Weekly Forex Currency Review 26-06-2009

The evidence of the past week suggests that markets still want to adopt a generally positive attitude towards the global economy and will look to buy high-yield currencies on any significant retreats. Overall market conditions are, however, liable to become more testing during the third quarter which would provide a stern test to underlying market confidence with some scope for limited defensive dollar support.      

Key events for the forthcoming week

Dollar:

Signs of stabilisation in the US economy will have a mixed impact as any potential dollar support on recovery hopes will be offset by reduced defensive demand. There are still very important risks to the US and global economy and the pendulum is liable to switch back to a more pessimistic tone during the next few weeks. There will be fears over debt issuance, although the impact could be offset by expectations of a higher domestic savings ratio. There will continue to be underlying fears over medium-term reserve diversification away from the US dollar which will certainly limit the scope for US currency gains.

The dollar weakened against the major European currencies over the first half of the week. Although it was able to resist substantial losses, the dollar struggled to sustain any momentum and dipped again on Friday. Markets still found it difficult to secure a decisive trend given underlying uncertainties with commodity-price trends important.

The US currency was again dogged by underlying speculation over medium-term central policies to diversify away from the dollar.

The US data was mixed over the week as a whole. The durable goods orders data was stronger than expected with a second successive 1.8% monthly increase. In contrast, there was a weaker than expected figure for new home sales with a slight decline to an annual rate of 342,000 in May from 344,000 previously.

Existing home sales rose to an annual rate of 4.77mn for May from 4.66mn previously which was also slightly below expectations. Prices were slightly higher over the month while inventories were lower which will provide some underlying support to optimism that the sector is bottoming out.

Jobless claims rose to 627,000 in the latest week from a revised 612,000 previously while continuing claims rose to near 6.74mn. The claims data has been showing signs of improvement and the latest release will cause some fresh anxiety over the labour-market situation, although there will inevitably be weekly volatility.

As expected, the Federal Reserve left benchmark interest rates on hold following the latest FOMC meeting and also stated that rates will stay low for an extended period. The statement was slightly more optimistic over economic trends with comments that policy actions should contribute to a gradual recovery while inventories were more in line with production. The Fed also removed the previous warning that inflation could be undesirably low. The amount of bond buying was left unchanged.

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The Euro will gain some support from expectations that the Euro-zone economy will start to recover. There are still important vulnerabilities which will limit the potential for Euro gains, especially if there are renewed fears over currency devaluations in the Baltic States.  There will also be further unease over the banking sector and the possibility that the ECB will need to take more aggressive policy action to help stabilise conditions. Overall, the Euro is likely to find it difficult to make much headway from current levels.

The Euro secured a generally firmer tone on the main crosses during the week, but still found it difficult to make strong headway given lingering unease over the fundamental outlook. The Euro was unable to sustain gains above 1.41 against the dollar with firm buying support on dips to the 1.38 area.

The Euro-zone PMI manufacturing indices were firmer with the flash index rising to 42.4 from 40.7 the previous month. The services sector index edged slightly lower for the month, contrary to expectations of a measured increase, which will be a cause for some concern with fears that improvements are being driven by inventory adjustment.

The German IFO index rose to 85.9 for June from 84.2 the previous month, maintaining the improvement seen over the past few months. Companies were, however, still pessimistic over current conditions and IFO officials did not describe the improvement as defining a turning point for the economy

The comments from ECB officials were generally supportive of the Euro with council member Weber stating that the bank had used up the space to cut interest rates. Weber did, however, also stated that it was essential to avoid premature tightening. The OECD also stated that there was scope for ECB to cut interest rates further.

The ECB allocated EUR442bn in its debut one-year refinancing operation. This was higher than expected which increased speculation that there wee still very important stresses within the Euro-zone banking sector. There will also be speculation that a significant amount of  funds were taken by banks outside the Euro area which could weaken the Euro.

Yen:  

The evidence suggests that there will be further capital outflows from Japan in search of higher yields. These flows will tend to increase when confidence in the global economy improves and yen moves will continue to be correlated strongly with degrees of international risk appetite.  Confidence is liable to falter over the next few weeks and this should be important in stemming aggressive yen selling pressure.  There will be official unease over yen strength with the potential for verbal intervention on any substantial appreciation. 

The dollar found solid support below 95 against the Japanese yen, although gains were very limited. The Japanese currency had a slightly weaker tone on the crosses with moves still generally measured.

The headline Japanese trade account remained in surplus for May, but the annual decline in exports was slightly higher than expected at 40.9% compared with 39.1% the previous month. There was still optimism that the industrial sector would continue to recover in the short-term  as inventory adjustments eased.

Core consumer prices fell 1.1% in the year to May while there was a decline of 1.3% for Tokyo prices in the year to June which maintained underlying deflation fears within the economy.

The latest capital account data was again important with net outflows from Japan of US$3.5bn in the latest reporting week as domestic investors looked to increase their exposure to higher-yield assets. It was the seventh successive week of outflows which undermined yen sentiment with further investment fund launches.

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There are still high risks associated with the UK budget and debt profile, especially with confidence unsettled by Bank of England warnings and friction between the bank and the government.  While the UK economy appears to be improving these fears will be contained while Sterling will be much more vulnerable if growth conditions appear to be deteriorating again.  Similarly,  there will be a much greater risk of selling pressure if international risk appetite falters. The overall risk profile is liable to be weaker during the third quarter.

Sterling was generally trapped within familiar ranges against the dollar during the week. It proved unable to break above 2009 highs above 1.66, but near-term technical support levels also held firm. Sterling weakened from 2009 highs against the Euro.

The UK CBI retail sales data recorded a figure of -17 for June, unchanged from the previous month, while retailers expected a further decline for July. The OECD forecasts were mixed as the 2009 GDP forecasts was revised to show an even sharper contraction while there was an upgrade for the 2010 figure.
Mortgage lending was still extremely subdued with the total declining to an 8-year low for May. The headline BBA mortgage approvals data was firmer than expected at a 13-month high which offered some prospects of recovery.

Comments from Bank of England officials again had a significant market impact. Chief economist Dale was generally cautious over prospects which pushed Sterling lower. Dale commented that a weaker currency was a key channel to spurring economic growth while the quantitative easing programme could be extended.

Bank Governor King and other MPC members were also very cautious over the economic outlook with King repeating comments that the recovery was liable to be protracted while there was a very high degree of uncertainty.

King again warned over the fiscal position and called for the government to tighten policy if there was any sign of economic recovery. The outlook, together with stresses between the bank and government, tended to undermine sentiment to some extent.

Swiss franc:

The National Bank has continued to show its determination to resist franc gains with a series of direct market interventions to weaken the currency. This strategy is liable to continue in the short-term  which will severely limit the scope for franc gains.  The franc will still gain some support when risk appetite deteriorates and it has still proved to be surprisingly resilient which suggests that there is still significant demand for the Swiss currency. 

The Swiss currency moves were dominated by National Bank policies during the week as the franc moved sharply. The dollar weakened to lows below 1.0650 against the Swiss franc before rallying strongly to near 1.10 on Wednesday. The franc also weakened sharply from highs near 1.50 against the Euro with lows beyond 1.5350.

There was strong evidence that the National Bank was intervening in the market through the BIS. As well as intervention on the Euro/Swiss cross, there was also evidence that the bank had intervened to buy the dollar directly. Following the intervention on Wednesday, there was further important franc selling by the National Bank during Thursday.

The trade account remained in surplus at just over CHF2.0bn, but there was an annual 20.1% annual decline in exports which dampened confidence in the economy.

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The Australian dollar struggled for direction over the week as a whole. As the US dollar rallied and commodity prices dipped sharply, the Australian currency weakened to lows below 0.78 against the US currency, but rallied to just above the 0.80 level.

Although global risk appetite stumbled at times, underlying sentiment was still relatively firm and the currency drew support from capital inflows from Japan while commodity prices also rallied later in the week. The domestic data releases did not have a significant impact with yield support having some positive impact..

Australian dollar sentiment should remain generally robust in the short-term . It will remain difficult for the currency to sustain gains much beyond current levels

Canadian dollar:

The Canadian dollar continue to weaken with lows beyond the 1.16 level against the US dollar before the currency found support. The Canadian currency was undermined by lower oil and commodity prices at times, although significantly, it struggled to regain much ground when commodity prices rallied.

There were no major domestic release over the week with trends in international risk appetite and commodity prices remaining very important.

Canadian dollar losses should be limited from current levels, at least in the short-term  even though it will be difficult for the Canadian currency to regain momentum. 

Indian rupee:

The rupee has again struggled to make any significant headway during the week and dipped to lows around 48.90 which was a six-week low for the currency before a recovery back to the 48.55 region as the dollar failed to hold gains.

Thee was month-end dollar demand for the US currency, although this tended to fade later in the week. There was a lack of confidence over market trends and uncertainty over the budget update which is due to be presented on July 6th was also a slight negative factor for the currency.

The rupee will continue to be influenced strongly by trends in international risk appetite. There looks to be little scope for strong rupee gains in the near term. 

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The Hong Kong dollar has maintained a strong tone and has not weakened significantly away from the 7.75 band limit. The HKMA injected further liquidity into the market to prevent he band limit being breached

There were further capital inflows on optimism over the regional economic outlook and optimism over forthcoming IPOs. There was a 14.5% annual decline in exports according to the latest data which did not have a substantial impact.

The Hong Kong dollar is likely to maintain a firm tone in the short-term , especially with the US currency still finding it difficult to secure strong support.   

Chinese yuan:

The yuan had a very slightly firmer tone over the week, but moves remained very limited as the central bank continued to limit moves. The yuan continued to gain some underlying support from evidence of renewed capital inflows.

Chinese officials remained generally cautious over the economic outlook while there was uncertainty ahead of the latest PMI releases due within the next few days.

The central bank will maintain its policy of yuan stability in the short-term  and will continue to resist more than limited spot moves. There will still be expectations of medium-term currency gains, especially given pressure for reserves diversification.