Weekly Forex Currency Review 24-07-2009

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It remains the case that all the major currencies have important areas of vulnerability. In this environment, it will still be difficult for any currency to make strong headway despite market attempts to forge a clear trend. Risk appetite is liable to deteriorate to some extent over the next few weeks which should provide some degree of dollar protection even though the US currency is unlikely to make much headway.

Key events for the forthcoming week

Dollar:

Underlying confidence in the US monetary and fiscal policies will remain fragile in the short-term. There will also be further speculation over a medium-term diversification away from the US dollar. The economy could remain firmer in the near term, but conditions are liable to deteriorate later in the year as underlying credit stresses continue.  There is still the potential for increased defensive dollar support if global risk appetite also deteriorates. Weakness in other major economies and currencies could be pivotal in providing underlying dollar protection, but the currency will find it difficult to secure strong support.   

Currency markets generally have been trapped within relatively narrow ranges over the past few weeks. In this environment, institutional investors looked to target a breakout and secure a substantial move. The US currency was still found support at lower levels and recovered from an intra-week trough.

There was still a lack of underlying confidence in the Federal Reserve’s monetary policies while there are also very important concerns over the fiscal outlook which is dampening confidence in the dollar.

In his semi-annual testimony to Congress, Fed Chairman Bernanke stated that there were tentative signs of stabilisation in the economy and that the pace of decline appeared to have slowed significantly. Bernanke also re-iterated that the bank did have a credible exit strategy from the ultra-loose interest rate policy. The bank is clearly taken this aspect of policy very seriously, especially as there was a Wall Street Journal article on exit strategies ahead of the Fed testimony.

These comments illustrate that the Fed is very sensitive to the issue of maintaining confidence in the US assets, particularly the Treasury market and dollar.

Nevertheless, Bernanke also stated that the Fed would maintain a highly accommodative monetary policy for an extended period and there is still very little chance of a near-term tightening.

The latest US initial jobless claims data was close to expectations with an increase to 554,000 for the week after a revised 524,000 the previous week while the continuing claims data was better than expected.

The existing home sales data recorded a slightly larger than expected monthly increase to 4.89mn for June from a revised 4.72mn the previous month. Prices were higher over the month while inventories also declined for the month which provided some degree of reassurance over the housing-sector trends, although sales were still at historically very subdued levels.

The latest US house-price data also recorded a 0.9% monthly increase for May which cut the annual decline to 5.9% and provided some degree of support for risk appetite. There was fresh speculation that US lender CIT would file for insolvency despite securing a US$3.0bn credit line while the corporate earnings reports were mixed with an overall firm bias.

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There has been little in the way of fresh evidence on the Euro-zone economy with the most likely outcome a very fragile recovery. Credit conditions will be monitored closely amid fears that that credit supply will deteriorate further this quarter. If stresses do intensify, there will be additional pressure for more aggressive direct action from the ECB. The Euro could maintain a firm tone in the near term, but it will be difficult to sustain gains much above current levels. 

The Euro attempted to challenge resistance levels during the week, but again struggled to sustain gains due to persistent doubts over the structural vulnerabilities. Euro moves were again influenced strongly by trends in risk appetite with gains when international sentiment was stronger.

The Euro-zone economic data was weaker than expected with a further small monthly decline in industrial orders to give a 30% annual decline, although the data impact was limited. The headline current account deficit widened for the month while the adjusted deficit was lower than expected.

The PMI data recorded a further improvement for July while the German IFO index strengthened to 87.3 for the month from 85.9 the previous month.

Yen:  

The latest export data will provide some degree of optimism over the economy, but confidence will remain very fragile given the underlying stresses.  Trends in risk appetite will remain very important and the currency will tend to lose support if there is a sustained improvement in risk appetite.  Given the underlying global vulnerability and weaknesses in other major currencies, the yen should still prove to be broadly resilient in the short-term.  

The Japanese currency was unable to strengthen through the 93 level against the dollar and, although it proved resilient for much of the time, there was selling pressure late in the week. There were also rumours that a key fund was set to buy the dollar on any dips to the 93 level and the dollar challenged levels above 95.0.

In the latest Bank of Japan minutes, one member called for an exit strategy for the current monetary policies, although there is unlikely to be any near-term move to change policy. Bank member Yamaguchi was very cautious over the outlook for corporate funding in comments during the week which maintained pressure for supportive measures.

The latest Japanese trade data recorded a slightly smaller than expected surplus for June with the export data a principal focus. There was a 35.7% annual decline with a 1.1% monthly increase in shipments which provided some degree of relief over near-term trends as exports to Asia looked to increase.

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The UK currency will continue to gain support when global risk appetite improves. The most recent growth indicators have also remained generally favourable which will underpin near-term sentiment. There are still very important vulnerabilities surrounding the government debt position and market confidence in the economy is liable to deteriorate as the debt burden comes under fresh scrutiny. In this environment, underlying Sterling will continue to face important downside risks even if it retains a firm near-term tone. 

Sterling again proved to be broadly resilient over the week with buying support on dips and a test of resistance levels above 1.65 against the US dollar. The growth-orientated data provided support and helped overcome persistent debt fears while risk appetite was firmer.

The currency was undermined temporarily by reports that the banking sector would require further capital and by a gloomy assessment of medium-term prospects by the NIESR institute.

The latest government borrowing data provided some degree of initial relief with a figure of GBP13bn for June after a revised GBP18.6bn the previous month and compared with expectations of a GBP16bn shortfall. This was still sharply higher than the GBP7.5bn recorded the previous year and overall debt fears will remain an important issue as the budget deficit is heading towards 14% of GDP for this year.

The headline UK retail sales data was stronger than expected with a 1.2% increase for June after a revised 0.9% decline the previous month as sales were boosted by favourable weather conditions and discounting.

There was also an increase in BBA mortgage approvals according to the latest data with approvals at a 15-month high and this helped maintain the mood of greater confidence towards the UK housing sector which also underpinned risk appetite.

Bank of England MPC member Sentance stated that the bank may pause the quantitative easing process, although there was also still a high degree of uncertainty over the situation. Deputy Governor Bean stated that second-quarter GDP was also certainly negative. In the event, there was a further 0.8% contraction for the quarter compared with expectations of a 0.3% decline.

The Bank of England recording a 9-0 vote for unchanged interest rates and no changes to the GBP125bn quantitative easing programme with a review scheduled at the August meeting. The bank was slightly less pessimistic over near-term economic prospects which underpinned the currency to some extent.

Swiss franc:

The Swiss franc has continued to be broadly resilient and the currency could still gain some degree of support if risk appetite deteriorates. The National Bank policies will remain extremely important in the short-term and there is a very high probability that the bank will act to curb franc gains. These risks will increase if there is any further franc advance against the US currency.  Given the intervention threat, the currency will struggle to sustain any significant advance.
 
The dollar struggled to make any headway during the week, but did find support on dips towards the 1.06 region and pushed back above the 1.07 level on Thursday. The franc was slightly weaker against the Euro on the crosses.

The Swiss trade surplus edged lower to CHF1.60bn for June from CHF2.00bn while exports and imports continued to decline sharply over the year. The export decline increased expectations that the authorities would combat currency gains.

The Swiss currency weakened during Thursday with speculation that several key financial institutions were set to have their credit ratings downgraded. There was no clear evidence of renewed intervention by the National Bank despite speculation over the moves by the bank.

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The Australian dollar continued to attack resistance levels during the week and strengthened to a high just above the 0.82 level against the US currency before weakening sharply in late US trading on Thursday. The currency continued to gain support from an improvement in risk appetite and firm commodity prices.

The headline consumer inflation data was in line with market expectations for the second quarter and did not have a substantial impact.
 
There was speculation that the Reserve Bank was selling Australian dollars at elevated levels to help curb any further appreciation.

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 further strong gains during the week, at one point strengthening to near 1.0850 against the US currency. There was further support from an improvement in global risk appetite as international trends remained important.

Domestically, the Bank of Canada left interest rates on hold and was generally optimistic that the economy was set to pull-out of recession during the current quarter which also helped underpin confidence.

The Canadian currency will gain further support on optimism over the relative economic performance, although resistance levels will be difficult to break.

Indian rupee:

The rupee struggled to find a decisive direction over the week, but did have a firmer bias over the second half and edged stronger to the 48.40 region against the dollar.

The currency drew support from gains in the local stock market with the bourse pushing to six-week highs as global markets rallied. Net overseas buying of Indian stocks has amounted to US$1.4bn in July.

The rupee will gain support when risk appetite improves. Nevertheless, the overall risks suggest that the currency will find it difficult to make strong headway. 

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The Hong Kong dollar has continued to trade at the strongest limit of the permitted and during the week. The HKMA was forced to intervene frequently during the week to preserve the band.

The currency was supported by a general improvement in international risk appetite and confidence in the regional economy. There were also further inflows associated with IPO offerings. 

The Hong Kong dollar should maintain a firm tone in the short-term with the potential for further intervention by the HKMA to preserve the band limits.   

Chinese yuan:

The yuan has still been maintained in a tight trading band over the past week with the central bank controlling the market tightly with the dollar around 6.8320. Government officials remained generally cautious over the economic outlook and also warned over the risk of asset bubbles.

The IMF stated that the yuan was substantially under-valued at current levels, but was not overly critical of the economic policies. In comments during the week, Prime Minister Wen indicated that the policy of yuan stability would be maintained.
 
There will be further expectations of medium-term currency appreciation as reserves continue to accumulate. With further short-term caution over recovery prospects, the central bank is likely to maintain the policy of near-term yuan stability.