Weekly Forex Currency Review 08-01-2010

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The markets will be looking at yield and structural factors over the next few weeks. There will be some speculation over a tighter Fed policy during 2010, but it will still be difficult to secure strong support. The US currency has the potential for some support given fears over structural vulnerabilities within the European economies.

Key events for the forthcoming week

Dollar:

There will be further expectations of a gradual US economic recovery during the first quarter of 2010. There will also be expectations of a Fed tightening during the first half. The central bank is still likely to take a cautious stance which will limit dollar support and there is also a high risk that the economy will falter again later in the year which will limit dollar support. The dollar should be able to gain some protection from a lack of confidence in the European economies. 

The dollar initially strengthened at the start of 2010, but was unable to break any key technical levels and found it difficult to maintain momentum as the economic data did not provide strong support, although there was an advance against the yen.

The latest US PMI manufacturing data was stronger than expected with an increase to 55.9 in December from 53.6 the previous month and this was the highest reading since June 2006. The US currency still managed to secure net gains following the data, although the advance was limited.

The services-sector data was slightly weaker than expected with the increase for December held to 50.1 from 48.7 the previous month. The employment component improved over the month, but remained well below the 50.0 threshold for expansion.

Elsewhere, the US pending home sales data was sharply weaker than expected with a 16% decline for November, primarily due to the fact that sales had been made earlier in anticipation that a tax credit for purchases would cease at the end of November. Sales were still over 15% higher than seen in November 2008. The factory orders data was stronger than expected with a 1.1% monthly increase

The ADP employment data was also slightly weaker than expected with reported private-sector job losses of 84,000 for December after a revised 145,000 decline the previous month.  The US jobless claims data was slightly stronger than expected with a figure of 434,000 for the latest week from a revised 433,000 previously

The FOMC minutes did not offer any dollar support with Fed members still very cautious over the economic outlook which will reinforce expectations of a very slow pace of tightening by the Fed, especially as they are still confident that inflation will stay low.

Regional Fed Governor Hoenig did, however, call for interest rates to rise soon which increased speculation over splits within the FOMC during 2010.

Markets have moved to price in a 60% chance probability that the Fed will increase interest rates by June. The dollar will, therefore, find it difficult to gain further strong support on yield grounds unless there is very strong data.

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There will be persistent unease over Euro-zone structural weaknesses, especially with fears over further credit-rating downgrades over the next few months. There will also be some further speculation over a debt default which would cause severe stresses. There will also be pressure on the ECB to adopt a very cautious approach to tightening policy in order to protect the weaker economies and this will tend to limit Euro support.

The Euro was slightly weaker on the crosses and also registered significant losses against commodity currencies while the overall performance was mixed.

There were reported remarks from ECB member Stark that Greece could not rely on external support which increased fears over a possible debt default and structural factors remained a negative Euro influence.

There were further warnings over currencies from French officials, pledging that currency imbalances would be a major topic during 2010. There were also in effect further protests against Euro strength which will also tend to unsettle the currency. Officials are concerned that that the Euro would be caught between competitive devaluations for the dollar and yen and be pushed to an artificially strong position which would undermine exports.

The German unemployment data was again stronger than expected with a 3,000 decline for December compared with expectations of a monthly increase. The Euro-zone headline inflation rate increased to 0.9% from 0.5% the previous month which was in line with market expectations

The Euro-zone industrial orders and factory orders data was also weaker than expected, although the impact was limited with markets tending to focus on the structural uncertainties.

Yen:  

There will be further unease over the government-debt situation over the next few months which will unsettle the yen. There will also be further speculation that the government will now be more receptive to the idea of a weaker domestic currency despite the mixed comments over the past 24 hours. There will still be a reluctance to sell the Japanese currency aggressively given vulnerabilities in the other major currency blocs. Any enthusiasm towards high-yield currencies could also fade rapidly later in the year.

The yen was generally weaker as markets were very sensitive to policy changes surrounding new government appointments. The dollar pushed to a four-month high around 93.75 before encountering profit taking.
The Finance Minister’s reported resignation on health grounds was a slight negative factor for the currency on continuing uncertainty surrounding economic policy.

With the confirmation of Kan as new Finance Minister, there was further speculation that the government would take a less robust stance in curbing government spending which would reinforce underlying debt fears.

There were also be expectations of additional government pressure on the Bank of Japan to provide additional monetary support which would tend to undermine the Japanese currency. Exchange rate policies will also be an important focus.

On Thursday, Kan openly called for a weaker yen which pushed the currency sharply weaker.  During Friday, Prime Minister Hatoyama warned against excessive yen moves and he also appeared to put pressure on the Finance Minister to change his rhetoric. Kan partially backtracked on his comments and called for exchange rates to be set by the market.

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Fears over the debt situation and speculation over a debt default will remain a clear threat to Sterling, especially as the deficit will not be addressed over the next few months. There will also be further speculation that the UK economy will under-perform other major economies during 2010 given the structural vulnerabilities. Weak performances in the Euro-zone economies and clear US weaknesses will still offer some degree of protection to Sterling, but there is some risk of heavy selling pressure on the currency.

Sterling depreciated over the week as a whole with markets still lacking confidence in the 2010 outlook. The UK currency weakened to lows below 1.60 against the dollar before finding some support and the Euro was again unable to hold above the 0.90 level against the UK currency.

The PMI index for the services sector edged higher to 56.8 from 56.6 previously which will maintain some optimism over the economy and offset the impact of a weaker consumer confidence survey released overnight.

The manufacturing index rose to a 25-month high of 54.1 from 51.8 the previous month which will provide some optimism over early-2010 prospects. The latest lending data also offered encouragement with a bigger than expected increase in mortgage lending for the month, although there was still a net contraction in consumer credit for the month.

The construction PMI index remained below 50 in December for the 22nd consecutive month, although there was some optimism surrounding 2010 in the residential sector. The Halifax reported a further monthly increase in house prices for December.

The latest Bank of England decision was in line with market expectations with interest rates left on hold at 0.50% with the quantitative easing amount also held at GBP200bn. The bank expects that the bond-buying programme will be completed during February with acute speculation over policies which will be pursued later in the first quarter.

Swiss franc:

Developments within Europe will continue to be watched closely and the Swiss currency is likely to gain some further defensive support from fears over the Euro-zone economy and the currency is liable to maintain a firm tone for now. The National Bank will remain an important focus, especially with a new Chairman now in office and the bank is still liable to block significant franc gains.  In this context, Swiss currency gains could still be limited.

The Swiss currency maintained a firm tone against the Euro and strengthened to highs beyond 1.48. The franc was slightly weaker against the dollar, but was able to resist heavy losses with the US currency blocked above the 1.04 level.

The PMI index weakened to 54.6 for December from 56.9 which raised some fears that the economic recovery will stall, although the short-term impact was limited.

There was a 0.2% decline in consumer prices for December with an annual increase in prices of 0.3%. The weak reading for inflation will tend to increase pressure for the bank to curb any further franc appreciation and markets will remain on high alert over the possibility

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The Australian dollar secured net gains over the week as there was optimism over 2010 economic prospects and renewed gains for commodity prices. The Australian currency strengthened to highs above the 0.92 level against the US dollar.

The latest Australian manufacturing PMI index retreated back to below the 50 level while the services-sector figure also weakened to 50 for the month which raised some doubts over the economic outlook.

Underlying confidence in the Australian economy and currency should remain firm in the short-term, but it may prove difficult to sustain further substantial gains.

Canadian dollar:

The Canadian dollar secured firm gains for the week as a whole, strengthening to a peak beyond 1.03 against the US dollar before consolidating above this level.

The Canadian dollar was boosted by a robust trend in commodity prices. There was also optimism over the domestic fundamental economic outlook with expectations of a solid recovery during 2010. 

The Canadian dollar fundamentals will remain firm, but a lack of yield support will tend to make it difficult to achieve further significant gains.

Indian rupee:

The rupee strengthened significantly at the beginning of the week and pushed to a 15-month high near 45.55 against the US dollar. There was optimism over 2010 economic prospects which triggered additional capital flows.

There was some speculation that the Reserve Bank would intervene to stem currency while importer dollar buying also increased as the rupee hit its best levels which stemmed a further advance for the currency.

The fundamental outlook should continue to underpin the rupee, although it will tend to be difficult to extend gains in the near term.

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The Hong Kong dollar broadly held its ground in the first week of 2010, moving slightly away from a low around 7.7580 against the US currency

The local stock market was firm which helped underpin the Hong Kong dollar during the week with expectations of further capital inflows to the region.

The Hong Kong dollar should be able to resist further significant near-term losses given confidence over the 2010 domestic and regional outlook.

Chinese yuan:

The Chinese central bank maintained tight control of the spot market during the week, although there was significant movement in the NDF market as yuan forward rates moved to a 1-month high

A prominent Chinese academic called for a one-off 10% yuan revaluation which maintained expectations that there would be an official policy shift during the course of 2010.

The speculation of a monetary tightening to stem credit growth was also boosted by an increase in the three-month bill rate to 1.37% from 1.33% previously and this would increase pressure for a firmer exchange rate policy as well.

The central bank will want to maintain a stable policy ahead of the Chinese New-Year period, but underlying pressure for a yuan policy shift will continue.