Weekly Forex Currency Review 20-02-2009

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Markets will continue to focus on global economic developments and countries which look to be in a position to recover first will gain support. The budget and monetary policies will also be very important and the currencies in economies where there is aggressive quantitative easing will struggle to hold their value in the medium term.  These contradictions illustrate that it will be difficult to secure a decisive market trend.

Key events for the forthcoming week

Dollar:

The manufacturing and employment-related data suggests that the severe US downturn will persist in the short-term.  The leading indicators have offered some suggestion of improvement over the second half of the year and there will be hopes that the huge fiscal stimulus will provide support. In this environment, the dollar will gain some support form expectations that the US recovery will be the first major economy to recover. The huge deficit financing will still be a major barrier to sustain dollar gains and advances are likely to be limited.    

The dollar strengthened over the week as whole as confidence in other currencies weakened and pushed to three-month-highs against continental European currencies.

The G7 meetings failed to announce any new significant policy measures over the weekend with more general comments on the need to tackle the severe downturn. Despite a promise to resist any moves towards protectionism, the lack of policy initiatives tended to undermine risk appetite early in the week

The US economic data continued to illustrate that the economy faces a further sharp contraction for the first quarter of 2009.  Housing starts fell by a further 16.8% in January with the annual rate at a record low of 0.47mn from 0.55mn the previous month while building permits declined to 0.52mn from 0.55mn.

The manufacturing survey data remained bleak with the New York PMI index weakening to a record low of -34.6 for February from -22.2. The Philadelphia Fed index also weakened sharply to -41.3 from -24.3 and this was the weakest reading since 1990. All the current components were depressed, although the improvement in the six-month outlook index will provide some slight optimism over second-half prospects. Leading indicators also strengthened for the second successive month.

The labour-market data also remained weak with initial claims at 627,000, unchanged from the revised level the previous week and at the highest level since 1980. Continuing claims also pushed to the highest level since at least 1970.

According to minutes from January’s FOMC meeting, confidence in the 2009 outlook deteriorated further with fears over the commercial-property sector and there was no indication that the housing sector was stabilising.  The FOMC also discussed the possibility of moving toward an inflation target

President Obama signed the US$798bn fiscal stimulus bill into law and there were hopes that fresh plans to ease mortgage difficulties would help improve conditions. The 2010 Fed growth projections were revised higher.

The US capital flows data was better than expected with net long-term inflows of US$34.8bn for December from a net outflow of US$25.bn in November. The data helped ease fears that the US would be unable to secure sufficient long-term flows.

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The Euro-zone economy will remain under pressure in the short-term with particular fears surrounding the industrial sectors. The situation within Eastern Europe will remain under close focus and fears over further baking-sector losses will be a negative factor for the Euro. The ECB is also set to cut interest rates further at the March council meeting. The Euro should still gain some support from expectations that the central bank will resist any policies which could increase the risk of currency debasement.
       
The Euro weakened to 3-month lows against the US currency over the week before finding some support while it held steady against the yen. The German ZEW economic confidence survey recovered further to -5.8 in February from -31 the previous month which briefly helped improve Euro sentiment, but the currency was unable to sustain the initial advance as confidence was weaker.

The currency continued to be unsettled by fears over the Eastern European economy and banking sector. Fears were fuelled by a warning from Standard & Poor’s that credit ratings were at risk. There were also warnings over a possible downgrading of Ukraine’s debt rating and some speculation over an Irish sovereign debt default. The internal Euro-zone stresses were illustrated by a further widening of yield spreads between Germany and the weaker Euro-zone members.

Later in the week, the Euro gained some relief on speculation that the German government would pledge support for Eastern European economies while there were report of new bonds to support the regional German state banks.

The Euro-zone PMI indices continued to deteriorate according to the flash data for February. The comments from ECB Chairman Trichet were in line with recent remarks and markets remain confident that the bank will lower interest rates at the March meeting with strong expectations of a 0.50% reduction.

Yen:  

There has been a clear deterioration in sentiment towards the Japanese economy, especially after the very weak GDP data and severe stresses in the industrial sector.  In this environment, there will be reduced confidence in the yen as a defensive safe haven.  There will also be further pressure on the Bank of Japan to resist any yen appreciation. The currency will still gain some support if there is a renewed surge in risk aversion, but yen gains are liable to be limited.         
  
The yen weakened steadily over the week as it tested 2009 lows near 94.50 against the dollar and also retreated to some extent against all major currencies.
The Japanese economy contracted by 3.3% in the fourth quarter of 2008 with a sharp decline in exports and this was the weakest quarterly performance since 1974. The Tankan manufacturing index remained close to historic lows of -74 for February from -76 the previous month, reinforcing severe industrial-sector difficulties. The Nikkei index also weakened to a three-month low as confidence remained fragile.

Following the latest meeting, the Bank of Japan pledged to expand the Commercial Paper buying programme and extend low-cost funding. There was no immediate move to re-introduce quantitative easing and interest rates were held at 0.10%. 

The domestic stresses were illustrated by moves in the debt default swaps with the cost of protecting against a Japanese default on government debt at a record high.
There were still some expectations of capital repatriation to Japan ahead of the fiscal year end which provided a degree of yen support.

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As the economy continues to weaken there will be pressure for further action to support demand. The Bank of England’s decision to seek approval for measures to directly boost the money supply will increase medium-term Sterling risks. Near-term moves will also remain correlated strongly with degrees of risk appetite and the UK currency will come under pressure if banking-sector confidence deteriorates further. There should still be some protection from Euro-zone difficulties with erratic trading set to continue in the short-term.

Sterling struggled to secure decisive direction over the week, but secured net gains against the Euro There was also support on dips towards the 1.40 region against the dollar. A renewed focus on the UK banking sector remained a negative factor for the currency early in the week as Lloyds Bank came under further pressure.

Headline UK consumer inflation fell to 3.0% in January from 3.1% previously while the core rate rose to 1.3% from 1.1%. The higher than expected data will demand Bank of England attention even though the RPI rate fell to 0.1%.

The Bank of England comments remained generally gloomy with MPC member Besley warning that the speed at which the economy is weakening is striking  The MPC minutes were in line with expectations with an 8-1 split for the 0.50% reduction to 1.0% with Blanchflower voting for a larger 1.0% cut. There was 9-0 vote to seek government approval for quantitative easing.

The currency was also undermined by renewed speculation that the AAA credit rating could be downgraded.  The industrial data provided no support with the CBI industrial survey weakening further to -56 in February from -48 and this was the lowest reading for 17 years as overseas demand deteriorated. Retail sales data was stronger than expected with a 0.7% January increase as price discounting boosted volumes.

The government registered a small net budget surplus for January, but this was the weakest January data since 1995 as spending commitments continued to rise while tax revenue also weakened significantly. The assumption of RBS and Lloyds Bank liabilities will increase the government debt burden by at least GBP1trn.
 
Swiss franc:

Confidence in the Swiss economy will remain weaker in the short-term. The developments in Eastern Europe will be watched closely. Although the franc will gain defensive safe-haven support when fears increase, there will also be increased unease over the Swiss banking sector. There will also be the threat of National Bank intervention to weaken the currency if there are strong gains and this threat will lessen the potential for franc appreciation.    

The Swiss currency weakened against the dollar over the week with lows near 1.1880. Initially, the franc advanced against the Euro before renewed selling pressure as confidence in the Swiss economy weakened.

The franc was undermined by speculation that a ruling against UBS would trigger a reform of Switzerland’s banking legislation which could trigger substantial capital outflows. A stronger January trade account reading provided relief as exports rallied.

The Eastern European developments remained in focus and the franc gained some support when fears increased. Underlying confidence in the Swiss banking sector was still fragile amid fears that financial-sector weakness would be medium-term negative influence on the Swiss currency. There was further speculation that the National Bank would intervene to weaken the franc.

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The Australian dollar recovered from lows around 0.6330 against the US currency during the week, but advances struggled to gain any momentum.

Currency moves continued to be influenced strongly be degrees of risk appetite with selling pressure when confidence in the global economy faltered. There was a temporary recovery as markets looked for a recovery in the Asian economy.

An official from the Reserve Bank stated that the recent Australian dollar decline was welcome and this undermined the currency to some extent with Bank Governor Stevens also cautious over prospects. The data releases did not have a major impact.

Trading conditions will tend to remain erratic, but there is scope for a limited Australian dollar advance on hopes that the Asian economy will recover later in 2009.

Canadian dollar:

The Canadian dollar came under pressure when confidence in the global economy deteriorated and oil prices came under pressure. There was support from an advance in gold prices with the currency resisting a decline through the 1.27 area.

The economic data recorded a further sharp decline in building permits and wholesale sales, reinforcing the domestic weakness, although the currency impact was measured

There is scope for limited Canadian dollar gains on hopes that the global economy will soon hit a trough, although gains are liable to be limited in the near term.
 
Indian rupee:

The rupee moves were again influenced strongly by conditions in the global economy and overall risk appetite. The currency struggled to sustain advances and weakened back towards the 50 region on Friday as Asian stock markets came under pressure.

There was evidence of exporter dollar selling as it approached the 50 level which provided rupee support. There was speculation that the central bank would cut interest rates again which had some positive impact on the local stock market and sentiment.

There is the potential for a limited improvement in risk appetite, but it will be difficult for the currency to secure a sustained advance unless growth indicators stabilise.   

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The Hong Kong dollar drifted marginally weaker, although ranges remained generally narrow and the currency consolidated around the 7.7540 region on Friday.

There was a concentration on global risk conditions and the currency gained some degree of support when sentiment improved, although conditions were erratic.

The Hong Kong dollar should be able to maintain a relatively steady tone with fluctuations again dominated by the degree of risk appetite in global markets. 

Chinese yuan:

The Chinese currency was confined to narrow ranges for much of the time and settled near 6.8350 against the dollar, although there was a period of erratic trading.

The yuan dipped after comments from a government official which suggested that it could weaken by around 7% due to economic weakness. Despite a more substantial NDF-market spike, the yuan rate returned to narrow ranges as reports were denied.

There were further doubts whether the central bank would cut interest rates further which provided some degree of yuan support. Political developments remained under close scrutiny with US Secretary of State Clinton due in China for a state visit.

The yuan will gain some support from hopes over a Chinese economic recovery, although confidence could reverse very quickly given serious stresses within the global economy. The G7 policy stance will remain an important focus.