Weekly Forex Currency Review 29-05-2009

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The dollar will remain vulnerable to underlying pressure on fears over the underlying debt situation. There are, however, very important vulnerabilities in all the major economic blocs which should offer some degree of dollar protection, especially with the balance of payments situation improving. In this environment, selling pressure on the US currency should be contained despite underlying vulnerabilities.       

Key events for the forthcoming week

Dollar:

Underlying confidence in the US fundamentals will remain fragile with continuing fears over the implications of a rising debt burden. Any further increase in bond yields would also risk undermining the signs of economic stabilisation. Such a trend would increase pressure for further Federal Reserve action which would increase medium-term inflation fears. The dollar is still in a position to gain support from a lack of alternatives, especially as an improved savings ratio will tend to lessen longer-term vulnerability.    

The dollar weakened to 7-month lows on reduced confidence in the US economy and an overall reduction in defensive support. The currency was able to find some support over the second half of the week, but rallies quickly attracted selling pressure. 

The US consumer confidence data was stronger than expected with a sharp rise to 54.9 in May from a revised 40.8 the previous month. This was the highest figure since October 2008 and the Richmond Fed data was also stronger than expected.

The headline US housing data was close to expectations with existing home sales rising to an annual rate of 4.68mn in April from a revised 4.55mn the previous month. Prices continued to decline over the year while there was a rise in inventories. Although there is evidence of interest in buying foreclosure-related properties, the rise in inventories dampened expectations of more than a limited recovery in the sector.

The sales data was overshadowed to some extent by a further reported rise in mortgage delinquencies for the first quarter of 2009 with 12% of mortgages either behind in payments or in a foreclosure proceedings. The further increase in delinquencies increased fears over the housing sector.

The US jobless claims was close to expectations with a decline in initial claims to 623,000 in the latest week from 636,000 previously while continuing claims continued to increase to a fresh record high. The stronger headline durable goods orders report was offset by a large downward revision.

The dollar was unsettled by speculation that the US Federal Reserve would move to increase the scope of asset-backed securities buying which increased fears over the bond-market outlook and triggered further fears over the underlying US fundamentals.

The latest Treasury auctions of bonds received strong demand and immediate fears over the US credit rating also eased which helped support the dollar to some extent on reduced fears over the immediate risk of reserve diversification.

The General Motors situation was watched closely amid strong expectations that the company would file for bank-ruptcy probably at the beginning of June. Optimism that that uncertainty would be removed was offset by fears that there would be renewed stresses in the manufacturing sector following any bank-ruptcy filing.

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The Euro-zone economy remains in a position to secure a fragile recovery. Overall confidence will still be fragile with fears that the improvement will not be sufficient to prevent a renewed increase in internal stresses. There will also be speculation that the ECB will take further policy action which will undermine sentiment. The Euro will gain support from improved risk appetite, although the Baltic situation will need to be watched closely given the possibility of severe stresses which would tend to undermine the Euro.

The Euro had a mixed performance with no clear trend. It ended little changed against the dollar while an advance against the yen was offset by 2009 lows against Sterling.

The German IFO index rose to 84.2 in May from 83.7 the previous month, but this was slightly below expectations and Euro-zone industrial orders fell again. The underlying tone created some caution over recovery expectations. There were also comments from an ECB official suggesting that interest rates could be cut again.

German unemployment rose by a less than expected 1,000 for May which boosted Euro sentiment slightly, although the impact was limited as the data may have been distorted. Elsewhere, the Euro-zone business and consumer confidence data was slightly weaker than expected which dampened the mood of optimism to some extent.

There were also renewed fears over the German banking sector which increased unease over the Euro-zone outlook. Internal bond-yield spreads also widened which was a negative factor for the currency with fears over the weaker regional economies.

Yen:  

The Japanese currency moves will continue to be influenced strongly by degrees of risk appetite and the yen will lose ground if there is a sustained improvement in confidence, especially given the amount of funds looking for higher returns. The industrial stabilisation will also provide some yen support. The capital outflows could still prove to be very volatile given the global stresses. There is likely to be Finance Ministry opposition to yen gains much beyond the 94 region.

The dollar found support close to the 94 region against the yen during the week and then advanced strongly with a high around 97.20. The Japanese currency weakened towards 2009 lows beyond 135 against the Euro.

The latest Japanese investment trust launches attracted strong retail interest and this increased speculation that there will be strong capital outflows from Japan in search of higher yields which would also tend to weaken the yen. There was still some caution, especially as any renewed increase in risk aversion would curb selling pressure.
 
The domestic data recorded a smaller annual decline in retail sales of 2.9% with a monthly improvement for the first time since August. There was a stronger than expected 5.2% increase in industrial production for April, but the labour-market data was weaker with unemployment rising to 5.0%. The Nikkei index also proved resilient which curbed defensive demand for the Japanese currency.

The Japanese trade data was slightly stronger than expected with a small seasonally-adjusted surplus for the third consecutive month. There was a 39.1% annual decline in exports which continued to suggest that the rate of deterioration was slowing following annual declines of over 50% early in 2009.

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The economy still appears to be stabilising, but there will be some important doubts whether the improvement will be sustainable given the underlying vulnerabilities. The UK debt situation will remain an important influence, especially as only a small shift in sentiment could trigger sharp downward pressure on the currency. Sterling will be in a much stronger position to resist selling pressure if there is a sustained improvement in risk appetite. Overall, it will be difficult to extend gains from current levels against major currencies.
   
Sterling again proved resilient over the week and strengthened to 7-month highs against the dollar with a challenge on resistance levels above the 1.60 level. The currency also advanced to 2009 highs beyond 0.87 against the Euro.

The UK currency continued to gain protection from the lack of attractive alternatives, especially given the renewed fears over the Euro-zone bond markets and US debt

The BBA mortgage approvals data recorded a small monthly improvement, but was below market expectations with a 15% annual decline. Mortgage lending also fell to GBP2.7bn in April from GBP3.4bn the previous month which suggested that there are still important structural vulnerabilities in the housing sector. Elsewhere in the housing sector, the Nationwide reported a 1.2% increase in prices for May.

The CBI retail sales index weakened to -17 in May from +3 previously and the expectations index for June was weaker. The April data had, however, been distorted by seasonal factors and the data indicated that conditions are slightly less severe.

Bank of England MPC member Besley stated that the government budget position would have to be tackled in the medium term, but he stated that there was some short-term room for manoeuvre.

Swiss franc:

The Swiss economy is likely to stage only a weak recovery which will limit independent demand for the currency. The franc could still gain support by default if fears over debt fears in other major economies increase further. The National Bank will remain on high alert over the franc situation and will certainly consider intervention to weaken the currency.  This factor should prove to be important in preventing significant Swiss franc gains.

The dollar weakened to test important technical support levels near 1.08 against the Swiss franc during the week as dollar sentiment was weaker. The Swiss currency was also generally resilient on the crosses with support beyond 1.52 against the Euro.

The franc gained some support from a lack of confidence in all the major economies, especially with fears over debt downgrades.

The Swiss trade surplus rose strongly to CHF2.6bn in April from CHF0.15bn the previous month. There was a recovery in exports while imports fell sharply. 

The IMF was very cautious over Swiss prospects with a warning that the economy faced a significant contraction in the short-term while the financial turmoil may necessitate further action by the National Bank.

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The Australian dollar retained a robust tone during the week with a further challenge on 2009 highs against the US currency. Although resistance levels above the 0.7850 region proved difficult to break down, the currency advanced further on Friday.

The currency gained support from a lack of confidence in the US dollar and improved risk appetite while there was further confidence in commodity prices.

The domestic economic data provided no significant support with a sharper than expected decline in first-quarter capital spending while credit demand was stable.

The Australian currency should be able to maintain a robust tone, especially if commodity price gain. A substantial amount of good news has now been priced in.

Canadian dollar:

The Canadian dollar maintained a strong tone against the US currency over the week with a peak near the 1.1020 level which was a fresh 2009 high. Domestic influences remained limited over the week with attention fixed on the international economy.

The currency gained support from a lack of confidence in the US dollar and improved risk appetite while the rise in oil prices also provided support to the currency.

The Canadian currency will continue to benefit from US dollar vulnerability, especially if confidence over the global economy improves, although it may be difficult to extend the gains much further in the near term.

Indian rupee:

The rupee found it difficult to extend gains during the week due in part to pressure for a correction following sharp gains the previous week. The currency was also hampered by increased importer dollar demand, especially with month-end pressures.

Underlying risk appetite was still firm with further optimism over net capital inflows which limited selling pressure and the rupee edged stronger to 47.50 on Friday.

The rupee will continue to gain support from underlying optimism over capital inflows and a subdued US dollar tone. Given the amount of recovery priced in, the rupee will find it difficult o make strong gains.

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The Hong Kong dollar edged slightly weaker to lows around 7.7530 against the US dollar with some further profit taking on short US currency positions

The underlying currency tone was still firm with solid risk appetite and capital inflows as the Hang Seng index robust. These flows were important in limiting Hong Kong dollar losses and it settled around 7.7520 on Friday.

Given the improvement in confidence surrounding the regional economy and net capital inflows, the Hong Kong dollar is unlikely to weaken sharply at this stage.   

Chinese yuan:

The yuan maintained a firm tone, although moves in the spot market were still limited, especially with market holidays during the week and it settled around 6.8290 against the US dollar. The State Council stated that the yuan would be kept stable which dampened speculation over sharp currency gains and curbed Chinese gains

There was uncertainty ahead of important political and economic events over the next week. The PMI data will be released which will give important evidence on underlying conditions. The visit of US Treasury Secretary Geithner will also be watched very closely for further evidence on underlying currency policies.

Speculation over an important Chinese role in reserve management policies was an important influence and provided underlying currency support.

The yuan will continue to be influenced strongly by degrees of optimism over the domestic and global economy. Given the weaker US dollar tone, the Chinese currency should maintain a firm underlying tone even if gains are strictly controlled.