Weekly Forex Currency Review 04-09-2009

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There will be a lack of confidence in the global economic direction and this could continue to stifle near-term market direction. The overall risks suggest that there will continue to be a slightly more defensive stance over the next few weeks which should help curb selling pressure on the dollar.

Key events for the forthcoming week

Dollar

The contradictory dollar influences are liable to continue in the near term at least. The US currency is tending to gain defensive support when risk appetite deteriorates while it is also looking to gain support on yield grounds. Given that risk appetite tends to improve on firm data, there have been opposing forces on the dollar and this trend could continue in the near term. The US currency will be in a stronger position to gain support if there is evidence that the European economies are in greater difficulties and it should be able to avoid heavy selling pressure from current levels.

The dollar gained defensive support at the beginning of the week, but still struggled to gain sustained support and ended little changed for the week as a whole. The principal trigger for the move was a sharp decline in Chinese equity markets with the Shanghai composite index falling by over 6.5% which took the cumulative August fall to over 20%. Markets recovered their poise later in the week, although the US dollar was still able to avoid heavy selling pressure as conviction remained low.

The US Chicago PMI index was stronger than expected with an increase to the 50.0 expansion threshold for August from 43.4 the previous month and this was the highest reading for 12 months. The index was boosted by the increased activity in the auto sector while the employment index remained weak.
The ISM manufacturing index rose to 52.9 for August which represented the first reading above 50 for 18 months, while the ISM index for the non-manufacturing sector strengthened to 48.4 from 46.4 the previous month. In addition, pending home sales rose by a further 3.2% for July, maintaining the run of favourable housing-sector releases.

The US employment data was weaker than expected with ADP estimating a 298,000 decline in private-sector payrolls for August compared with expectations of around 250,000 although this was an improvement from July’s decline. The data overall was consistent with expectations of a very slow recovery in the economy as a whole with labour markets still very weak and an important barrier to increased spending. jobless claims edged slightly lower to 570,000 from a revised 574,000 the previous week.
The FOMC minutes were broadly consistent with expectations as the Fed warned that the economy would recover only slowly and would be vulnerable to external shocks.

In recent weeks, the dollar has tended to lose ground on favourable releases, but there was a slightly different reaction this time as the dollar gained ground. In part, this was due to hopes that the key US sectors will be able to rebound at a faster pace than Europe, although confidence was again fragile.

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The most likely outcome is that the ECB will maintain a steady policy over the next few months in order to assess economic and monetary conditions and the Euro implications should be broadly neutral. The currency will tend to gain some support when risk appetite improves while there will be an important negative impact if Eastern European fears intensify. The Euro is also fully-valued at current levels which will make it difficult to secure a significant net advance.

The Euro dipped lower when risk aversion spiked higher and was also unsettled briefly by comments from German Finance Minister Steinbrueck who stated that financing conditions were liable to deteriorate over the next few months. The Euro consolidated near 1.4250 against the dollar and struggled for clear direction on the crosses.

The flash estimate of Euro-zone inflation was slightly higher than expected at -0.2% for August compared with the -0.7% previously which dampened expectations of a more aggressive ECB monetary policy.
There was no surprise with the ECB interest rate decision as the central bank left rates on hold at 1.00% following the latest council meeting. There was also a small upgrade to the economic projections with marginal growth expected for 2010.

In contrast, bank President Trichet was very cautious over the outlook, warning that risks to the economies remained high despite the signs of stabilisation. Trichet also stated that exit strategies could be discussed, but that this was no time for tightening policy. The ECB also announced that there would be a further unlimited tender of funds at 1.00% following the first allocation in June. Trichet’s overall tone tended to sap confidence in the Euro-zone and limit any potential Euro support.

Japanese yen

Degrees of risk aversion will inevitably be important for the Japanese currency and there will be further currency support when international confidence deteriorates. The domestic policies will also be watched closely over the next few weeks. In particular, the stance on international reserves management will be important with comments from Finance Ministry officials also under close scrutiny. Overall opposition towards yen gains is likely to intensify towards the 90 level.

The dollar weakened to test seven-month lows near 92 against the yen during the week before finding some degree of relief.

The Japanese currency gained significant support from the opposition DPJ’s weekend general election victory. There was further speculation that the government will move towards a more aggressive currency reserve management policy which would tend to lessen support for the dollar. The positive yen impact was offset to some extent by doubts over domestic fiscal policy as the government remains committed to a further expansion of fiscal spending which would increase he already substantial underlying debt fears.

The yen also gained some significant degree of support from a deterioration in risk appetite early in the week, although the underlying moves still suggested that overall yen demand also increased. With evidence of strong short yen positions among retail investors there was some speculation of rapid position adjustment and further upward pressure on the yen.

Markets, however, were also monitoring comments from Japanese officials while there is likely to be dollar buying support from semi-official institutions.

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Underlying confidence in the UK economy and currency is likely to remain very fragile in the short-term. There will be fears over the outlook for consumer spending and business investment, especially after the recent weakness in lending data. These fears, in turn, will increase the degree of unease over government borrowing levels. Sterling will gain relief at times, especially with all major economies in difficulties and the services data was firmer, but the UK currency overall is likely to remain vulnerable to further depreciation.

Sterling was subjected to renewed selling pressure early in the week with lows near 1.61 against the dollar, but did manage to stage a tentative recovery during the second half as domestic and international factors turned more benign. There was also support weaker than 0.8820 against the Euro.

The PMI manufacturing index fell back to below the 50.0 level for August which caused some unease and the lending data also caused significant concern. Consumer lending recorded a net contraction for the first time since 1993 while there was also the biggest net repayment of credit by the non-financial private sector since 1997.

There were further concerns that a lack of credit and an unwillingness to borrow would limit the scope for economic recovery. There were renewed fears over the outlook for government revenues and confidence is liable to remain fragile. The construction PMI report remaining below the 50.0 level for August.

In contrast, the PMI index for the services sector rose to 54.1 for August from 53.2 the previous month and this was the strongest reading for close to two years. Following recent weakness, the data revived some degree of optimism over underlying economic conditions, although confidence was still fragile given the extremely important issue of rising government debt.

Sterling trends were also still influenced strongly by degrees of risk appetite with a recovery in global stock markets later in the week also important in easing selling pressure on the UK currency.

Swiss franc

The evidence of the past moth continues to suggest that the franc will gain some degree of defensive support when international risk appetite deteriorates. This support is likely to be more fragile if there are renewed fears over the banking sector. National Bank policies will remain a key focus and there is still a strong probability that the bank will act to block currency appreciation. In this context, any franc gains from current levels are unlikely to be sustained.

The Swiss currency tended to lose some support when there was an improvement in risk appetite, although the gains for gold prices suggested that underlying demand for the currency could remain firm and the franc has still proved to be broadly resilient over the past week. The dollar found support below the 1.06 level against the franc, but was unable to make any significant headway. The Swiss currency also remained form on the European crosses.

There were persistent rumours of imminent National Bank intervention to weaken the Swiss currency during Wednesday. Although there was no evidence of actual intervention, markets will remain on high alert over the potential for action.

Fresh global anxiety over the financial sector tended to have a mixed influence on the Swiss franc as safe-haven demand was offset by renewed fears over the domestic financial sector.

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The Australian dollar weakened to test support below 0.83 against the US dollar early in the week, before trending higher again as conditions improved.

As expected the Reserve Bank of Australia left interest rates at 3.00% following the latest council meeting. In the statement accompanying the decision, the bank was more cautious than expected on the potential for higher interest rates in the short-term

Global influences were also strongly negative for the Australian currency early in the week with a sharp decline in equity prices and a drop in commodity prices despite the generally upbeat manufacturing-sector releases.

The currency gained support from a general improvement in risk appetite later in the week as global stock markets posted a recovery.

The strength in gold prices should provide some degree of support for the Australian dollar, but the overall risks suggest it will be difficult to make much headway.

Canadian dollar

The Canadian dollar tested resistance levels close to 1.09 against the US currency, but was unable to make any further headway and was generally trapped weaker than the 1.10 level

The local currency was undermined by a weaker trend for crude oil prices and weaker commodity prices in general, although conditions did stabilise later in the week which offered some respite

The Canadian dollar’s fortunes will tend to remain linked strongly with degrees of confidence in the global economy and the net risks suggest that it will be difficult o make strong headway.

Indian rupee

The Indian currency remained generally on the defensive during the week and tested six-week lows beyond 49 against the US currency before staging a limited corrective recovery.

The local currency was undermined early in the week by a sharp decline in global stock markets and the currency struggled to regain support. For the week as a while, the local bourse lost around 3.0%, maintaining fears that capital inflows would be weaker.

A decline in oil prices and an easing of month-end pressures provided some degree of support for the currency.

The rupee should be able to avoid substantial selling pressure from current levels, although the net risks suggest that there is little scope for appreciation.

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The Hong Kong dollar remained slightly weaker than the 7.75 band limit, although movement was again very limited with consolidation near 7.7510 against the US currency.

The currency was unsettled briefly by a sharp decline in Chinese equity markets, but confidence recovered later in the week which also limited any selling pressure. There was evidence of a demand for funds ahead of forthcoming IPO offerings.

There looks to be little prospect of substantial selling pressure on the Hong Kong dollar in the short-term.

Chinese yuan

The Chinese yuan trading with a slightly firmer bias during the week, although the central bank was still keeping the currency within a narrow range close to 6.83 against the US dollar.

The latest Chinese and global PMI data provided some degree of support for the yuan with a continuing expansion boosting confidence in the economy, although officials were still very cautious over the short-term outlook.

Central bank representatives suggested that interest rates or reserve requirements would not be tightened over the next six months, but there was further speculation over further restrictions on bank lending.

The medium-term case for yuan appreciation will remain robust, but there is little evidence that the central bank will tolerate a near-term move for significant currency gains.