Weekly Forex Currency Review 17-10-2008

Overall strategy:

Conditions within the banking sectors will remain very important, although attention for the global economic prospects could well become the more dominant short-term market influence. Defensive strategies will tend to dominate in the short-term, although there is scope for a very tentative recovery in sentiment if credit stresses ease further.

Key events for the forthcoming week

Dollar:

Confidence in the US economy is liable to deteriorate further with fears that the sharp deterioration in survey evidence and credit tightening will trigger a serious recession. With inflation pressures easing, there will be pressure for the Federal Reserve to cut interest rates further. The interaction of economic trends and global financial markets will remain very important. The dollar will continue to gain some defensive support from global recession fears. It will, however, be increasingly difficult for the currency to hold firm if economic fears intensify, especially if credit-related fears start to subside and Libor rates decline. 

The dollar strengthened at the end of last week as global equity prices fell sharply on recession fears. Global banking stresses intensified with markets barely functioning as liquidity dropped. The US currency remained volatile during this week and gained strong support at times, but had a slightly weaker bias.

At weekend meetings, G7 officials pledged that they would take all measures to protect the banking sector and stabilise the financial sector as a whole. 

As part of these measures, the US Administration announced that it would take equity stakes of up to US$250bn in the top US banks to help stabilise the sector, although there appeared little enthusiasm for the plans within the Treasury.

The US economic data gave increased cause for concern. Retail sales fell by 1.2% in September with a core 0.6% decline which was the steepest decline for over three years as there were falls across most categories.

The New York manufacturing index fell sharply to -24.6 in October from -7.4 previously which was a record low for the index   The Philadelphia Fed index also weakened rapidly to -37.2 in October from +3.8 the previous month and this was the lowest reading sine 1990.  Industrial production fell a sharp 2.8% in September, although this was distorted by the impact of hurricanes and the Boeing strike.

There was some relief from the US jobless clams which edged lower to 461,000 in the latest week from 477,000 previously. The Fed's Beige Book recorded a further slowdown in the economy and a sustained tightening of credit conditions.

Fed Governor's Yellen and Bullard, who are non voting members of the FOMC this year, voiced caution over the need for lower interest rates. The attitude from Fed Chairman Bernanke were generally more downbeat with comments that the economy faced serious risks and Governor Kohn was even more negative in his remarks.

In this environment, markets continued to price in further interest rate cuts by the Federal Reserve. Credit markets remained an important focus and, although Libor rates remained at highly-elevated levels, there was a gradual narrowing of spreads.

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The Euro-zone economy will continue to weaken in the short-term  as business confidence deteriorates sharply. The ECB will be uneasy over high wage claims, but is set to cut interest rates further. There will be further banking-sector stresses given the bad debt position, but the Euro-zone as a whole should be slightly less vulnerable on economic grounds. Confidence will be very fragile given the downturn, but the Euro should be able to avoid heavy selling pressure.
       
The Euro struggled to make much headway with sharp weakness on the crosses at times. In general, the Euro came under pressure when global stock markets fell and looked to gain relief when markets rallied. Lower oil prices were a net Euro negative.

Following weekend G7 and European meetings, the German and French governments moved to increase depositor protection in the banking sector. The money markets also remained an important focus by amending the domestic money-market rules and providing unlimited dollar liquidity to counter recent shortages.

The German ZEW index fell sharply in October to -63.0 from -41.1 the previous month, reinforcing expectations of a sharp deterioration in conditions.

The statement from German union IG Metall that it would push for wage increase of around 8% caused some concerns within the ECB, but comments from officials suggested that they would move towards a further cut in interest rates.

Yen:  

There will be increased fears over the domestic economy as a sharp slowdown in the global economy will have a particularly serious impact on the export sector. The Japanese financial sector has also shown increased signs of vulnerability. The degrees of risk aversion will be watched very closely in the short-term  and the yen will continue to gain support from elevated fears. There should, however, be scope for some rally in financial markets, especially as falling commodity prices will increase the scope for monetary stimulus which will curb yen buying.    
The yen strengthened to highs beyond 99 against the dollar, but struggled to sustain the advance beyond the 100 level and edged lower late in the week. The Japanese currency retained a firm tone against the Euro with a high degree of volatility.

The yen moves were still dominated by degrees of risk aversion and the currency gained renewed strength as equity markets were subjected to downward pressure.

The Bank of Japan held an unscheduled monetary policy meeting during the week. The central bank left interest rates unchanged at 0.50%, but announced a suspension of share sales and also pledged that it would provide unlimited dollar liquidity.

The Japanese data was of secondary importance. There were, however, emerging stresses within the life-assurance sector which unsettled the yen to some extent.

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The economy will continue to deteriorate with credit stresses having a negative impact on demand while business confidence is liable to dip sharply. There will be some hopes that the banking sector can stabilise and Sterling should gain some important protection from the deteriorating US outlook. The key factor is likely to be the reaction to interest rate cuts and whether the impact of reduced yield is offset by hopes for an improvement in economic conditions. The UK currency should be able to avoid heavy selling in the short-term .

Sterling remained volatile over the week, but did find some degree of resilience with support towards the 1.70 level against the dollar while it also secured net gains relative to the Euro with tough resistance on moves towards the 0.7750 level.

The UK government brought forward its plans to invest in the banking sector with plans to take stakes of up to GBP37bn in two of the main banks in order to boost capital if the banks were unable to raise the new funding themselves.

Consumer inflation continued to rise in September with the annual rate increasing to 5.2% from 4.7% the previous month as energy costs continued to rise strongly. The core rate rose to 2.2% from 2.0%. The data impact was limited with expectations that there would be a sharp decline in inflation pressures over the next few months.

UK unemployment data recorded a further 31,800 increase in jobless claims in September after a revised 35,700 increase the previous month and there was the biggest quarterly increase for 17 years during the last recession.

MPC officials took a generally negative stance towards the economy, reinforcing market expectations that interest rates will be cut again in the near term.

Swiss franc:

The Swiss economy will weaken further in the short-term , especially with export markets under pressure. The banking sector will be an important focus and there will be some relief that the authorities are stabilising the sector. There will, however, be longer-term unease over the financial sector. Even if the banking sector has been tarnished slightly, the franc will continue to gain some support on safe-have grounds if risk aversion remains very high. 

The dollar hit tough resistance close to the 1.15 level against the franc, but retained a generally firm tone. The Swiss currency weakened slightly against the Euro, although it retained a generally robust tone with renewed gains late in the week.

The authorities provided support for the main Swiss banks as confidence surrounding the sector deteriorated. The government will take a stake in UBS and the bank's non-performing loans of up to CHF60bn would be transferred out of the bank into a new fund. The initial reaction was slightly positive for the franc on relief that stresses in the sector were being tackled with reduced fears over deposit outflows.

The ECB and Swiss National Bank announced that they would provide additional franc liquidity to ease funding pressures in the domestic money markets.

There was only limited domestic economic news, but there was a very sharp deterioration in the ZEW business expectations index to -91.1 from -44.4 previously.

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The Australian dollar was subjected to further intense volatility. The currency dipped to four-year lows below 0.65 against the US dollar before a corrective recovery.

There were no major domestic economic releases over the week with the currency-market trends dominated by global considerations and stock-market trends. There were still expectations that the Reserve Bank would continue to cut interest rates while the government announced fresh support for the banking sector.

The currency weakened sharply when there was substantial downward pressure on stock markets, especially when Asian markets fell sharply. The rapid decline in commodity prices was also damaging, especially as industrial metals prices came under sustained selling pressure on global growth fears.

The key feature is likely to remain a sustained increase in volatility with the net risks suggesting scope for a limited corrective Australian dollar recovery.

Canadian dollar:

The Canadian dollar was subjected to huge selling pressure last Friday with lows beyond the 1.21 level against the US dollar. The currency rallied strongly early in the week before hitting renewed selling pressure.

The Canadian currency was undermined by the erosion of risk appetite and the fall in commodity pries seen over the week. The latest data recorded a sharp decline in manufacturing sales which reinforced fears over a serious economic slowdown..

The government strengthened its position in the General Election, although the market reaction was limited with concerns over a sharp downturn in the housing sector.

The Canadian dollar will remain vulnerable on domestic and global growth fears, especially if commodity prices continue to weaken. Nevertheless, there is scope for at least a limited corrective recovery.

Indian rupee:

The rupee remained under pressure during the week as stresses in global markets remain very high. The rupee found some support close to the 49 level against the dollar with evidence of heavy intervention by the central banks.

The Reserve Bank also moved to cut reserve requirements twice over the week with a total reduction of 2.5% which eased tensions and the rupee edged back to 48.60.

The rupee was still drive primarily by moves in global stock markets with further fears over net capital outflows as regional markets remained under pressure.

The degrees of risk appetite and global growth fears will tend to remain dominant for now. Overall, the rupee will find it difficult to make more than a limited recovery.

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The Hong Kong dollar strengthened over the week as a while and challenged levels close to the 7.75 level. There was evidence of US dollar selling as institutions were forced to sell the currency to meet funding requirements

If the currency hits this level, then the HKMA will be forced to intervene to protect the currency band. The HKMA re-iterated that it would not change the currency peg which has now been in existence for 25 years.

The Hong Kong dollar could retain a firm tone in the near term, but is liable to drift weaker as liquidity pressures should ease slightly.

Chinese yuan:

The Chinese yuan  remained trapped in a relatively tight range over the week with lower trading volumes while the central bank also looked to maintain stability. The yuan consolidated around the 6.8330 level against the US currency.

The economic data was mixed as  sharp slowdown in money supply growth was countered by a stronger than expected September trade surplus which pushed to a record high. Overall dollar supply was still relatively high in the market which helped protect the yuan from any concerted selling pressure.

The Chinese authorities will continue to focus more on supporting growth which will limit scope for yuan gains. The bank's primary aim will be to avoid any disorderly currency moves and it will aim for relative stability in the near term.

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