Weekly Forex Currency Review 23-05-2008

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The trends in oil and wider commodity prices will remain a very important market influence in the short-term. The increase in oil prices and dollar weakness have tended to be very highly correlated over the past few weeks. In this environment, G7 officials are likely to push for a firmer US currency to help cap oil prices and inflationary pressure.                       

Key events for the forthcoming week

Dollar:

There have been little in the way of US data releases over the past week. There is still some cautious optimism that a further near-term downturn can be avoided which will provide some dollar support. There are also continuing expectations that the Federal Reserve will reject any further short-term interest rate cuts, especially with increased inflation fears. In this environment, the dollar should still find some degree of support, especially as G7 officials and the Federal Reserve are likely to promote a firmer US currency. Confidence will, however, be very fragile and the dollar will be vulnerable to renewed downward pressure if there is evidence of further economic deterioration.    
 
The dollar was unable to strengthen through the 1.55 region against the Euro and dipped to lows beyond 1.58 over the week before consolidating. The US currency also retreated to a one-month low on a trade-weighted basis.

There were limited US data releases over the week to guide markets with other asset-market prices very important for US currency direction. Jobless claims fell slightly to 365,000 in the latest week from 374,000 the previous week which did not suggest that there had been a further deterioration in the labour market.

Producer prices rose a modest 0.2% in April. There was a sharper than expected increase in core prices of 0.4% with the annual increase at a 16-year high.

Dollar moves were again linked strongly to trends in oil prices and the US currency came under pressure as crude surged to new record highs around US$135 per barrel. Gold prices also generally rallied which added to selling pressure on the currency.

In the minutes from the late-April FOMC meeting, the Fed effectively confirmed that the it would look to keep interest rates on hold in the short-term. Some members also suggested that rates would not be reduced further even if the economy contracted.

Members were still generally downbeat over growth prospects and the Fed also again downgraded its 2008 GDP growth forecasts while inflation forecasts were increased.

The suggestion that interest rates would be left on hold was also maintained in Federal Reserve comments over the week with Governors Kroszner and Warsh effectively suggesting that a pause was appropriate.

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The generally solid data from Germany will provide some direct support to the Euro. The data will also encourage the ECB to maintain a tough stance on inflation and monetary policy in the short-term. There are still major economic risks surrounding the Euro-zone as a while and this will discourage aggressive Euro buying from current levels, especially after the PMI data. There will also be an increasing risk of internal divisions within the ECB and member governments which would damage sentiment towards the currency. 
       
The Euro secured net gains over the week, although the trading patterns were still erratic with sharp intra-day fluctuations.

There was mixed data over the week as a whole with a focus on the two major German sentiment surveys. The ZEW survey weakened slightly to -41.4 for May from -40.7 previously. In contrast, the more influential IFO survey strengthened to 103.5 from 102.4 the previous month.

Comments from the institutes were also mixed as the ZEW head Franz stated that he expected the ECB to increase interest rates in the near future. In contrast, IFO head Nerb stated that there would be scope for the ECB to lower interest rates later in 2008.

The data from other Euro-zone members was generally weaker with downbeat comments from Spanish officials and a further dip in French business confidence. There was also a 2.5% annual decline in industrial orders for the region.

The Euro-zone PMI index for the manufacturing sector weakened to 50.5 in May from 50.7 while the services-sector index dipped sharply to 50.6 from 52.0 which suggests that the economy has stalled.

Inflation concerns persisted following a strong 6.5% annual increase for producer prices and the ECB retained a tough stance on inflation in comments over the week.

Yen:  

The domestic economic trends are likely to remain generally weak in the short-term. There will also be fears over a further slowdown in export growth and this will be watched closely as there will be an increasing risk of opposition to strong yen gains by the Japanese authorities. Yen moves are still likely to be dominated to a large extent by trends in global risk and developments in carry trades. The currency will tend to gain support if there is a sustained downturn in global stock market prices, but overall credit-related risk should remain at a lower level which will provide support with further retail yen selling. 
                    
The dollar was again unable to make any headway above the 105.0 level against the yen during the week and weakened to test levels below 103.0 before a rebound. The Japanese currency suffered net losses against the European currencies over the week.

The Bank of Japan left interest rates on hold for the 18th successive month following the latest council meeting. The central bank was generally gloomy over economic prospects in its latest survey while the government left its assessment unchanged. The all-industries index rose 0.5% in March, but there was still an annual decline.

The trade surplus dipped by over 40% in the year to April. Imports were pushed higher by the impact of oil prices while exports were undermined by the weak US economy and a slowdown in regional growth.

The yen moves were still dominated by degrees of risk aversion during the week and, despite stock-market vulnerability, there was some increase in retail yen selling as Japanese investors looked for additional yield overseas.

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Housing difficulties will continue and the increase in energy prices will also increase pressure on consumer spending. Confidence in the economy will, therefore, remain weak in the short-term with increased speculation over a slide into recession. The Bank of England will look to retain a tough policy to combat inflation which will maintain short-term yield support. The UK currency will also gain some support on valuation grounds with the potential for investment inflows. It will still be difficult to make much headway given the growth fears.
 
Sterling found support close to 1.94 against the US dollar during the week and advanced to highs near 1.9850 before a correction. The UK currency weakened to a 1-month low beyond 0.80 against the Euro before recovering in choppy trading.

The Bank of England minutes from May's MPC meeting recorded an 8-1 vote for unchanged rates. Blanchflower voted for a 0.25% rate cut to 4.75% while the majority wanted to concentrate on inflation risks.

The latest retail sales report recorded a 0.2% decline in volumes for April after a revised 0.2% decline the previous month. There was, however, some relief over the data as markets had been expecting a steeper monthly decline.

The latest CBI industrial survey recorded a slight improvement in the orders balance to -10 in April from -13 previously, although this was still a historically weak level. The latest investment data was also depressed which undermined confidence.

Swiss franc:

The Swiss currency will gain support if there is a sustained decline in global stock markets and reduced risk appetite. Overall credit fears should still remain at a reduced level which will lessen the risk of heavy Swiss franc buying. There will also be further unease over the Swiss economy with the potential for a sharp slowdown, especially if the export sector starts to slow sharply. Volatile trading may persist, but substantial franc gains look unlikely from current levels. 
 
The dollar was unable to make a fresh challenge on levels above 1.06 against the franc and dipped sharply to lows below 1.0250. The franc also found support weaker than 1.63 against the Euro.

Producer prices rose by 0.6% in April to give a 3.6% annual increase which reinforced the National Bank's unease over underlying inflation trends.

The Swiss currency gained some support as equity markets were generally lower over the week, although it failed to hold its best levels.

In comments on Thursday, National Bank member Hildebrand stated that the franc level was not a threat to exports and that the room for manoeuvre on interest rates had narrowed which provided some currency support.

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The Australian dollar pushed to a 25-year peak against the US currency during the week with a high around the 0.9650 level before a partial retreat.

The Australian currency was again supported by commodity-price moves as gold moved sharply higher over the first half of the week There was some corrective move in commodities later which helped trigger a correction in the Australian dollar, although underlying sentiment remained strong.

The domestic influences were also generally positive as the Reserve Bank minutes warned that the bank had considered an increase in interest rates to stem inflationary pressure. There was also a recorded increase in consumer confidence.

The Australian dollar will look to secure support from yield support and capital inflows will remain firm if commodity prices remain strong. There will, however, be an increasing threat of a sharp correction.

Canadian dollar:

The Canadian dollar pushed to a three-month high near 0.98 against the US unit as it gained traction beyond parity. Currency moves were still dictated to a large extent by oil prices as the Canadian dollar drew support from a surge in prices.

There was a higher than expected increase in consumer prices for April while there was also an underlying increase of 0.3% for the month which pushed the annual core rate to 1.5% from 1.3%. Although the rate was still subdued, there was speculation that the Bank of Canada would be more cautious over cutting interest rates again.

Retail sales increased by only a marginal 0.1% in March while core sales were unchanged over the month.

The Canadian currency will continue to gain support from the strength in commodities, especially if near-term fears over the impact of weak US demand fade. The Canadian dollar will still find it difficult to make much further headway.

Indian rupee:

The rupee has remained generally under pressure during the past week and dipped to lows beyond 43.20 against the dollar which was a fresh 13-month low for the rupee.

Oil prices were again an important influence on the currency as prices hit fresh record highs. There was a direct impact on the rupee as importers needed to buy dollars.

Overall sentiment towards the Indian economy was also weaker with fears over a sharp slowdown in growth and a wider trade deficit. In this environment, capital flows were generally weaker which unsettled the rupee. There was evidence of central bank dollar selling which pulled the rupee back from lows to around 42.90 on Friday.

Rupee sentiment has continued to deteriorate and underlying capital inflows are liable to be weaker. Nevertheless, there should be scope for some corrective recovery unless there is a fresh surge in oil prices.  

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The Hong Kong dollar has generally traded just weaker than the central rate of 7.80 during the past week with consolidation around the 7.8010 level on Friday.

The Hang Seng index dipped to a one-month low during the week which was a negative influence on the Hong Kong currency.

Short-term inter-bank rates were generally low, but the impact was limited by the fact that the consumer price inflation index rose to 5.4% in April which fuelled unease over underlying inflation trends.
 
The Hong Kong currency should continue to find near-term support just weaker than  the 7.80 level against the US currency, especially with inflation concerns likely to continue which will put some upward pressure on longer-term yields. 

Chinese yuan:

The yuan regained upward momentum during the week and pushed to high beyond 6.95 against the US dollar with a string of fresh post-revaluation highs. The yuan was underpinned by a generally weaker US currency trend over the week.

There was evidence that the central bank was happy to keep a high degree of uncertainty in the market as it is looking to discourage speculative inflows. In this context, sharp daily currency moves will tend to discourage aggressive yuan plays.

The central bank will aim to discourage speculative inflows and, in this context, may be happy to see erratic moves to stem capital inflows. The overall trend for capital flows should secure underlying gains for the Chinese currency.  

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

Launched in 2006, dbFX is available in multiple languages and accessible in over 70 countries around the world. Deutsche Bank was  ranked the No.1 Foreign Exchange Bank in 2007 by Euromoney magazine  for the third year running. The platform can be accessed here