Weekly Forex Currency Review 04-12-2009

Markets will increasingly be looking at the 2010 outlook for the global economy. There are likely to be increased fears that underlying vulnerabilities will quickly erode the underlying recovery and threaten a prolonged period of sub-par growth.  In this environment, there is likely to be a more cautious attitude towards risk which will help protect the dollar, at least to some extent.

Key events for the forthcoming week

Dollar:

The most recent economic data will maintain expectations that the economic recovery will be fragile and vulnerable to a reversal, especially with a continuing contraction in credit. There will also be expectations that the Federal Reserve will be very slow to remove the monetary stimulus which will sap yield support. The dollar should still find some protection from difficulties in finding attractive alternatives at current valuations, especially given that overall risk appetite is liable to be lower as 2010 doubts increase.

The dollar came under pressure for much of the week as the defensive demand seen last week surrounding the Dubai debt situation faded. There was support near the 2009 lows against the Euro and the dollar gained some defensive support as confidence in the global rebound faded slightly.

The latest US ADP employment report recorded net private-sector losses of 169,000 for November from a revised 195,000 decline the previous month and this continued to suggest a gradual improvement in the labour market. The latest Challenger survey also recorded a sharp decline in major job cuts from last year.

There was a further 3.7% increase in pending home sales for October following a revised 6.0% increase the previous month. In contrast, the manufacturing PMI index weakened to 53.6 for November from 55.7 previously.

The ISM index for the services sector was weaker than expected with a drop to 48.7 for November from 50.6 the previous month with a renewed decline to below the 50 level after only two months. The orders component was above 50 which will help cushion the impact, but the employment component remained very weak at 41.6.

The latest jobless claims data was again stronger than expected with a decline to 457,000 in the latest week from 462,000 previously which maintained some hopes of an improved non-farm payroll reading for Friday as the four-week moving average fell to a fresh 12-month low.

The Fed’s Beige Book stated that most districts reported an improvement in conditions during the latest survey period with consumer spending slightly higher. The commercial real-estate market was still deteriorating while loan conditions were still being tightened. The data reinforced expectations that any economic recovery will be subdued at best given the underlying pressures.

In congressional testimony on Thursday, Fed Chairman Bernanke made reference to gradual exit strategies and a withdrawal of liquidity measures, but there was no suggestion that interest rates would be increased in the short-term. There were also no strong mention of the dollar in his remarks.

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The ECB will gradually withdraw the extraordinary liquidity measures during 2010 which should help underpin the Euro. There is likely to be increased pressure for the tightening to be delayed. There are also likely to be increased fears over the structural vulnerabilities with some further speculation that countries such as Greece could be forced into a debt default which would trigger heavy selling pressure on the Euro. There is also likely to be verbal intervention to curb further Euro appreciation which will curb any initial gains.

The Euro maintained a generally firm tone against the dollar and Sterling, but failed to hold its best levels in a choppy market with some fears that the Euro is over-valued while there were also continuing fears over underlying internal stresses.

As expected, interest rates were left unchanged at 1.00%following the latest council meeting. The ECB announced that the long-term 12-month liquidity tenders would cease in December while the shorter-term programmes would continue into 2010. 

There were mixed comments from bank President Trichet, although the overall tone of his comments was slightly more dovish than expected and the Euro failed to hold initial gains with fears that the economy would not be able to achieve a self-sustaining recovery during 2010.

In comments on Wednesday, Euro-group head Juncker stated that the Euro was overvalued which will create some caution over currency buying.

There was a firm reading for German retail sales while the unemployment data was also stronger than expected with a monthly decline supported by government fiscal measures. There was a small upward revision to the Euro-zone PMI manufacturing data, although there was also important signs of divergence as conditions in Spain and Greece deteriorated.

Yen:  

The Bank of Japan action to provide additional low-cost financing is likely to have only a limited direct impact on money markets and the yen. There will, however, be speculation of further policy action by the central bank. There will also be pressure for yen gains to be resisted as currency strength will tend to intensify the deflation threat. The yen should still gain strong protection given a reluctance to push funds overseas amid speculation over competitive devaluations throughout the major economies.

The Japanese yen remained strong at the start of the week, but was unable to break through the 85 level and was then subjected to a sharp reversal.

The yen weakened sharply in Asian trading on Tuesday as the Bank of Japan announced an unscheduled policy meeting. There was speculation that the bank would announce additional easing measures to help ease the deflation threat with the potential for additional quantitative easing.

The yen weakened to lows near 87.50 against the dollar before recovering back to 86.80 as the bank announced a new 3-month lending facility. Markets were sceptical that the measures would have a substantial impact.

Risk appetite attempted to stabilise during the week with solid readings for the Chinese PMI readings which underpinned hopes for a regional economic rebound, although confidence was still fragile.

Finance Minister Fujii stated that he had not ruled out intervention. There were comments from the Prime Minister that yen strength needed to be tackled and underlying pressure for yen gains to be resisted increased during the week.

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Underlying confidence in the economy is likely to remain weak with further serious fears over the government debt outlook. Although international fears over sovereign ratings have eased very slightly, there will still be speculation that the UK credit rating will be downgraded during 2010 while media speculation over sharp Sterling losses is also likely to persist. In this environment, Sterling will find it difficult to sustain any near-term advances.

Sterling continued to be subjected to choppy trading conditions as bargain hunting was offset by underlying fundamental fears. There was selling pressure above 1.67 against the dollar, although it did rebound from levels below 1.65.

There was further unease over the UK credit-rating outlook with fears over the government debt outlook compounded by fears that the stresses surrounding Dubai debt will trigger a reassessment of sovereign ratings and further damage confidence in the UK currency. These fears gradually eased during the week.

The latest PMI manufacturing report was significantly weaker than expected with a decline to 51.8 for November from a revised 53.4. The construction PMI index also remained below the 50 level for November at 47.0, maintaining the 3-year contraction within the sector.

The services-sector index weakened to 56.6 from 57.1 the previous month. The initial impact was limited as it was still comfortably above the 50 threshold.

The UK lending data remained weak with a further contraction in consumer credit. Indeed, there was the sharpest decline on record for credit which will also maintain fears over the spending outlook and the economy as a whole.

Swiss franc:

The National Bank policies will remain a very important focus and the most recent comments from bank Chairman Roth will dampen expectations that the intervention policy will be suspended, at least in the short-term. The franc will also tend to gain some support when global risk appetite deteriorates. From a longer-tem perspective, markets will also expect the National Bank to resist a policy of currency debasement and this will certainly tend to limit any selling pressure on the franc.

The dollar continued to probe support below parity against the franc. There were further reports of BIS support below the 1.00 area, but the US currency was unable to make any headway. The Euro remained below 1.51 against the Swiss currency.

National Bank chairman Roth stated that the bank will continue to act decisively to block franc appreciation and this will tend to dampen speculation over a near-term policy shift by the bank which should also tend to weaken the franc to some extent.

The latest PMI data was stronger than expected with a rise to 56.9 for November from 54.0 the previous month which will support optimism over the economy.

The ECB was slightly more dovish than expected which will provide some near-term franc support. There was also caution ahead of the quarterly monetary policy meeting next week.

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The Australian dollar rallied for much of the week as risk appetite improved and there was solid buying support on dips, but there was further selling pressure above the 0.93 level against the US currency.

The Reserve Bank of Australia increased interest rates by a further 0.25% to 3.75%, the third consecutive increase, and this was in line with market expectations. The Australian dollar failed to gain any initial benefit, but then gained ground with a move to above the 0.92 level against the US dollar as markets took a more optimistic stance towards the global economy.

The Australian currency continued to gain some support from an easing of fears surrounding the Dubai situation while solid Chinese PMI data also provided support on optimism over the regional outlook.

Australian dollar sentiment is likely to remain robust, but it will be difficult to extend gains given that doubts over international risk conditions are liable to increase.

Canadian dollar:

The Canadian dollar tested US dollar support levels below 1.05 against the US dollar, but failed to hold the gains as crude oil prices were subjected to renewed selling pressure and there was a slightly more cautious attitude towards risk. 

The GDP data confirmed that the economy returned to growth for the third quarter, although the data impact was limited during the week.

The net risks suggest that Canadian dollar losses should be contained unless there is a substantial deterioration in risk appetite.

Indian rupee:

The rupee strengthened for much of the week and pushed to a 2-weeh high against the US dollar near 46.05 as equity markets rallied and there was a weaker US currency.

Trends in risk appetite were still generally dominant during the week and an easing of fears surrounding Dubai helped underpin sentiment which supported the rupee. Speculation over capital controls also faded slightly.

The rupee will be vulnerable to significant selling pressure if there is a serous deterioration in risk appetite. Overall, heavy losses look unlikely in the short-term.

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The Hong Kong dollar maintained a position very close to the 7.75 limit against the US dollar during the week.

After some weakness last week, there were strong gains for Hong Kong stocks for much of the week with four consecutive daily advances. In this environment, there were robust inflows and Hong Kong dollar support as capital inflows remained strong.

The Hong Kong dollar will tend to weaken if there is a serious deterioration in international risk appetite, but losses should be very limited in the near term.

Chinese yuan:

There was no evidence of a policy shift by the Chinese authorities during the week as tight control of the spot market persisted with the yuan near 6.827 against the dollar.

The economic data was broadly favourable with the PMI indices remaining comfortably above the 50 expansion threshold for November. There was some caution with expectations that the amount of bank loans would be cut back during 2010. 

The central bank is still likely to maintain yuan stability in the short-term with fears that the Chinese economic recovery will still be brittle. International pressure for a stronger currency will continue.