Weekly Forex Currency Review 09-10-2009

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There is likely to be a greater focus on individual-country fundamentals over the next few weeks as general fears over the global economy remain slightly lower. There are, however, clear risks in this stance as there are still very important financial stresses and risk aversion is still liable to return quickly. In the near term, the dollar and Sterling will still tend to be on the defensive.

Key events for the forthcoming week

Dollar:

Overall confidence in the dollar is likely to remain fragile in the short-term with further fears that there will be a medium-term diversification away from the currency. In this context the dollar will remain very sensitive to international rhetoric. Short-term yield support will also remain weak with the currency needing a series of more aggressive Fed comments to secure any robust support. The currency is, however, attractively valued at current levels and risk appetite is also likely to be generally weaker which should offer some degree of protection.  G7 members will also look to limit currency losses.

The US currency attempted to correct stronger at times, but generally remained on the defensive as rallies quickly attracted fresh selling pressure. The US currency tested 2009 lows before staging a limited recovery on Friday after Bernanke’s comments.

Overall confidence in the US fundamentals remained weak amid further speculation over reserve diversification. The dollar was unsettled by a media report that Gulf producers would look to switching oil pricing to a basket of currencies.

The dollar was undermined to some extent by the weekend G7 meetings where there was no additional support for the US currency. European policy makers continued to voice their support for a strong dollar in comments with ECB President Trichet stating that there was no need for the dollar to weaken against the Euro.

The US ISM index for the non-manufacturing sector rose to 50.9 from 48.4 the previous month and this was the strongest reading for over 12 months, although there was still evidence of underlying vulnerability.

The US remaining economic data was slightly stronger than expected with jobless claims falling 521,000 in the latest week from a revised 554,000 the previous week which will maintain some cautious optimism that the labour market is at least stabilising. The US dollar was still tending to lose support on reduced defensive demand as confidence in the global economy improved.

Fed officials gave broadly neutral comments for much the week. Fed Chairman Bernanke then commented that monetary policy would need to be tightened as the economic recovery took hold and and speculation over an early move to increase interest rates gained some renewed traction which helped support the dollar.

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The situation within Eastern Europe will be watched closely as any Latvian devaluation would be likely to undermine the Euro, especially as it would reinforce market fears over the Euro-zone banking sector. Rhetoric from Euro-zone officials will also be watched closely and there are likely to be further efforts to curb further appreciation, especially with the economy still in a fragile condition.  Markets will tend to look for a firmer Euro, but barriers to gains will remain tough above current levels.     

The Euro maintained a generally firm tone during the week with a notable strength against the dollar and Sterling, although it failed to hold the best levels.

There was further verbal intervention by European officials with Portuguese officials, for example, warning that the Euro’s value was not in line with fundamentals.

The German industrial data was broadly in line with market expectations with a further recovery in orders for August and did not have a significant market impact. There was some further unease over the situation in Latvia amid fresh rumours of devaluation and this is likely to have some negative Euro impact.

As expected, the ECB held interest rates at 1.0% following the latest council meeting. In the press conference following the meeting, President Trichet was generally slightly more optimistic on the economy with a suggestion that downside risks were starting to ease, although there was no suggestion of an early move towards tightening.

Trichet continued to express confidence in a strong US dollar policy which was broadly in line with recent comments and there was no aggressive warning over the Euro’s value. As usual, Trichet also refused to comment on the possibility of joint intervention in the currency markets. The measured stance on the Euro will dampen any expectations of near-term action to weaken the currency and also suggests that the bank does not consider that the currency is in the danger zone at current levels.

Yen:  

The yen is still proving to be broadly resilient in global markets. There should be some near-term flows into high-yield currencies and capital repatriation will be less of a threat, but the evidence suggest that the yen is not as vulnerable to being used as a funding currency. There is also still the potential for a closing of speculative positions. The authorities will be very reluctant to intervene directly, but will tend to oppose rapid appreciation. Overall, the yen will find it difficult to sustain gains much beyond current levels.   

The dollar was unable to gain any significant traction against the yen during the week and weakened to test important support levels close to 88. There was evidence of institutional dollar buying support close to this level and the US currency was able to stage a limited corrective recovery towards 89.20

There was some evidence of capital flows into high-yield currencies, but the Japanese currency was still broadly resilient during the week.

Finance Minister Fujii was reported as saying that the government would be open to intervention on outrageous and reckless exchange rate movements. There was still a high degree of uncertainty over official policy.

There was a small 0.5% increase in core machinery orders for August, but this followed a sharp 9.3% decline the previous month and there was still important underlying weakness in capital spending

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Confidence in the economy and Sterling will remain generally weak in the short-term with persistent fears over the government debt situation and there is likely to be renewed speculation over a credit-rating downgrade. While the housing data remains more favourable, selling pressure is liable to be contained. A steady Bank of England policy would also provide some degree of relief, but the underlying policy mix will remain unfavourable for Sterling as interest rates will need to stay low. Rallies will tend to attract selling pressure relatively quickly. 

Sterling remained under selling pressure over the first half of the week and the trade-weighted index dipped to a five-month low while there was a test of support below 1.59 against the dollar while Sterling dipped to lows near 0.93 against the Euro. The currency was able to secure some respite later in the week, although selling interest on rallies remained a key feature.

The UK Halifax house-price index recorded a further 1.6% monthly increase for September, maintaining the run of generally favourable housing-sector releases. The services-sector PMI index was also stronger than expected with a move to a two-year high of 55.3 for September from 54.1

In contrast, the industrial data was sharply weaker than expected with a 2.5% monthly decline for August. Although the data may have been distorted by the timing of Summer production shutdowns, the very sharp decline will maintain fears over the industrial sector.

The NIESR reported that the economy recorded no growth in the three months to September following a revised 0.1% increase the previous month. The actual data being recorded still appears to be in significant contrast to the survey evidence which will tend to maintain a defensive stance towards the UK economy and assets.

The Bank of England left interest rates on hold at 0.50% following the latest policy meeting which was in line with expectations. The amount of quantitative easing was also left on hold at GBP175bn with the bank expecting that the programme of bond purchases will be completed within the next month.

The bank stated that all possibilities will be examined once the programme has been completed. The November MPC meeting will, therefore, be very important both for the bank and for Sterling direction over the remainder of 2009.

Swiss franc:

The National Bank will remain very sensitive to the deflation risk and there is likely to be further intervention to prevent significant franc appreciation. In particular, there is likely to be aggressive resistance to gains beyond 1.50 against the Euro. The currency could still prove to be broadly resilient in the near term given a diminished role as a global funding currency. Renewed stresses in Eastern Europe would have a mixed impact on the franc. Overall, the franc will still find it difficult to sustain gains from current levels.
 
The dollar was unable to sustain a move above 1.04 against the franc during the week and dipped to test support below 1.0250. The Euro again found support close to 1.51 against the franc and pushed to highs near 1.52 where resistance remained tough to break down.

The Swiss CPI data was slightly weaker than expected with prices unchanged for September for a 0.9% annual decline which will maintain National Bank unease over the deflation threat. There was, however, no evidence of intervention by the central bank during the week. Swiss unemployment rose to 4.1% from 4.0% which was in line with market expectations.

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The Australian dollar maintained a very strong tone during the week as the domestic and international backdrop was favourable.

Following the latest meeting, the Reserve Bank announced a 0.25% increase in rates to 3.25% as it ended what it called emergency interest rate levels. Although there had been some speculation over a hike, it was still a surprise and the Australian currency jumped to 2009 highs above 0.89 against the US dollar and gains extended to above 0.90 late in the week as confidence remained high.

The latest labour-market data was substantially stronger than expected with employment rising by 40,600 for September compared with expectations of a further decline while the unemployment rate fell to 5.7% from 5.8%.

The data will reinforce expectations that the Reserve Bank will increase interest rates again in the near term which will maintain optimism towards the Australian currency.

Canadian dollar:

The Canadian dollar maintained a strong tone against the US currency over the week and strengthened to highs near 1.0520. The currency was driven to a large extent by shifts in commodity prices and gained support from fresh 18-month highs in the gold price. Volatility was a feature both in the energy complex and the Canadian currency.

There was some speculation that the Bank of Canada would move to a policy-tightening bias following the Australian interest rate increase.

The Canadian currency will remain vulnerable to choppy trading in the short-term and the international risk profile will make it difficult to secure significant gains.

Indian rupee:

The rupee pushed sharply higher for the week as a whole and strengthened to 12-month highs near 46.20 against the US currency. A break of the 47 level triggered stop-loss dollar selling which contributed to the sharp move.

The rupee was underpinned by a generally weaker US currency as well as evidence of further capital inflows, although there was a partial correction on Friday. There was some speculation that the central bank would intervene to slow the rupee’s advance, but there appeared to be no sign of major concern by the bank

The rupee will still gain support when there are wider US dollar losses, but it is likely to be a near-term peak, especially as central bank reservations are liable to increase.

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The Hong Kong dollar has maintained a very firm tone close to the 7.75 band limit against the US dollar. There has been further HKMA action in the market to prevent Hong Kong dollar appreciation.

The local stock market has remained firm which helped underpin the currency and underlying dollar confidence remained weak. The regional incentives were limited with mainland Chinese markets closed for most of the week.

Underlying confidence is liable to remain broadly firm in the very short-term with further intervention required to preserve the currency band. Inflows are liable to weaken slightly before the end of the year.

Chinese yuan:

The Chinese markets were closed for most of the week with a series of holidays surrounding the National Day. Markets re-opened on Friday and the yuan pushed to a 4-month high near 6.825 as the central bank set a slightly firmer mid-point.

G7 members continued to push for a stronger Chinese currency, but the rhetoric was broadly in line with recent meetings.

The underlying pressures for yuan appreciation will continue to build and the central bank is likely to be slightly more tolerant of very limited short-term appreciation.