Weekly Forex Currency Review 23-01-2009

The global economy and financial-sector trends will remain key influences. As stresses increase, developments in currency policies will also become an even more important issue. Countries are likely to be increasingly reluctant to tolerate strong currencies with political pressure for depreciation. Official policy statements on exchange rates will, therefore tend to have an increasingly important influence on currency trends and valuations. 

Key events for the forthcoming week

Dollar:

The US economic data is liable to remain very weak in the short-term with further downward pressure on consumer spending and industrial production. The Obama fiscal stimulus proposals will be watched closely with some optimism that the package will help stabilise conditions. The underlying debt burden will remain a serious barrier to a sustained improvement in growth and there will also be very serious fears over the budget implications. The dollar will gain some support on defensive grounds as risk appetite remains low on financial fears, but underlying fundamental weakness will make it very difficult to sustain gains. 

The dollar retained a generally firm tone over the week and pushed to one-month highs beyond 1.28 against the Euro as European currencies weakened. The dollar continued to gain some defensive support as financial fears intensified.

The US economic data maintained a very weak tone. Jobless claims increased to 589,000 in the latest week from 527,000 previously which pushed claims back towards the 26-year highs seen during December.

Housing starts weakened further to a fresh 50-year low with an annualised rate of 0.55mn while permits were also at this depressed level. The industrial data remained bleak with a 2.0% decline in output for December after a revised 1.3% decline the previous month while capacity use also fell sharply to 73.6% from 75.2%.

The capital account data was significant as there were net long-term capital outflows of US$21.7bn in November following an outflow of US$0.4bn the previous month. Although overall inflows were positive, the weakness in long-term flows maintained underlying unease over the US structural financing position.

In congressional testimony, Treasury Secretary nominee Geithner stated that a strong dollar is in the national interest. He also stated that President Obama believes that China is a currency manipulator and called for a realignment of currencies which increased fears that exchange rates would become more politicised.

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The Euro-zone economy will continue to weaken in the short-term as industrial production continues to decline. The ECB will remain determined to avoid ultra-low interest rates and will also be determined to avoid currency debasement. There will, however, be pressure for further interest rate cuts. The structural vulnerabilities will remain an important focus, especially if there are further credit-rating downgrades.  These debt and ratings fears will be an important negative factor for the currency and will tend to stifle gains.       
       
The Euro had a mixed tone over the week as it weakened further against the dollar and yen while gaining ground against most European currencies in choppy trading.

The Euro was again undermined by debt considerations with Standard& Poor’s downgrading Spain and Portugal’s credit ratings. The losing of its AAA status tended to widen yield spreads over German bunds which reinforced fears over the weaker Euro-zone economies and undermined capital inflows. There were fears that ratings for Italy and Ireland would also be downgraded.

The German ZEW index was stronger than expected with a further recovery to -31.0 in December from -45.2 previously. The prospect of further fiscal support measures had some positive impact on sentiment and the PMI data was slightly better than expected, but the Euro failed to gain any traction.

ECB officials stated that a 2.0% interest rate was not necessarily the lower limit, while they remained uneasy over the growth outlook.

Yen:  

The economy will continue to weaken in the short-term with increasing unease within the Bank of Japan and Finance Ministry as exports decline sharply. The central bank is unlikely to adjust interest rates, but there will is scope for additional policy measures. There will also be increasing pressure for the Finance Ministry to curb any renewed yen appreciation. The near-term yen moves are still likely to be dominated by trends in risk appetite and the global banking-sector fears will provide near-term support.
         
The yen secured a firmer tone over the week as it continued to gain defensive support. Technical moves were also important and there was a rapid decline in the US currency to lows near the 87 level following an option expiry on Wednesday. The Japanese currency also tested October 2008 highs beyond 113 against the Euro.

The Finance Ministry warned against rapid currency moves, edging closer towards intervention with markets looking at the key 85 dollar support region. The Bank of Japan left interest rates on hold at 0.10% following the latest policy meeting. The bank confirmed that it would buy corporate bonds in the market and also warned again over the economic outlook

The economic difficulties were illustrated by the latest trade data with Japan again running a monthly deficit as there was a severe 35% annual decline in exports. Consumer confidence also dipped to a record low while officials stated that the economy was weakening rapidly.

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Fears over the economy will continue in the short-term with GDP set to contract sharply. The Bank of England will need to maintain very low interest rates while the potential for quantitative easing will also be very unsettling. The banking sector will also be an important focus and fears that the latest measures will not be sufficient to stabilise the sector will undermine confidence. There will also be fears over rising public debt and the risk of a credit-rating downgrade. Sterling should still gain some protection from the very weak fundamentals elsewhere.

Sterling came under heavy selling pressure for much of the week as confidence evaporated.  The UK currency weakened to a 23-year low below 1.36 against the dollar while it also weakened against the Euro as rallies were sold into.

The banking sector remained a very important focus as the government announcing fresh support measures. As well as an increased equity stakes, there were plans to set up an insurance scheme for loans. There was also a new GBP50bn programme for the Bank of England to buy securities, effectively a move towards quantitative easing.

There were rumours of a sovereign credit rating downgrade which also undermined confidence, especially as a downgrade would have serious negative medium-term implications for the economy and currency. Jobless claims rose by a further 77,900 in December after a revised 83,100 increase previously. The latest government budget data was also weaker than expected with a net borrowing requirement of GBP14.9bn. The CBI industrial survey remained depressed with the orders component weakening further to -48 in January from -35 and overall conditions were at the worst level for 26 years.

GDP recorded a 1.5% decline for the fourth quarter, officially confirming a recession, and this was the weakest figure for at least 28 years. Retail sales rose 1.6% in December as price cutting boosted volumes.
The headline UK consumer inflation rate fell to 3.1% in December from 4.1% the previous month which was higher than expected. Core inflation fell more sharply to 1.1% from 2.0% the previous month.

According to the latest minutes, the Bank of England voted 8-1 for a 0.50% rate cut to 1.50% in January. Blanchflower wanted a 1.00% cut, but the majority of members were wary of cutting rates at all which triggered some doubts whether the bank would cut aggressively again in February.

There were reports that Sterling weakness would be discussed at the February G7 meting and this triggered a sharp short-covering rally as high volatility continued.

Swiss franc:

There will be further fears over the Swiss economy in the short-term, especially with the export sector under serious pressure. The National Bank will also maintain a very low interest rate policy in the short-term and there is likely to be opposition to currency gains. The degrees of financial-sector stresses will remain very important in the short-term. The franc will gain some defensive support from elevated levels of risk aversion, but there will also be fears over the Swiss banking sector which will limit franc support. 

The Swiss currency edged weak against the dollar over the week with lows beyond 1.16. The franc also weakened to test support levels near 1.51 against the Euro, although it gained some fresh support on Friday as risk tolerances declined.

National Bank member Hildebrand stated that the bank could sell an unlimited amount of francs to stop appreciation of the currency. He also stated that the bank must not increase money supply indefinitely, but the comments reinforced market speculation over a more aggressive policy to stem franc appreciation.

Headline Swiss retail sales fell 1.4% in the year to November, but there was a small increase when adjusted for the number of shopping days. The ZEW business confidence index staged a small recovery for December while still historically wea

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The Australian dollar had a generally weaker tone over the week and tested levels below 0.65 against the US dollar while a cautious recovery hit fresh selling pressure.

The domestic indicators failed to have a major impact with Australian dollar moves dominated by risk appetite trends. Fears over the banking sector triggered a new spike in risk aversion and this unsettled the Australian dollar, especially after the government warned over a funding gap.

The impact of financial stresses was magnified by fresh downward pressure on commodity prices as growth fears intensified.

There is scope for a fragile recovery in the Australian dollar, but strong gains are unlikely without significantly improved confidence surrounding the global economy.

Canadian dollar:

The Canadian dollar had a generally weaker tone over the week, testing levels beyond 1.27 against the US currency. The currency was unsettled by a renewed spike in risk aversion and downward pressure on commodity prices as global growth fears intensified. A firm tone in gold prices provided some degree of support.

The Bank of Canada cut interest rates by a further 0.50% to 1.00% at the latest council meeting. The bank warned over growth prospects and the statement was generally weaker than expected even though it described the risk of deflation as remote. The bank also expected that the recession would be short-lived.

The economic data failed to offer support for the currency with a sharp 2.4% decline in retail sales for November while manufacturing sales also fell sharply.

Volatility levels are liable to remain high in the short-term as the currency is buffeted by global trends. There is scope for a limited Canadian dollar recovery.
 
Indian rupee:

The rupee was confined to narrower ranges despite the high degree of uncertainty. There was caution ahead of a scheduled central bank policy review next week.

Market sentiment was still driven by trends in risk appetite and the degree of fear on global stock markets as international risk appetite trends dominated. The rupee consolidated near 49 against the dollar before weakening on Friday as regional stock markets came under further pressure.

Overall, there is little scope for significant Indian rupee gains until there is a stabilisation in sentiment towards the global financial sector and economy.

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The Hong Kong dollar continued to find support weaker than the 7.76 level against the US dollar and consolidated just stronger than this level. Trading activity was severely curtailed by the forthcoming New Year holiday.

The inflation data was weaker than expected with the annual rate declining to 2.1%.
Markets remained uneasy over the risk of capital outflows associated with selling pressure in the stock market and this curbed support for the local currency.

The Hong Kong dollar could drift slightly weaker on persistent fears over capital outflows, although substantial losses from current levels should be avoided. 

Chinese yuan:

The Chinese yuan was again confined to very narrow ranges over the week as the central bank resisted significant moves by maintaining tight control over the market.

Growth fears persisted with China’s GDP slowing to 6.8% in the fourth quarter of 2008 which was a seven-year low. There was some relief given fears over an even steeper downturn, but there were also doubts over the data’s accuracy and unease over the risk of a further deterioration.

Exchange rate policies were an increasingly important element with Treasury Secretary nominee Geithner stating that the Obama administration considered that China was manipulating its currency.

Political and economic risk factors will continue to increase in the short-term. The overall evidence suggests that the central bank will still look to maintain a very tight control of the market in the short-term even if underlying capital flows are less stable.

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