Weekly Forex Currency Review 11-12-2009

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Structural considerations will remain important over the next few weeks with a focus on the areas of economic vulnerability. Overall confidence in the US economy will remain weak due to important weaknesses, but there is also likely to be a further increase in unease over the Euro-zone outlook which will limit the potential for Euro support.

Key events for the forthcoming week

Dollar:

The US employment data triggered a rise in short-term interest rate expectations, but the shift ebbed quickly with markets still expecting rates to stay low for an extended period. The US fundamentals will also remain weak which will limit dollar support. Markets are still likely to be more cautious over the global outlook and there are likely to be reservations over aggressive dollar selling at current valuations given areas of concern elsewhere. The US currency will still find it difficult to make much headway given long-term vulnerability.

The dollar strengthened sharply at the end of last week following the stronger than expected employment data with non-farm payrolls falling by just 11,000 for November, the slowest rate of job losses since late 2007. The dollar strengthened to test one-month highs below 1.47 against the Euro before stalling.

Initial US jobless claims were higher than expected at 474,000 in the latest week from 457,000 previously, but there was a further decline in continuing claims which maintained some degree of optimism over a gradual labour-market improvement.

The trade deficit was lower than expected with a US$32.9bn shortfall for October after a revised US$35.7bn deficit the previous month and the dollar will take some limited comfort from a rise in capital goods exports which suggested a firm competitive position.

The other data was weaker than expected with the IBD consumer confidence index weakening to 46.8 from 47.9 the previous month and this was the lowest figure since August which maintained doubts over the spending outlook

In comments to the Washington press club, Fed Chairman Bernanke was generally cautious over the outlook for the US economy, warning that there were still important headwinds and that there were still doubts over the scope for a self-sustaining recover. The Fed chief also repeated comments that interest rates would remain at very low levels for an extended period. The comments were important in dampening the yield-based dollar rally seen on Friday following the November payroll report.

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At this stage, the ECB will maintain its policy of gradually withdrawing the extraordinary liquidity measures introduced at the height of the banking-sector crisis. There will, however, be increased fears over the internal stresses with a particular focus on the Greek debt situation. There will also be fears that these stresses will spread to other peripheral euro-zone economies. These concerns are liable to undermine wider Euro confidence with a small risk that there is substantial selling pressure on the currency if fears over a debt default increase.

The Euro was generally on the defensive during the week with fears over the structural situation contributing to significant selling pressure at times.

As far as the economic data is concerned, there was a 2.1% October decline in industrial orders for Germany and output also fell which created some doubts over the strength of a recovery although monthly data is volatile.

The Euro was undermined significantly by a Fitch downgrading of the Greek sovereign credit rating to BBB+ from A and there was also a negative outlook for the rating. There was a further widening of Greek bond spreads over German bunds. Standard & Poor’s also put Spain’s credit rating on negative watch from stable previously due to fears over the debt situation.

Bundesbank head Weber warned that Greek bonds would not be eligible to be used as collateral for ECB funds from the end of 2010 when the temporary reductions in eligibility criteria are due to end.

Yen:  

The Japanese currency will continue to gain some degree of support when there is a wider deterioration in global risk appetite. Overall selling pressure on the yen is also liable to be curbed by a lack of confidence in the major currency alternatives. There will be pressure on the Bank of Japan to resist currency gains and there will also be further serious doubts over the Japanese debt situation which will make it difficult for the yen to sustain any substantial gains, especially with a possible intervention threat.

After falling sharply at the end of last week following the US payroll data, the yen recovered ground as doubts over the global economy continued. There was also evidence of exporter selling at levels above the 90 level.
The third-quarter Japanese data was revised sharply lower to record a 0.3% increase compared with the previous 0.8% figure while the GDP price deflator was also revised sharply lower which will reinforce deflation fears. The data will maintain pressure for additional support measures from the Bank of Japan and maintain fears over the economic outlook.

Domestically, machinery orders declined 4.5% in October following a sharp increase the previous month. This was broadly in line with market expectations and suggested some underlying stabilisation in capital spending, although confidence will remain fragile as the economy is still vulnerable to underlying pressure.

The government formally announcing a US$80.6bn fiscal stimulus package. There will be some optimism that there will be support for the economy, but there will also be further unease over the debt outlook even though the government pledged to curb bond issuance. There was also a significant deterioration in the services-sector PMI index which will maintain underlying fears over the domestic growth outlook.

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There will be persistent fears over the UK government debt position, especially as the pre-budget report did little to tackle the underlying deficit. There will be further speculation over a credit-rating downgrade and these fears are liable to intensify if there is any evidence of a renewed downturn in the economy. Sterling will also tend to lose support if there is a sustained deterioration in global risk appetite. In this environment, Sterling is likely to have weaker tone and there is some risk of heavy selling pressure on a wider loss of confidence.

Sterling remained under pressure during the week as government debt fears persisted, although the degree of selling slowed later in the week with Sterling finding support below 1.62 against the dollar.

The trade data was weak with a GBP7.1bn deficit for October, the highest deficit level since January. The industrial data was weak with production unchanged for October compared with expectations of a 0.5% increase.

The impact was offset to some extent by the Halifax house-price index which recorded the fifth successive monthly advance while the CBI industrial survey also recorded an improvement. The NIESR also recorded a return to growth with a GDP expansion of 0.2% in the year to November

In the pre-budget report, the government announced a slightly higher budget deficit forecast for the current fiscal year of GBP178bn with very little change for next year with a deficit of GBP176bn.

There was a proposed tax on banking-sector bonuses, but little in the way of fresh measures to curb near-term borrowing levels, although labour-market taxes were raised slightly from 2011. There were increased fears that no significant action would be taken before the general election which must be held by June 2010.

In this environment, there is a high risk that market confidence in the debt situation will deteriorate further and there was speculation that there could be a very serious loss of confidence which could trigger heavy Sterling selling. There was renewed selling pressure following the report, but Sterling again found support below 1.62 against the dollar.

The central bank policy was in line with expectations with interest rates held at 0.50% while the amount of quantitative easing was also left on hold at GBP200bn. The bank expects that the bond-buying programme will be completed in 2 months and that it would reassess the situation then.

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 central bank to resist a policy of currency debasement and this will certainly tend to limit any selling pressure on the franc.

The dollar strengthened against the franc during the week, but hit tough resistance close to the 1.03 level. The Euro advanced to the 1.51 area, but again stalled close to this area.

In its quarterly monetary policy decision, the National Bank left interest rates at 0.25%, in line with expectations. The bank also maintained its policy of intervention to prevent franc appreciation while corporate bond purchases were scaled back. This represented a gradual move towards a more normal policy, but interest rates were expected to remain at very low levels over the next few months.

The decision to maintain the intervention policy also tended to curb franc support with expectations that any advance will be blocked by the bank.

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The Australian dollar weakened significantly to lows near 0.90 against the US currency during the week. Buying support on dips was again a notable feature with a rally back to the 0.92 area.

There was another stronger than expected labour-market data. Employment rose by over 30,000 for November compared with expectations of a 5,000 increase, maintaining expectations of a robust performance by the Australian economy, especially in comparison with the G7 economies.

Australian dollar sentiment is likely to remain robust which will limit losses, but resistance levels are likely to remain difficult to break down.

Canadian dollar:

The Canadian dollar familiar ranges against the US currency and after a retreat towards 1.0650, the Canadian currency was able to strengthen back towards the 1.05 level. The currency moves were again influenced significantly by degrees of risk appetite with a recovery in equity prices providing some degree of support.

The Bank of Canada left interest rates at 0.25% following the latest central bank meeting and also took a slightly more cautious tone on economic prospects which dampened currency support.

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

Indian rupee:

The rupee had a generally weaker tone over the week and dipped to two-week lows near 46.70 against the dollar, undermined in part by a firmer US currency and importer demand for dollars, especially in the energy sector.

The Reserve Bank announced that it would tighten rules surrounding external borrowing which increased speculation over weaker investment inflows while stock-market conditions were uncertain. The currency was cushioned by hopes over a recovery in the domestic and regional economy.

The fundamental outlook should offer some degree of reassurance, but the rupee will continue to be vulnerable to selling pressure if there is a deterioration in risk appetite.

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The Hong Kong dollar maintained a position close to the 7.75 limit against the US dollar during the week with only marginal losses.

The general stock-market tone was slightly less confident over the week which curbed capital inflows and also eased upward pressure on the Hong Kong currency.

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

Chinese yuan:

The Chinese central bank maintained very tight control of the market during the week with wider dollar moves not having a major impact on the yuan rate.

Government advisors continued to suggest that there would not be big yuan moves, while central bank officials stated that Chinese currency moves were not central to global economic rebalancing.

There was also some suggestion that the central bank would look for a tighter policy on loans during 2010 which increased speculation over a medium-term move to let the currency advance. Robust industrial data provided some support to sentiment.

Although, the central bank is still likely to maintain yuan stability in the short-term , the potential for a gradual tightening of monetary conditions will make this policy even more difficult to sustain.