Weekly Forex Currency Review 15-01-2010

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The markets will continue to look at yield and structural factors over the next few weeks. The US currency has the potential for some support given fears over structural vulnerabilities within the European economies as fears surrounding the weaker Euro-zone economies continue. The US currency will find it difficult to gain strong support given underlying US fundamental vulnerabilities.

Key events for the forthcoming week

Dollar:

The latest economic data will maintain hopes for a firmer US economy, but there will also be continuing expectations that the Federal Reserve will be extremely cautious in increasing interest rate. The dollar will not be in a position to gain strong support on yield grounds and there will also be fears that the US economy will falter again later in 2010, especially with money supply contracting. The dollar should still be in a position to gain support from a lack of confidence in other major currencies.

Following the weaker than expected US payroll report last Friday, there was a downgrading of market expectations surrounding higher US interest rates during the first half of 2010. This hampered the dollar during the week, although it did make gains to near 1.44 against the Euro late in the week.

The headline US retail sales data was also weaker than expected with a December decline of 0.3% compared with expectations of a small increase. Although the November data was revised up, the data will create some doubts over spending trends.

The jobless claims data was also slightly weaker than expected with an increase in initial claims to 444,000 in the latest week from a revised 433,000 previously. The data can be distorted by holidays around this time of the year and the underlying claims data still indicates an underlying improvement.

Regional Fed President Plosser stated that rates would need to rise well before unemployment fell to acceptable levels, but there were still major doubts whether the Fed would tighten policy given the underlying economic stresses and there were other more dovish comments from Fed officials.

The Fed’s Beige Book reported some improvement in conditions in most districts, but sentiment was still generally fragile and there will be particular unease over a further tightening of credit conditions.

Following the mixed comments from Fed officials, there were still doubts over the potential for an early increase in interest rates with markets putting a 30% chance of a Fed funds rate increase by the June meeting.

The US trade deficit was wider than expected at US$36.4bn for November from a revised US$33.2bn the previous month. Imports rose strongly, primarily due to rising oil imports, although there was also a robust export performance which will increase optimism over the economy to some extent.

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Firm rhetoric on inflation could provide some Euro support, but the ECB is likely to maintain a steady policy in the short-term which will limit support. There will be persistent fears over structural weaknesses, especially as it will be extremely difficult to adopt a convincing strategy to cut budget deficits in countries like Greece.  In this environment, underlying Euro sentiment is likely to remain fragile and there is still some risk of heavy selling pressure on fears that there will be more severe tensions within the area. 

The Euro held its ground against the dollar, but was unable to make much headway as underlying sentiment remained fragile and was subjected to renewed selling late in the week, undermined in part by rumours that German Chancellor Merkel would resign.

The Greek government announced that it would launch a fiscal stability plan on Wednesday, designed to cut the budget deficit to 3% of GDP within three years. There were still very important doubts whether a credible plan could be put together. The Euro was also unsettled by comments from German Chancellor Merkel who stated that the Greek budget situation risked damaging the Euro.

China’s increase in reserve requirements, allied with weaker than expected earnings from US company Alcoa unsettled the Euro to some extent as risk appetite deteriorated, although the impact was measured as the dollar found it difficult to gain.

As expected, the ECB held interest rates at 1.0%. In the statement following the meeting, President Trichet again commented that interest rates were at appropriate levels and that the risks to growth were broadly balanced.

Trichet stated that it was absurd to speculate that any country could be forced to leave the Euro area, although he was still reluctant to make substantive comments on the situation surrounding Greece’s government debt position.

Yen:  

Underlying confidence in the Japanese economy will remain weak in the short-term, especially with fears over the government-debt situation. Exchange rate policies will remain important and there will be continuing pressure for yen gains to be resisted. There will also be speculation that the government will now be more willing to push the currency weaker. A lack of confidence in the other major economies and currencies should still offer some degree of yen protection.

The yen tended to trade erratically over the week as markets struggled to find a clear direction.  Some caution over global economic prospects helped protect the Japanese currency from heavy selling pressure and the dollar was unable to push back above the 92.50 level against the yen.

In comments on Tuesday an official of China’s sovereign wealth fund stated that the dollar had hit bottom and had little room to decline while the yen was likely to weaken. These comments triggered a spike higher in the dollar/yen rate.

The latest Japanese machinery orders data was sharply weaker than expected with a substantial decline of 11.3% for November which pushed the series to a record lows since the data started in 1987 and undermined confidence.

The data increased fears over the economy and maintain pressure for the Bank of Japan to provide additional support to the economy. There was also additional pressure for the authorities to weaken the currency.

Finance Minister Kan stated that currency rates should be set by markets unless there are rapid moves.

China continued to have an important influence on the Japanese currency during the day and an increase in reserve requirements, allied with expectations of further tightening triggered a downward move in the dollar against the yen.

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Fears over the debt situation and speculation over a debt default will remain a clear threat to Sterling, especially as political uncertainty will remain a key feature over the next few months. The latest economic data will maintain some speculation that the Bank of England will need to tighten policy relatively quickly during 2010 and this is likely to provide some degree of support for Sterling.  Given the debt vulnerabilities, currency gains are still liable to hit selling pressure quickly. 

Sterling maintained a generally firm tone during the week, challenging 1-month highs against the dollar above the 1.63 level while the UK currency also strengthened through 0.89 against the Euro.

Industrial output rose 0.4% in November as energy output gained, but manufacturing output was unchanged over the month. There was a firm figure for retail sales according to the BRC, but the latest RICS house-price survey recorded a slight deterioration for the first time for 10 months.

The NIESR reported a 0.3% increase in GDP for the fourth quarter of 2009 which should mean that the official figure will also register growth and an end to the recession which underpinned UK currency sentiment with further speculation over an early increase in interest rates.

Bank of England MPC member Sentence warned over the risk of higher inflation in the medium term and the potential need for higher interest rates during 2010 which provided additional Sterling support.

Swiss franc:

Developments within Europe will continue to be watched closely and the Swiss currency is likely to gain some further defensive support from fears over the Euro-zone economy, especially if structural fears intensify. The National Bank is still concerned over the implications of franc strength and there will be further intervention to curb currency gains if necessary. In this environment, it will be difficult for the franc to make much headway from current levels.

The dollar found support below the 1.0150 level against the franc during the week, but was unable to sustain any strong gains even with a move to 1.0250. The Euro tested support levels below 1.4750 against the franc.

National Bank chairman Hildebrand stated that the bank would continue to resist excessive Swiss currency appreciation, but there was still some speculation that the rhetoric was less aggressive than expected with the bank less willing to make aggressive moves.

The central bank head also commented that the bank has begun to withdraw excessive liquidity and this will tend to provide some degree of support for the Swiss currency.

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The Australian dollar was subjected to choppy trading. China’s decision to increase reserve requirements had an important negative impact both on commodities and risk appetite and the combination pushed the Australian dollar to lows below the 0.92 level against the US currency. Nevertheless, it recovered ground quickly following significant retreats and re-tested levels above 0.93 against the US dollar.

The latest housing-finance data was weaker than expected. In contrast, the labour-market data was again stronger than expected with an employment increase of over 35,000 for December compared with expectations of a 10,000 increase.

The data reinforced optimism over the economy and speculation over further interest rate increases within the next few months.

Underlying confidence in the Australian economy and currency should remain firm in the short-term, but it may prove difficult to sustain further substantial gains.

Canadian dollar:

The Canadian dollar maintained a firm for the week as a whole, again strengthening to a peak beyond 1.03 against the US dollar before consolidating close to this level.

The currency was supported by optimism over a former global economy during 2010 and hopes for higher commodity prices.

The Canadian dollar fundamentals will remain firm, but a lack of yield support will tend to make it difficult to achieve further significant gains.

Indian rupee:

The rupee initially pushed to 16-month highs against the dollar with a peak just beyond 45.3 against the US currency. The rupee was unable to sustain the gains and then weakened significantly following the Chinese central bank’s decision to increase reserve requirements, consolidating around the 45.7 level. 

The currency was also hampered by an increase in importer buying. There was some speculation that the Indian central bank would announce a policy tightening at the end of January which provided some degree of support for the rupee.

It will tend to be difficult for the rupee to extend gains in the near term, especially with some unease over a slowdown in the global economy later in 2010.

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The Hong Kong dollar was unable to regain much ground against the US dollar during the week. Risk appetite was still broadly firm which helped limit selling pressure on the currency.

China’s move to increase reserve requirements increased speculation over further tightening moves in the short-term and there was also speculation that there would be reduced capital inflows into Hong Kong.

Although there will be speculation over weaker capital inflows, the Hong Kong dollar should be able to resist more than limited near-term losses.

Chinese yuan:

The Chinese central bank maintained tight control of the spot market during the week even though there were important developments during the week.

The central bank announced that it would increase reserve requirements and this increased speculation that there would also be a move to increase interest rates
These central bank moves also increased underlying pressure for a yuan revaluation.

The trade data was also stronger than expected with exports recording an annual increase and the trade data was influential in pushing the NDF rates to a three-month high. Government officials were still very cautious over the yuan.

The central bank will still want to resist pressures for currency-policy changes ahead of the Chinese New-Year period, but underlying pressure for a policy shift and a stronger currency will continue.