Weekly Forex Currency Review 14-08-2009

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Central bank policies suggest that the sense of panic has eased and that there will be greater confidence in resisting more aggressive quantitative easing. Interest rates will, however, remain at very low levels throughout the G7 area and this will still make it difficult for any of the major currencies to secure strong gains on yield grounds.  The quality of fundamentals and relative debt fears will be under close scrutiny.  The dollar should be able to resist heavy selling pressure from current levels. 

Key events for the forthcoming week

Date Time (GMT) Data release/event
Tuesday August 18th 08.30 UK consumer prices
Tuesday August 18th 12.30 US housing starts
Thursday August 20th 08.30 UK retail sales

Dollar:

The Federal Reserve statement will reinforce expectations that interest rates will stay at very low levels for an extended period and this will sap yield support for the dollar. The US currency is also still tending to lose support when global risk appetite improves with a flow of funds into higher-yield assets.  The pattern is, however, liable to become less stable which will tend to increase the risk of erratic trading. The dollar can also still gain support on valuation grounds while structural weaknesses elsewhere will also provide support.   

The dollar strengthened over the first half of the week, capitalising on the stronger than expected payroll data the previous Friday. The US currency was unable to sustain the gains and dipped weaker following the Federal Reserve meeting as rate expectations were scaled back again.

The US consumer-related economic data was weaker than expected with a headline retail sales decline of 0.1% for July after a revised 0.8% increase the previous month while underlying sales fell by 0.6%.

Initial jobless claims also edged higher to 558,000 in the latest week from 554,000 previously, although there was a decline in the number of continuing claims. The data overall will raise some doubts over consumer spending levels and triggered caution over underlying trends.

The US trade deficit rose to US$27bn for June from US$26.0bn as oil imports rose, but an underlying improvement in the non-oil account provided some degree of underlying US currency support.

There was the sharpest rise in non-farm productivity for six years during the second quarter as companies aggressively cut costs. The downward pressure on labour costs increased speculation that the Fed would be able to justify very low interest rates.

As expected, the Federal Reserve left interest rates on hold in a 0.00 – 0.25% range at the latest FOMC meeting. The amount of agency bond buying was left on hold while the Fed announced that the US$300bn Treasury bond buying programme would be completed at the end of October rather than September as planned previously with a slower rate of purchases over the next two months.

The Fed remained cautiously optimistic that economic conditions were improving as activity was levelling out, but there was further unease over the investment outlook. The statement also commented that interest rates would stay at very low levels for an extended period with markets scaling back expectations of higher interest rates.

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The latest Euro-zone economic data has been stronger than expected which will provide some degree of Euro support. There are still very important underlying vulnerabilities, especially as there will still be fears over a developing credit crunch within the European banking sector.  In this environment, the Euro will still find it difficult to gain strong support, especially as it is generally over-valued on fundamental grounds.  

The Euro was generally weaker against the dollar over the first half of the week, but proved to be resilient and optimism over the economy helped trigger a firmer trend over the second half. The Euro was able to secure modest net gains on the crosses.

The Euro-zone data offered some support with an improvement in the sentix investor confidence index to -17 for August from -31.3 the previous month. There was also a narrowing of internal yield spreads which helped underpin confidence.

The French and German GDP data was also stronger than expected both registering 0.3% quarterly increases compared with expectations of further declines. The Euro-zone data as a whole was also stronger than expected with the quarterly decline held to 0.1% which helped underpin sentiment towards the regional economy.

Yen:  

The short-term yen movements will still tend to be influenced strongly by trends in risk appetite. The Japanese currency will lose ground when risk conditions improve as capital outflows continue. There will be renewed support when confidence deteriorates and capital repatriation will still be a significant risk. There will tend to be domestic opposition to substantial yen gains and, with overall confidence in the economy fragile, there appears little scope for substantial yen appreciation.     

The yen resisted further selling pressure following the sharp losses seen following the US employment data. From lows beyond 97.50, the Japanese currency strengthened to highs near 95.0 and also resisted further selling pressure on the crosses. The yen gained some support when Chinese equity markets fell sharply.

The Japanese industrial economic data had a firmer bias with machinery orders rising sharply by 9.7% in June, although companies are still expecting a capital-spending decline for the third quarter.  The current account surplus was stronger with some evidence of investment flows into Japanese assets.

The Chinese economic data released continued to suggest a recovery in the industrial sector with output growth at a nine-month high. The data was, however, not as strong as expected which triggered a mild increase in risk aversion, especially with Chinese consumer prices continuing to decline and this provided some underlying yen support.

The Bank of Japan held interest rates at 0.10% following the latest policy meeting and also maintained a generally cautious tone towards the economy. The bank stance suggested that it will maintain an aggressive monetary policy in the short-term. 

The Bank warned that an exit strategy from the quantitative easing was required.  Wholesale prices, however, registered a 8.5% decline in the year to July which maintained deflation fears.

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The Bank of England comments continue to suggest that interest rates will be held at very low levels over the next few months. With the bank also expanding quantitative easing, overall sentiment towards the economy is liable to remain weaker in the short-term.  Underlying trends will also continue to be influenced strongly by degrees of risk appetite and the currency will be much more vulnerable to selling pressure when international confidence falters.  The net economic risks still suggest that Sterling will have a weaker trend  

Weaker confidence in the UK economy pushed Sterling to lows below 1.64 against the US dollar. Much of the adjustment had already been seen ahead of the Bank of England quarterly inflation release which limited any further selling pressure and it rallied back to above 1.65. Sterling weakened to beyond 0.86 against the Euro.

The UK unemployment claimant count increase was slightly lower than expected at 24,900 for July after a revised 21,500 increase the previous month, but the ILO unemployment rate was higher than expected with a rise to a 13-year high of 7.8% from 7.6% and the currency impact was broadly neutral.

The visible trade deficit widened to GBP8.5bn for June from GBP8.3bn as the oil account returned to deficit, but the gains in imports helped maintain optimism that there was an economic recovery. Former Bank of England MPC member Wadhwani warned that the economy could face very serious challenges over the second half of 2010

In its quarterly inflation report, the Bank of England warned that inflation would significantly undershoot the 2.0% target in two years time if interest rates are increased in the first quarter of 2010 while the recession was deeper than expected. The bank was slightly more optimistic over economic prospects, although the underlying tone was still for extreme caution and uncertainty over the outlook.

Swiss franc:

Overall confidence in the Swiss economy is liable to remain generally weak which will limit fundamental backing, although there could still be some degree of support when risk appetite is weaker. The National Bank will continue to monitor the situation closely and there is still the high risk of renewed intervention if the franc appreciates strongly. In this context, the risk of franc selling will be much higher if there is renewed US currency weakness.  
 
The dollar pushed to a high just above the 1.09 level against the Swiss franc during the week, but was unable to sustain the gain and weakened back to 1.07. The franc also found support weaker than 1.53 against the Euro.

The latest wholesale prices data registered a record 6.1% annual decline in prices in the year to July and this tended to maintain National Bank fears over deflation

In this environment, the central bank remained on high alert and will still be ready to intervene aggressively to stem any renewed franc gains. The risk of intervention will also inevitably intensify if there is wider selling pressure on the dollar.

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The Australian dollar challenged resistance levels above 0.8450 against the US dollar, but found it difficult to sustain the gains as selling pressure increased at higher levels.

Risk appetite deteriorated following a sharp decline in Chinese equity prices while commodity prices were also weaker on expectations that Chinese industrial buying was also fading. There was a rise in the NAB business confidence index which provided some degree of support.  The rise in Australian consumer confidence did not have a significant impact as global trends dominated.

The Reserve Bank Governor again warned over the potential for higher interest rates which triggered temporary Australian dollar gains.

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 aggressive selling pressure.

Canadian dollar:

The Canadian dollar strengthened to highs beyond the 1.08 level against the US currency during the week, but was unable to sustain the gains and weakened back toward the 1.09 level as the recent pattern of high volatility continued.

The currency continued to be driven to a large extent by trends in risk appetite and commodity prices. A rally in crude oil prices helped trigger a firmer currency tone.
The trade account was in deficit for the third consecutive month, but the impact was limited as exports showed some signs of recovery.

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

Indian rupee:

The rupee had a slightly weaker tone over the week, although ranges were relatively narrow for much of the time. Risk appetite recovered late in the week as equity markets rebounded and the rupee also gained support from a weaker US currency. There was also some evidence of IPO-related capital inflows.

There was unease over the Monsoon season during the week with fears that weaker than expected rainfall would undermine the economy.

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 edged slightly weaker, although movement was still very limited with the currency close to 7.7508 against the US currency

The currency was unsettled temporarily by a sharp drop in local equity prices as Chinese fears increased, but markets recovered their poise late in the week which curbed any selling pressure.

The US currency was hampered by the Federal Reserve commitment to low interest rates which limited Hong Kong dollar losses.

The Hong Kong dollar should maintain a firm tone unless there is a serious deterioration in confidence surrounding the Chinese equity markets and economy

Chinese yuan:

The yuan was trapped within relatively narrow ranges during the week with an initial slightly weaker bias reversed later in the week. The latest economic data continued to suggest a recovery in the economy, although the industrial output data was below expectations while consumer prices continued to decline

The Commerce Ministry was optimistic that the export sector was past its worst which provided some currency support. In contrast, there were fears over the impact of a sharp downturn in credit supply during July which maintained a cautious tone and equity markets dropped sharply over the week as a whole.
 
Despite expectations of medium-term appreciation, the central bank is likely to maintain the near-term policy of targeting currency stability, especially with persistent doubts over the economic developments.