market currencies.

Risk appetite and the local bourse were also generally firm which helped underpin sentiment. The rupee was curbed by speculation of central bank intervention

The rupee should be able to maintain a relatively firm tone against the dollar in the near term, especially if there is a move to revalue the Chinese currency. 

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The Hong Kong dollar resisted further losses and strengthened back to the 7.76 region against the US currency during the week

The local currency dew support from generally firm risk appetite. Increased speculation over a Chinese yuan revaluation also provided significant support, especially over the second half of the week.

There will be mixed currency influences from Chinese pressures and any yuan revaluation would tend to be a net positive for the Hong Kong dollar. Volatility levels are liable to be higher in the short-term.

Chinese yuan:

The spot yuan rate strengthened over the week with a move to around 6.823 against the dollar which was the strongest level since October 2009.

There was increased speculation over a near-term move to revalue the yuan in tandem with a move to widen the trading band. There were media reports suggesting that the central bank was winning the battle with the Commerce Ministry over the need for a stronger currency as inflation fears increased.

There was also a meeting between US Treasury Secretary Geithner and senior Chinese officials while the US delayed the publication of its semi-annual currency report which may have labelled China as a currency manipulator.

Speculation over an adjustment to the yuan regime will remain very high. There is a certainly a strong possibility of at least a limited policy move with the authorities likely to veto more aggressive moves.