Weekly Forex Currency Review 31-07-2009

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Risk appetite has proved to be broadly resilient over the past month on evidence of an improvement in financial and credit conditions. There are still very important risks surrounding the global economy and confidence is likely to face a stern test over the next 2 months as fears over the banking sector return, especially given the sharp rise in unemployment and serious consumer debt levels.

Key events for the forthcoming week

Dollar:

The latest US data suggests a tentative improvement in the housing sector while the industrial sector has also stabilised. There are still very important vulnerabilities in the economy, especially as the labour-market is still very weak. Over recent weeks, the dollar has consistently lost support on firm economic data as risk appetite improved, but this pattern could start to break down. Although there will be further unease over the risk of medium-term reserve diversification, the net trade position has improved sharply and major players have a strong incentive to keep the US currency stable.  In this environment, there should still be some important dollar protection. 

The dollar survived a test of 2009 lows over the first half of the week and was able to regain some ground as stock markets turned more cautious. The US currency was unable to generate strong momentum and drifted lower late in the week as markets still looked to take an optimistic stance towards the global economy..

US consumer confidence weakened slightly to 46.6 in July from 49.3 the previous month. This was the second successive decline with the sub-index for job availability falling to the lowest level since 1983. The data impact was measured, but tended to increase unease over the economic outlook.

Elsewhere, the Richmond Fed composite index rose to 14 in July from 6 the previous month while the housing data was also positive with prices edging firmer in June according to the latest Case-Shiller index reading which helped stabilise confidence.

The US new home sales was stronger than expected with an increase in annualised sales to 384,000 for June from a revised 346,000 the previous month. There was also a significant decline in inventories over the month which pushed the number of unsold homes down to the lowest level for over 10 years. The sharp decline in inventories boosted optimism that construction will recover over the next few months.

Initial US jobless claims increased to 584,000 in the latest week from a revised 559,000 the previous week as the distortions caused by the auto sector persisted. The continuing claims data was lower than expected which provided some relief.

Regional Fed President Yellen was optimistic that there were the first signs of a recovery from recession, but she was also very cautious over the commercial real-estate market and uncertainty will be a key feature.

The Fed’s Beige Bok reported that the downturn was easing in most districts. There were, however, still very important areas of weakness with labour markets being reported as being very soft while there was also a deterioration in the commercial property sector. Bank lending also declined in most categories which maintained speculation that any recovery in the economy will stall very quickly.

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The Euro-zone economic data has continued to suggest a slow improvement in conditions while the Euro will also gain support when risk appetite improves. There are still important underlying structural vulnerabilities and there is still an important risk that these structural weaknesses will return to the surface over the next few weeks, especially if credit stresses intensify.  In this environment, the Euro still faces substantial barriers to gains much beyond current levels. 

The Euro attempted to make 2009 highs against the dollar during the week, but was unable to sustain the advance and weakened back to the 1.40 region before finding support. The Euro also lost ground against Sterling over the week.

The Euro secured an initial boost from a stronger than expected increase in German consumer confidence to the highest level for over 12 months. There was a seasonally-adjusted decline in German unemployment for July, although the data was distorted by a change in the calculation method and the underlying figures reported an increase.

There was a further recovery in industrial and consumer confidence. The prices data was weaker than expected with a provisional 0.1% drop in German consumer prices for July to give an annual 0.6% decline. The IFO institute also reported that lending was more restrictive during July which maintained fears over a credit crunch.

The currency was undermined by a spike in risk aversion as the Shanghai equity markets declined sharply by over 5%. Commodity prices also dipped sharply at one point which was a negative influence. The IMF stated in comments on Thursday that the Euro was overvalued by around 15% and this put some near-term downward pressure on the currency, although the impact was transitory.
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Yen:  

There will be capital outflows from Japan in search of higher yields. It is also the case that outflows and potential selling pressure on the yen will be more acute when risk appetite is strong.  In contrast, the yen will gain support when fears over the global economy increase.  Given the underlying global vulnerability and weaknesses in other major currencies, the yen should still prove to be broadly resilient in the short-term  with caution over aggressive selling.  

The yen strengthened to the 94 level against the dollar, but failed to break this level with further reports of institutional dollar support at lower levels and the yen retreated back to beyond the 95.50 level in cautious markets.

The retail sales data was weaker than expected with a 3.0% decline in the year to June which maintained unease over the spending outlook. The industrial data provided some degree of relief with a move above the 50.0 level for the first time in 18 months.

Corporate services prices fell 3.2% in the year to June which was in line with market expectations. Core consumer prices fell 1.7% in the year to June which maintained underlying deflation fears while unemployment rose to 5.4% from 5.2%.

The Ministry of Finance still upgraded its assessment of the economy in the latest report as the global industrial downturn eased. Bank of Japan member Noda remained cautious over the corporate financing outlook which will maintain expectations that the bank will retain a highly-expansionary monetary policy. 
There was some evidence of month-end repatriation in to the Japanese currency and there was also speculation that there was a repatriation of funds as European bonds matured which provided some yen support.

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The continuing evidence of a fragile improvement in the housing sector will provide some degree of Sterling support. The UK currency will also secure important protection when international risk appetite is stronger. There will continue to be important fears surrounding the government debt burden and, in this context, any evidence of renewed deterioration in the economy would have a potentially very negative impact on Sterling.  There are, therefore, still important medium-term risks even if the currency holds firm in the near term.  

Sterling proved broadly resilient over the week as international risk appetite remained solid which provided important support. The domestic fears were kept at bay as the housing data was firmer and the UK currency strengthened to above 1.65 against the dollar while it also appreciated to near 0.85 against the Euro.

The Bank of England reported that credit conditions had improved during the second quarter, but doubts over bank lending persisted. The mortgage approvals data recorded a small increase for June which pushed the total to a 15-month high. The bank lending data was very weak with the increase in lending held to GBP0.4bn for June which was the lowest since the series was introduced in 1993.

The latest CBI retail sales survey recorded a figure of -15 compared with -17 the previous month. Although markets had expected a slightly larger improvement, the data suggests that consumer spending is still holding relatively firm.  Overall consumer confidence was fragile given the massive debt burden. There was a monthly increase of 1.3% in house prices according to the latest Nationwide survey with prices now having risen for three months in succession which cut the annual decline to 6.2%.

Swiss franc:

The National Bank policy actions will continue to be watched very closely in the short-term  an will have a pivotal impact on the Swiss currency. The bank is likely to maintain an aggressive policy of intervening if necessary and this will remain a major obstacle to any significant franc appreciation. Overall, the dollar should be able to secure a net firmer tone against the franc.
 
The dollar weakened to lows near 1.0650 against the franc before finding firm support and rebounding to the 1.09 region. The franc drifted weaker against the Euro with lows just beyond the 1.53 level.

There was another warning over franc strength from National Bank member Jordan with comments that the bank would continue to intervention to push the currency weaker.  The threat of bank sales remained an important negative factor for the franc.

The UBS consumption index improved for June which will provide some degree of support to confidence over the economy, although the impact was limited.

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The Australian dollar pushed to highs above the 0.83 level against the US currency during the week with a jump higher following the Reserve Bank comments.

The currency dipped when risk appetite faded, but there was firm buying support on retreats. As far as the data was concerned, there was a recovery in business confidence and gains in building approvals while the inflation data was stronger than expected.

Reserve Bank Governor Stevens took a hawkish stance on monetary policy in a speech on Tuesday with comments that interest rates could be tightened before the domestic unemployment rate had peaked. 

Markets will look to maintain a positive stance towards the Australian currency. It is still the case that resistance above current levels will be difficult to break down

Canadian dollar:

The Canadian dollar advanced to highs near 1.0750 against the US currency during the week and retreats quickly attracted fresh buying support as sentiment remained firm.. Trends in commodity prices remained important as the currency tended to track moves in oil prices and global stock markets.

There was little in the way of domestic data to provide guidance as trends in international risk appetite remained important.

The Canadian dollar should be able to resist heavy selling pressure in the short-term , but is likely to face much tougher resistance from current levels.

Indian rupee:

The rupee was trapped in relatively narrow ranges near 48.50 against the dollar over the week as international markets also struggled for a decisive move.

A firmer US currency, allied with month-end demand for dollars, led to a slightly weaker rupee tone, although ranges were narrow with buying support on dips.

The currency also dipped lower briefly as Chinese share prices fell, but domestic confidence held broadly firm. There was speculation that the Reserve Bank would block any rupee gains around the 48 level against the US currency.

The rupee will gain support when global risk appetite improves. Nevertheless, the net risks suggest that the currency will find it difficult to secure more than limited gains. 

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The Hong Kong dollar has again traded at the strongest limit of the permitted and for most of the week. The HKMA has intervened on several occasions to preserve the target band and prevent gains through the 7.75 level against the US dollar.

There has been evidence of further capital inflows into Hong Kong and the trend was interrupted only briefly by the sharp decline on the Shanghai stock market.

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 narrow trading band near 6.83 against the dollar over the past week with the central bank still maintaining tight market control

The US-China talks on trade and the economy did not result in any notable rhetoric with both apparently looking to maintain a positive tone and avoid market tensions.

The central bank pledged to maintain a low interest rate policy to help support the economy and this curbed yield support to some extent, but did help underpin confidence in domestic assets.

There was some unease over trends in fiscal and loans policies with some speculation that loans were being withdrawn.
 
The central bank is likely to maintain the near-term policy of maintaining currency stability, especially with persistent doubts over the quality of the economic rebound.