Weekly Forex Currency Review 01-08-2008

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Overall strategy:

The key feature in the short-term is likely to be a lack of confidence in all the major economies with fears over the US and Euro-zone outlooks. In this environment, markets will find it difficult to a decisive direction with range trading liable to persist over the next few weeks. Declining liquidity levels will maintain the threat of erratic trading if there are renewed stresses in financial and credit markets.                 

Key events for the forthcoming week

Dollar:

There is scope for some degree of optimism over the economic trends given that there has been evidence of stabilisation in the economy. There will be some further speculation over higher interest rates, although confidence will inevitably be very brittle given the underlying stresses and sentiment could turn rapidly. There is certainly no real prospect of a strong recovery. Fears over global deterioration will be very important in underpinning the US currency. Unease over growth trends could also be important in weakening commodity prices which would tend to support he US dollar and heavy selling should be resisted.         

The dollar secured a net advance over the week and pushed to a three-month high on a trade-weighted basis. It still struggled to hold its best levels as doubts over the US economy persisted following mixed data with selling near 1.5550 against the Euro.

There was a small recovery in consumer confidence for July with the index rising to 51.9 from a revised 51.0 the previous month. This maintained the slightly firmer data tone seen in the durable goods orders and new home sales seen at the end of last week, but there were fresh doubts as the week progressed.

GDP growth for the second quarter was recorded at 1.9% following a 0.9% increase the previous quarter, but this was below expectations and the domestic economy was weak while the 2007 fourth-quarter estimate was revised to show a contraction.

The Chicago PMI index rose to 50.8 for July from 49.6 the previous month and this was the first reading above the 50.0 level for six months which provided some relief.

The latest Case-Shiller house-price index recorded a 15.8% decline in prices in the year to May. This was slightly better than expected and 7 of the 20 cities recorded an increase in prices for the month which offered some hopes for stabilisation.

The ADP employment report recorded an increase of 9,000 for July compared with expectations of a substantial decline with gains concentrated in small company sector. There was a sharp rise in jobless claims to a 5-year high of 448,000 while continuing claims also rose, although the data may have been distorted by technical changes.

There were no major comments on interest rates during the week while the Fed extended the TAF lending facility to inject liquidity into the banking system.

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Fears over the Euro-zone economy are liable to increase further in the short-term as confidence continues to deteriorate. There will be particular fears over economies such as Spain and Italy. The ECB will remain concerned over the inflation outlook and there is the growing threat of further divergence between the individual countries. At the extreme, there will be further speculation that countries could decide to abandon the Euro area. Any such speculation would be very negative for the currency. In this context, the Euro will remain vulnerable to renewed selling pressure on any significant rallies.          
       
The Euro held firm against low-yield currencies during the week, probing 2007 highs against the Swiss franc and yen, but it was unable to secure a wider advance and hit significant selling pressure late in the week.

The Euro-zone data releases remained weak with a decline in the main industrial confidence index as industrial sentiment deteriorated sharply. Consumer confidence across the Euro-zone also continued to weaken in the latest data.

German inflation estimates remained at an elevated level with the provisional inflation estimate at 3.3%. The flash Euro-zone consumer inflation rate also rose to 4.1% for July from 4.0% previously. There were reports from ECB sources that interest rates could be increased again if inflation failed to decline, but overall market confidence in the economy deteriorated.

There was some media speculation that Italy could be forced to leave the Euro-zone if the downturn intensified while the Spanish data remained extremely weak with a decline in retail sales of over 10% in the latest month.

Yen:  

Confidence in the Japanese economy will remain weak, especially with fears that the export sector will remain under pressure. There will be particular fears if there is evidence of a sharp downturn in the Asian economy. The Bank of Japan is liable to resist an interest rate increase in the near term which will reinforce the lack of yield support. The Japanese currency will also be vulnerable to selling pressure if there is a sustained improvement in risk appetite. The yen should gain some protection on valuation grounds while confidence in the global financial sector will be brittle which will strengthen the yen at times.
                    
The yen continued to attract selling pressure on significant rallies and dipped to re-test support levels above the 108.0 level against the dollar. After testing record lows, the yen gained some respite against the Euro late in the week.

The Japanese data was generally weak which maintained a lack of confidence in the economy. Industrial production fell 2.0% in June following a 2.8% increase the previous month while the Industry Ministry downgraded its outlook for the sector

The unemployment rate rose to 4.1% in the month from 4.0% while there was a further decline in household spending over the year. The PMI index remained below the 50.0 level while housing starts also continued to decline.

There was further speculation that summer bonus payments were being allocated overseas to take advantage of higher yields. There were some important reservations over the global financial conditions which limited aggressive yen selling

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Confidence in the economy will remain very weak in the short-term with further fears that housing-sector weakness and downward pressure on consumer spending will push the economy into recession. The Bank of England will face major difficulties in the near term with pressure to cut interest rates to support the economy offset by the needs for inflation control. Sterling will gain some support on yield grounds while a lack of confidence in the Euro-zone will also provide some significant protection to the UK currency.    
 
Sterling sentiment was generally depressed over the weak as economic fears continued to mount. The price action was still favourable for much of the week as the UK currency gained some ground against the Euro, but it lost ground on Friday with a fresh retreat back to below the 1.98 level against the dollar.

The UK housing related data remained weak with mortgage approvals falling to a fresh record low of 36,000 for June from 41,000 the previous month. The latest Nationwide house-price index also recorded a further 1.7% decline for July with the annual drop of 8.1% the weakest for at least 15 years.

Consumer orientated releases were also weak with a drop in bank lending. Consumer confidence levels remained depressed while the latest CBI retail survey recorded a net balance of 36% of respondents reporting lower sales which was the lowest reading for at least 25 years. There was extreme weakness in the housing-related areas. The PMI index for the manufacturing sector fell to a 10-year low of 44.3 in July from 45.9.

Bank of England officials continued to warn over growth and inflation fears, especially as there were announcements of fresh energy price increases.

Swiss franc:

There will be further expectations of an economic slowdown, especially after a further downturn in the KOF index. The franc will continued to be influenced strongly by degrees of risk appetite and it will tend to weaken when markets feel more confident. There will also be unease over the recent National Bank stance on inflation and interest rates. Overall, the Swiss currency is likely to remain vulnerable to some further selling pressure, although substantial losses from current losses are unlikely. 

The Swiss franc remained generally on the defensive over the week and struggled to gain any significant support when fears over the global economy and stock markets increased. The franc dipped to test 3-month lows against the dollar and also retreated to test 2008 lows against the Euro.

The UBS consumption index was firm for June, although this may have been influenced by the World Cup. In contrast, the KOF leading index of business conditions recorded a further decline to 0.90 in July from a revised 0.99 the previous month and this was the lowest reading for over five years.

Consumer prices fell 0.4% in July, but the annual inflation rate was still at above the 3.0% level at 3.1% which was the highest level for 5 years.

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The Australian currency lost ground over the week and dipped to lows below the 0.94 level against the US currency. It was undermined by a drop in commodity prices with the slide in gold and copper prices particularly damaging for the currency. It was also unsettled by an increase in bad debt provisions by two of the main Australia banks

The latest building approvals data recorded a further 0.7% decline for June with a 7.8% annual decline which maintained fears over the housing sector while business confidence also continued to weaken.

There was also a decline in retail sales of 1.0% for the month after a 0.9% increase the previous month which reinforced speculation over a slowdown in the economy with some expectations that the Reserve Bank would switch to an easing bias next week.

The Australian dollar will be at risk of further losses if there is sustained downward pressure on commodity prices, especially as domestic doubts have increased.

Canadian dollar:

The Canadian dollar retained a weaker tone against the US dollar, although it resisted heavy losses as confidence in the economy was still firm and settled around 1.0250.

The latest GDP data was weaker than expected with a 0.1% monthly decline for May. The latest producer prices data continued to rise strongly over the month which will reinforce Bank of Canada unease over inflation trends. Markets overall expected that the Bank of Canada would retain a steady monetary policy in the short-term.

The US dollar may retain a firmer tone in the short-term, but it will be difficult to make strong headway with underlying confidence in Canadian fundamentals.

Indian rupee:

The Indian currency weakened slightly over the week as contradictory pressures were a key feature with selling pressure on any move towards the 42.00 level

Yield support was boosted by a further Reserve Bank interest rate, the third increase on the past two months, with the benchmark rate increased to 9.0% from 8.5%.

The central bank ended its direct supply of dollars to oil refiners and this increased demand for the US currency in the market. There was a lack of confidence in stock market tends with doubts over capital inflows, although the main index did rally.

A sustained decline in oil prices would continue to improve the rupee's risk profile, but the currency is unlikely to make much headway as sentiment will remain weaker with unease over regional economic trends. 

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The Hong Kong dollar edged weaker against the US currency, although ranges remained narrow with consolidation around 7.8025. There was a spike in local money-market rates at month-end which provided some degree of currency support.

Overall confidence in the Hang Seng index was still fragile given fears of a regional slowdown and this curbed support for the local currency.

Range trading is liable to remain the dominant influence with unease over Asian growth trends deterring strong capital inflows.

Chinese yuan:

The yuan edged depreciated over the week to 6.8430 in part to wider resilience by the US currency.  For July, the yuan appreciation was the slowest for 16 months reinforcing speculation that the authorities would look to slow the pace of gains.

The imposition of capital controls by the central bank to curb fraud also slowed the pace of export settlements which created a shortage of dollars in markets.

There was further speculation that the authorities would curb monetary restraint in order to help lessen the pressure on exports given fears of a sharp slowdown as the global economy cools. These fears were illustrated by a dip in the Chinese PMI index to below the 50.0 level, the lowest for over five years.

The authorities will be looking for market stability during the Olympic period which, allied with growth doubts and speculation over a policy shift, will continue to limit the scope for near-term yuan gains with reduced market expectations of appreciation.  

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