Weekly Forex Currency Review 02-05-2008

Overall strategy: The US and Euro-zone growth trends and credibility of the central banks will continue to be the dominant short-term focus for currency markets. The evidence of a deterioration in the Euro-zone could let the dollar maintain a near-term advantage on a correction from recent losses, especially as confidence in the Fed has recovered to some extent. There will be the risk of a fresh US currency relapse later in the year.                    

Key events for the forthcoming week

Dollar:

The most recent data has suggested that the US economy may be able to avoid further deterioration as the data has been slightly better than expected. Following the latest interest rate cut, there is also evidence that the Federal Reserve will look to suspend interest rate cuts and wait for further developments which will underpin the dollar. An improvement in risk appetite would also provide some support for US assets. These factors combined will offer further near-term dollar support, but confidence will be fragile and a renewed downturn in indicators would trigger fresh selling pressure on the currency.      
 
The dollar was able to secure a further significant advance over the week with a five-week high against the Euro while the trade-weighted index pushed to the highest level for seven weeks as sentiment improved.

US GDP for the first quarter recorded annualised growth of 0.6%, unchanged from the previous quarter. There was a sharp drop in investment spending while consumer sending growth slowed and exports secured a solid advance.

The ADP report recorded a 10,000 increase in private-sector employment for the month compared with expectations of a substantial monthly decline. Jobless claims rose to 380,000 in the latest week from a revised 345,000 previously.

This data pattern continued with the PMI report for the manufacturing sector as it was unchanged at 48.6 for April compared with expectations of a small deterioration.

Overall confidence remained fragile, but fears over a deepening recession eased, at least in the near term. which helped support the US currency.

Inflation fears were still an important factor with the PMI index at close to record highs for April while there was a 0.2% increase in the core PCE inflation index for an annual increase of 2.1%.

At the latest FOMC meeting, the Federal Reserve cut interest rates by a further 0.25% to 2.25% with a 8-2 vote as two members voted for no change. The statement still registered concerns over growth, but the references to downside risks were removed and there was a shift to a near-neutral policy with a greater focus on inflation. Markets put the chances of a further rate cut in June at less than 25%.

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There will be further fears over a sharp slowdown in the Euro-zone economy, especially with evidence of increased difficulties in the French economy and a marked slowdown in Germany. The ECB will still be concerned over inflation and will want to maintain a restrictive policy, but the drop in headline inflation will increase speculation that the central bank will be able to move towards a more relaxed stance within the next few months. There is also evidence of some capital outflows from Europe which will limit the scope for renewed Euro gains.
       
The Euro had a decisively weaker trend as it lost ground against all major currencies expect the Swiss franc. There was a significant switch in sentiment over the week which undermined the Euro with reduced evidence of central bank Euro buying.

Provisional German consumer inflation fell sharply to 2.4% in April from 3.1% the previous month while the estimate of Euro-zone inflation also fell to 3.3% in April from 3.6% the previous month.

There was a further significant decline in business confidence for the month while consumers also remained cautious according to the latest survey evidence. There was a sharply reduced decline in German unemployment for April, which increased expectations that the economy was weakening, and retail sales were lower.

There was also a sharp decline in Spanish inflation and French housing starts which reinforced speculation over an important slowdown in the Euro-zone economy.

Official comments on inflation and exchange rates were generally subdued over the week, although ECB officials continued to concentrate on inflation risks as they looked to curb wage demands.

Yen:  

The domestic economic trends remain weak, illustrated by the fact that the Bank of Japan has dropped references to higher interest rates in its latest statement. The yen will, therefore, remain vulnerable to selling pressure on yield grounds and yen vulnerability will tend to increase if there is a sustained improvement in risk appetite. The dollar, however, has struggled to make much headway which suggests that there are underlying capital flows into Japan which will stem yen declines. The currency could still gain rapidly if risk fears intensify.
                    
The Japanese currency was trapped within a relatively narrow ranges against the dollar over the week, but the yen did secure gains against the Euro.

The Bank of Japan left interest rates on hold following the latest council meeting. The bank took a generally downbeat outlook on the economy and references to higher interest rates were removed from their latest economic outlook.

The economic data was generally weak with a sharp 3.1% decline in industrial output for March as shipments to the US declined. There was also a decline in household spending for the month, but headline unemployment was lower

Improved risk tolerances in global markets curbed demand for the Japanese currency, but there was increased exporter selling on US dollar gains towards the 105.0 level.

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There will be continuing fears over economic trends with house-price falls and evidence of a sharp slowdown in consumer spending as tight mortgage conditions persist. There will be strong expectations of further interest rate cuts over the next few months. The Bank of England will remain concerned over inflation and will want to be cautious in cutting rates, especially if there is greater confidence that credit difficulties are easing. The UK currency will tend to gain support when there is an improvement in risk appetite and there is scope for a further limited Sterling recovery, although a strong advance looks unlikely.
 
Sterling struggled to secure decisive direction against the dollar over the week with selling pressure on any push towards the 2.00 level. The UK currency did, however, strengthen to a three-week high against the Euro as it gained support from a recovery in global risk appetite.

The PMI index for the manufacturing sector edged lower to 51.0 in April from 51.3, although this was slightly above market expectations.

The housing data remained weak with the Nationwide Bank reporting a decline in house prices in the year to April while the Halifax Bank reported a further 1.3% decline for the month. There was also a sharp drop in mortgage approvals to a record low while difficulties in the mortgage market continued.

There was also a very weak CBI retail survey for April and consumer confidence weakened further for April, although this may have been distorted by the fact that Easter was in March this year.

MPC member Blanchflower called for interest rates to be cut quickly to avert recession and markets were expecting rates to be cut again before the end of the second quarter even though expectations of a May cut faded.

Swiss franc:

There will be further doubts over the economy following the weaker than expected KOF index. There will be some renewed speculation that the National Bank will move to cut rates in the third quarter. If there is evidence that the banking sector is deteriorating then any downward pressure on the franc would intensify. The Swiss currency will also tend to lose ground if there is a sustained improvement in risk tolerances. Nevertheless, market sentiment could still reverse rapidly which would put renewed upward pressure on the franc.  
 
The Swiss franc continued to weaken against the dollar over the week and dipped to two-month lows around the 1.05 level. The currency also recorded slight net losses against the Euro during the week.

The KOF leading indicator weakened to 1.20 in April from a revised 1.40 the previous month. The index has fallen sharply over the past six months and was at the weakest level since late 2004 which reinforced expectations of a sharp slowdown. In contrast, there was a solid PMI report which provided some relief

The latest consumer spending evidence was firmer which provided some relief, but there was some renewed speculation that the National Bank would cut interest rates during the third quarter to support the economy.

National Bank member Jordan stated that the economy was liable to weaken, but he also stated that interest rates were currently at an appropriate level.

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The Australian dollar found support below the 0.93 level against the US currency, but was unable to make a challenge on fresh 24-year highs and there were renewed losses late in the week.

The domestic influences were mixed over the weak as there was a solid increase in retail sales, while a sharp drop in building approvals increased unease over underlying housing-sector trends.

The Australian dollar drew further support from high commodity prices, although volatility levels also increased as a firmer US currency put downward pressure on metals prices. An improvement in risk tolerances provided net support for the Australian currency with evidence of some inflows from Japan.

Given domestic uncertainties, the Australian currency will be vulnerable to a further correction weaker, especially if commodity prices continue to drop sharply.

Canadian dollar:

The Canadian dollar found tough resistance on gains towards parity against the US dollar and dipped sharply to lows around 1.02 on Thursday.

The latest GDP data was weaker than expected with a monthly decline of 0.2% for February as the manufacturing sector weakened. There was, however, a sharp increase in wholesale prices which reinforced inflation fears within the central bank.

Governor Carney suggested that the bank would be cautious over cutting interest rates aggressively further even though further cuts were realistic.

The Canadian currency is vulnerable to further overall losses in the short-term, especially as there is the threat of a further decline in oil prices.

Indian rupee:

The rupee weakened over the week despite a general improvement in risk appetite with the Indian currency dipping to lows around 40.60 against the dollar.

There was strong dollar demand from oil refiners as month-end demand combined with near-record oil prices and US currency demand remained firmer on Friday. The rebound in US yields also tended to discourage flows into the Indian currency

There were current account fears over the week while there was also some disappointment that the Reserve Bank did not increase benchmark interest rates.

The rupee will gain some support if global risk tolerances remain higher, but the overall trend suggests that the currency is unlikely to make much headway.  

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

Launched in 2006, dbFX is available in multiple languages and accessible in over 70 countries around the world. Deutsche Bank was  ranked the No.1 Foreign Exchange Bank in 2007 by Euromoney magazine  for the third year running. The platform can be accessed here