Weekly Forex Currency Review 11-09-2009

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Underlying confidence in the US dollar is likely to remain generally weak in the short-term with further speculation over a medium-term central bank diversification away from the currency.  Given vulnerabilities elsewhere, the dollar could still prove to be broadly resilient in the near term, especially as there are still very important global vulnerabilities.  

Key events for the forthcoming week

Dollar:

Overall confidence in the dollar will remain fragile in the short-term with further speculation over medium-term reserve diversification away from the US currency. The massive debt financing burden will also tend to be a negative influence while there will be an increased risk of the dollar being used as a funding currency. The dollar will also tend to lose support when confidence in the global economy is stronger, especially if US investors take a more aggressive stance. There are still important vulnerabilities in other major currency areas which should limit selling pressure on the dollar.    

Market activity was stifled early in the week by the US Labour-day holiday, but the general theme was a trend towards US dollar weakness. The US currency dipped to 12-month lows against the Euro as there was evidence of general selling with the trade-weighted index also at 2009 lows.

There was further speculation over medium-term reserve diversification away from the US currency. There were also greater expectations that the dollar would be used as a global funding currency as short-term interest rates declined to record lows with Libor rates dipping to below Japanese rates.

The US trade deficit rose sharply to US$32.0bn for July from a revised US$27.5bn the previous month and this was the biggest percentage monthly increase for 10 years. There was a sharp increase in exports and imports over the month which maintained optimism over an improvement in conditions and a recovery in trade volumes.

Elsewhere, initial jobless claims fell to 550,000 in the latest week from a revised 576,000 previously while continuing claims fell. The data maintained expectations that the labour market is gradually improving, but remains very weak in historic terms and did not signal a peak in unemployment.

In the Federal Reserve’s Beige Book report, most districts noted a gradual improvement in conditions while manufacturing was expanding. Housing and commercial property demand was still very weak while credit standards were tight and inflation pressures were weak while the labour market was also still very fragile.

The report overall created some degree of caution over the economy and stemmed any further strong improvement in risk appetite. Fed officials reinforced their medium-term determination to curb inflation pressures, but suggested that policy stimulus would not be withdrawn at this stage.

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The overall evidence still suggests a gradual improvement in Euro-zone conditions which will help underpin sentiment. The Euro will also tend to gain support when global risk appetite is firmer. There are still important structural risks and the ECB will maintain an aggressive monetary policy in the near term. In this environment, the Euro will still find it difficult to gain strong traction from current levels, especially with fears over a deterioration in credit conditions over the next few months.    

The Euro maintained a generally firm tone over the week with an advance against the dollar a main focus while the currency struggled to secure strong gains on the crosses.

The Sentix business confidence index improved for September. There was also a larger than expected 3.5% increase in German factory orders for August, although the annual decline was still close to 20.0%.  The Euro also gained some initial backing from the latest German trade data with a 2.3% monthly increase in exports.

There was a surprise 0.9% decline in German industrial production for July after a revised 0.8% increase the previous month, but the negative Euro impact was short lived with investors more confident over the near-term outlook.

ECB council member Weber repeated recent ECB comments that it was too early for the bank to make an exit from the extraordinary policy measures, although monetary developments did need to be watched very closely.

Yen:  

The yen is still proving to be broadly resilient to selling pressure even when risk appetite is firmer and underlying selling pressure appears to have eased. There will be some speculation that the yen will be less vulnerable to being used as a global funding currency. There will be increased institutional dollar support towards the 90 region which will provide some significant degree of support to the US currency even if the yen resists selling pressure. 

The Japanese currency probed 7-month highs against the dollar over the week and was generally resilient on the crosses, although it was unable to make significant headway. The dollar dipped to lows near 91 against the yen on Friday.

There was speculation over a repatriation of capital by Japanese companies ahead of the end of the third quarter which supported the yen.

The domestic data was weaker than expected with a sharp 9.3% decline in core machinery orders for July compared with expectations of a 3.5% decline. Although the data is volatile, the weak releases reinforced fears over the economy’s trajectory.  Wholesale prices fell 8.5% in the year to August which was close to expectations.

Bank of Japan member Suda commented that the need for unconventional policies was fading. Suda is a notable hawk in policy terms and the overall short-term market impact should be limited as the majority of bank members will look to maintain the current policies in the near term.

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The Bank of England decision to rest a further expansion of quantitative easing will provide some degree of Sterling support and the recent data has provided some degree of relief with optimism over near-term economic trends. There will still be an important element of protection when international risk appetite is at a stronger level. Given the weakness in the debt and credit position, the UK currency is still likely to be subjected to renewed selling pressure over the next few months as a whole even with a firm near-term tone.

Sterling was able to resist further selling pressure during the week and eventually pushed towards 1-month highs above 1.67 against the dollar. There was also buying support weaker than 0.88 against the Euro.
UK industrial production rose 0.5% in July after a revised 0.6% gain the previous month which will helped underpin sentiment towards the manufacturing sector and also push Sterling stronger.

The NIESR institute also reported GDP growth of 0.2% in the three months to July which reinforced speculation that the recession has ended, although there was also major caution over the outlook with a warning of stagnation.

The visible trade deficit was unchanged at GBP6.5bn for July. There was a tentative increase in import and export volumes which could offer some degree of support, but the data did not have a major impact on the currency.

The Bank of England left interest rates on hold following the latest MPC monetary policy meeting and the amount of quantitative easing was also left unchanged at GBP175bn. The bank is expecting the current bond buying programme to be completed within the next two months.

There had been some speculation that the bank would expand its quantitative easing and the decision to maintain a steady policy provided some relief with speculation that the bank was now slightly more optimistic which boosted Sterling confidence.

Swiss franc:

The National Bank policies will remain extremely important in the short-term and there is still a high risk of intervention to deter further franc gains. The bank will, however, be reluctant to aggressively take on the market which will maintain the risk of volatility.  The franc will tend to lose some support if there is a sustained improvement in international risk appetite and looks to be very fully valued at current levels.     
 
The dollar dipped to test 2009 lows against the Swiss franc during the week with a low around 1.0350. The franc was also generally firm on the crosses during the week.

There were rumours of National Bank intervention to weaken the Swiss currency and this contributed to the sharp dollar advance, but the US currency was unable to sustain the gains. The central bank declined to comment on the market rumours, in line with its normal policies. The franc also resisted losses against the Euro despite intermittent spikes weaker.

Seasonally-adjusted Swiss unemployment rose to 4.0% for September from 3.9% which was a six-year high, although the impact was limited. Consumer prices fell 0.8% in the year to August.

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The Australian dollar maintained a firm tone against the US currency during the week, but found it difficult to make strong headway with selling pressure above 0.8650 against the US currency.

Retail sales fell 1.0% for August compared with expectations of a significant monthly increase while there was also a decline in mortgages for the month. The data created fresh doubts over the scope for Reserve Bank tightening and was a negative factor for the Australian dollar. 

There was also a sharper than expected fall in employment for August, although the unemployment rate was slightly lower than expected at 5.8%. The construction PMI index improved for September, but was still substantially below the 50 level.

The Australian dollar is likely to be near a peak level even though near-term corrective reversals will be limited and will attract firm buying support.

Canadian dollar:

The Canadian dollar maintained a generally firm tone against the US dollar over the week, but there was resistance on gains towards the 1.07 level.

The Bank of Canada left interest rates on hold at 0.25% following the latest council meeting. The central bank again warned over the potential negative impact on the economy of a strong currency, but there was little evidence that the bank was preparing to be more aggressive on blocking currency gains.

The trade account recorded a CAD1.4bn trade deficit for July, maintaining a poor run of data. Trends in risk appetite and commodity prices tended to have a bigger impact and provided net underlying support to the local currency as there was increased confidence in the global economy.

The Canadian dollar should prove to be generally resilient in the short-term even if further advances are limited.

Indian rupee:

The rupee maintained a generally firm tone against the US currency and strengthened to highs around 48.30 before correcting slightly weaker. The Indian currency was underpinned by a generally weaker US currency trend over the week while risk appetite was generally firmer.

The local bourse advanced to a 15-month high which underpinned sentiment and net capital inflows have improved over the past few weeks.

The rupee will continue to gain support when global risk appetite improves, especially if the US dollar remains under pressure. Nevertheless, the net risks suggest that the currency will find it difficult to make much headway. 

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The Hong Kong dollar strengthened back towards the 7.75 band limit against the US dollar during the week. Trends in international risk appetite were generally favourable which helped underpin confidence.

There was also further evidence of IPO-related fund inflows. Which helped support the local currency during the week.

The Hong Kong dollar should maintain a broadly firm tone unless there is a serious deterioration in confidence surrounding the Chinese equity markets and economy.

Chinese yuan:

The yuan moves were still very limited during the week and it was only able to secure marginal gains against the US dollar, although it did move to a 14-week high against the US dollar. There was a firmer tone in the NDF market with the forward rates moving to a two-month low as markets were more confident over medium-term currency appreciation.

The latest data was generally favourable with industrial production growth at a 12-month high while the trade surplus was wider for the month. Government officials were still generally very cautious over recovery prospects and pledged that the fiscal stimulus plans would be maintained in the short-term.

There will be further expectations of medium-term Chinese currency appreciation, especially if the US dollar retains a softer tone against the major currencies.