Weekly Forex Currency Review 17-07-2009

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The medium-term outlook for the US currency will continue to be a very important area of debate in the short-term and underlying dollar confidence will remain fragile. The difficulties in other major currencies should still offer some important protection to the US currency, especially if there is general erosion in international risk appetite.

Key events for the forthcoming week

Dollar:

There will be some cautious optimism that the economy can secure a further near-term improvement as inventories are re-built. There are still very important sources of vulnerability, especially with unemployment set to rise further, while commercial-property stresses could also trigger further financial-sector vulnerability. Defensive dollar demand is liable to remain lower in the near term and there will be medium-term unease over reserve diversification into alternative currencies.  Nevertheless, the dollar should still be able to resist heavy selling pressure during the third quarter.  

The dollar posted gains early in the week, but was unable to break any important Euro support levels and was then on the defensive for much of the time. Risk appetite improved significantly which undermined demand for the dollar and the trade-weighted index dipped to a one-month low on broad selling before a slight recovery.

The US retail sales data failed to have a substantial impact as it was close to expectations. Headline sales rose 0.6% in June after a 0.5% increase the previous month while there was a 0.3% underlying increase. Overall confidence in the economy was still be fragile given the data breakdown and the latest IBD consumer confidence index recorded a monthly decline

The other growth-orientated data was mixed, but offered some degree of support with the New York Empire manufacturing index strengthening to -0.6 in July from -9.4 the previous month which was the strongest reading sine October last year. The decline in industrial output also slowed to 0.4% in June from a revised 1.2% decline previously while there was a further small decline in capacity use to 68.0% from 68.2%.

Initial jobless claims fell again to 522,000 in the latest week from a revised 569,000 the previous week. There was again a high degree of distortion from the auto sector as seasonal layoffs were lower than usual due in part to the number of job cuts already announced.

The Philadelphia Fed manufacturing index weakened to -7.5 for July from -2.2 the previous month as optimism over future business conditions deteriorated, although the orders component was at a 10-month high. The data will spark some degree of unease over industrial trends later in 2009.

US consumer prices rose 0.7% in June as gasoline prices rose sharply while there was a core increase in prices of 0.2% which was in line with expectations. Overall consumer prices still fell 1.4% over the year while there was a 1.7% underlying increase. The producer prices data was stronger than expected with a 1.8% monthly increase while core prices rose 0.5%

The latest capital account data recorded net long-term outflows for May of US$19.8bn compared with net inflows of US$11.5bn the previous month. Chinese Treasury holdings did increase over the month, but the net outflows maintained underlying market fears over a medium-term move away from the US currency.

The Federal Reserve minutes from June reported mixed views with a majority still very concerned over the economy, although there were also some increase in medium-term inflation fears. The Fed raised its 2009 GDP forecasts slightly, although the unemployment forecasts were also increased.

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The latest indicators for the Euro-zone suggest that there will be only a very fragile economic recovery at best as confidence remains weak. There will also be further structural vulnerabilities and these will come into much sharper focus if there is a sustained deterioration in risk appetite and further stresses in Eastern Europe. Although the Euro can secure additional near-term support, the overall risks suggest that it will be difficult to make strong headway from current levels.

The Euro maintained a firm tone during the week, although it was still finding it difficult to make strong headway with resistance levels difficult to break down. Confidence was underpinned by an improvement in risk appetite and the Euro pushed to highs near 1.4150 against the dollar before a modest correction.

There were still underlying structural vulnerabilities, although they were masked during the week by international developments.

There was a weaker than expected German business confidence survey with the ZEW index falling to 39.5 for July from 44.8 the previous month. This was the first monthly decline sine October and, although the data was still substantially higher than levels seen in late 2008

Yen:  

The near-term yen trends will remain correlated strongly with degrees of risk appetite and the Japanese currency will lose support if global confidence stages a further recovery. In contrast, renewed fears would tend to strengthen the yen and it is likely to prove broadly resilient. There will be strong expectations of verbal intervention if there are substantial yen gains from current levels which will make it difficult for the yen to sustain any gains through the 90 level against the US dollar. 
 
The Japanese currency was unable to strengthen through 92 against the dollar during the week and had a slightly weaker tone, although there was support beyond the 94.40 region with the Japanese currency broadly resilient.

Risk appetite was underpinned to some extent by stronger than expected Chinese GDP data with a 7.9% annual growth figure for the second quarter.  There was, however, a credit rating downgrade of New Zealand’s debt which triggered some reassessment of the situation in overall terms, the yen was still able to resist heavy selling given the push higher in equity markets.

The Bank of Japan held interest rates at 0.10% following the latest council meeting. The bank stated that the economy had stopped deteriorating, but it was still very cautious over the outlook and downgraded the 2009/10 GDP forecast. The bank also announced that the special corporate funding support measures would be extended for a further three months.

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The most recent indicators have offered some degree of support to the UK currency and confidence will edge firmer if there is evidence of recovery in the housing sector.  There are still very important underlying vulnerabilities and Sterling will be vulnerable to substantial selling if there is evidence of further deterioration in the debt position. The UK currency trends will also be very strongly correlated with risk appetite with Sterling much more vulnerable if there is deterioration in global confidence.  The overall risks suggest that Sterling is likely to have a weaker tone.

Sterling proved broadly resilient for much of the week and pushed to a two-week high towards the 1.65 level against the dollar while the UK currency was little changed against the Euro. Sterling retreated from its best levels late in the week.

The headline UK unemployment claimant count increase was lower than expected at 23,800 compared with expectations of an increase of over 40,000 for the month which provided some degree of initial support for the UK currency.

The ILO unemployment rate, however, was significantly worse than expected with an increase to 7.6% from 7.2% the previous month and this represented the biggest quarterly increase in unemployment on record with the level rising to a 12-year high. There will be some suspicions that the claimant count is being kept artificially low.

The headline UK consumer inflation rate fell to 1.8% in June from 2.2% previously which was in line with market expectations while the retail prices index fell 1.6% over the year. The decline to below the target level increased speculation that the Bank of England could move to expand the quantitative easing.

The IMF warned that the UK government may need to take more action to stabilise the financial sector which undermined confidence to some extent and the IMF also warned over the debt situation which tended to reinforce underlying market fears.

Swiss franc:

The Swiss franc has struggled to find a decisive direction, but has proved to be broadly resilient over the past few weeks. The National Bank will remain uneasy over the threat of deflation and there remains a strong probability of further intervention to weaken the franc if it makes strong gains. Sustained dollar weakness would increase the risk of National Bank action and the Swiss currency is likely to be blocked close to current levels.
 
The franc gain proved resilient during the week, strengthening to highs near 1.07 against the dollar while the franc moved back to near 1.5150 against the Euro. The franc still found it difficult to secure a decisive trend with shifts in risk appetite having a mixed influence on the currency.

The latest retail sales data was weaker than expected with a 1.4% decline in the year to June after a 1.2% increase the previous month. The Swiss ZEW business confidence index weakened to 0.0 for July from 9.7 the previous month, illustrating that confidence is still generally fragile

Producer prices were unchanged in June to give a 5.6% year-on-year decline and, although this was close to expectations, the annual drop in prices maintained National Bank unease over the threat of franc strength.

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The Australian dollar weakened early in the week, but was then able to secure a strong reversal as the week progressed before consolidating around 0.80 against the US currency.
 
The local currency was underpinned by a general improvement in risk appetite as equity markets rallied strongly while there was additional support from renewed gains in commodity prices.
 
The domestic releases did not have a significant impact with a dip in leading indicators. The latest data recorded that that the Australian reserve Bank had sold close to AUD2.0bn during May which may have capped the currency's upside.

Although Australian dollar sentiment will remain robust in the short-term, it will be difficult to sustain gains much above current levels.

Canadian dollar:

The Canadian dollar secured strong gains during the week, at one point strengthening to near 1.11 against the US currency. There was support from an improvement in global risk appetite while oil prices also recovered from recent losses.

Domestically, there was a very sharp drop in manufacturing sales, but this failed to have a substantial impact on sentiment or currency markets.

The Canadian currency will gain further support if there is a further improvement in risk appetite. The net risks suggest that gains will be limited from current levels.

Indian rupee:

The rupee dipped to two-month lows early in the week with a decline to 49.3 against the US currency, but it was able to regain some ground later in the week
 
Confidence was boosted by a recovery in the domestic stock market which increased optimism over capital inflows, while there was also a generally weaker tone for the US dollar which helped cushion the rupee.
 
The currency was still hampered to some extent by importer demand for dollars while there was still some unease over export trends and gains were generally unconvincing.
 
The rupee will continue to be influenced strongly by trends in international risk appetite as well as the domestic economic trends. The overall risk profile suggest that there will be little scope for near-term appreciation. 

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The Hong Kong dollar resisted selling pressure during the week, maintaining a position close to the 7.75 band limit against the US currency.
 
The Chinese data releases helped maintain confidence in the currency as capital inflows remained firm. There was also evidence of capital inflows associated with the latest IPO offerings.

The Hong Kong dollar is likely to maintain a firm tone in the short-term even if the currency does weaken marginally from current levels.   

Chinese yuan:

The central bank maintained tight control of the spot currency rate over the week with the yuan near 6.83. There was, however, a shift in the NDF market as futures suggested a faster rate of medium-term appreciation.
 
The domestic data was generally supportive with a stronger GDP release for the second quarter at 7.9% over the year while production also rose at a faster pace, although the inflation data was weaker than expected.
 
The increase in global reserves to over US$2.0trn in the latest month increased expectations that the government and central bank would push for alternative reserve currencies to the dollar to help diversify risk.

There will be further expectations of medium-term yuan appreciation, especially with evidence of a stronger economy. With officials still very cautious over recovery prospects, the central bank is likely to maintain the policy of near-term stability.