Weekly Forex Currency Review 12-12-2008

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Confidence in the global economy will remain very weak in the short-term. There is tentative evidence that money-market tensions are easing and further progress in stabilising conditions would underpin risk appetite, although sentiment will still be very fragile, especially with no resolution to the US auto-sector crisis. There will tend to be a greater focus on economic fundamentals which could expose the dollar to further selling pressure.  

Key events for the forthcoming week

Dollar:

There has been no evidence of stabilisation in the economy and fears over the impact of a sharp rise in unemployment and downward pressure on house prices will continue in the short-term. The Federal Reserve will continue to adopt an aggressive policy on interest rates. Any direct action to push long-term interest rates down would also tend to undermine capital inflows into the US.  The dollar will be more vulnerable to selling pressure if there is a greater focus on economic fundamentals rather than risk-related fears. In this context, the US currency will struggle to secure support on the failure of the auto-sector support package. 

The dollar generally lost ground over the week, notably against the Euro with a seven-week low around 1.34, as a combination of factors unsettled the US currency.

There were increased fears over the US fundamental outlook while defensive demand for the currency was also weaker as markets attempted to stabilise. Dollar Libor rates fell which suggest ed that funding pressures could be easing. Commodity prices also rallied with notable advances for gold before some reversal on Friday.

Confidence remained very fragile following the extremely weak payroll data at the end of last week. There was a 533,000 decline in non-farm payrolls for November which was the sharpest monthly decline since 1974 while unemployment continued to rise. The employment data continued to give cause for concern this week with initial jobless claims rising to 573,000 in the latest week from a revised 515,000 the previous week. This was a 26-year high for claims and continuing claims were at a record high.

Continuing stresses within the labour market maintained expectations that the Fed will cut interest rates again to below 1.0% next week and also consider more radical, direct quantative policies to support the economy.

The trade deficit widened to US$57.2bn in October from US$56.6bn the previous month as imports from China were at a record high. Import prices continued to decline sharply which alleviated upward pressure on imports.

Congressional negotiations surrounding a support package for the auto sector was an important focus over the week and Senate rejection of the plan caused a renewed spike in risk aversion on Friday which triggered a partial reversal of dollar losses.

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The Euro-zone economy will continue to weaken in the short-term with a particular fear over the industrial sector while consumer spending levels are likely to be slightly more resilient. The ECB will certainly consider cutting interest rates again, but the bank is now likely to be more cautious unless there is evidence of serious deterioration, especially as it will continue to target medium-term stability. Confidence in the Euro will weaken if there is a further increase in internal stresses, tensions over fiscal policy and rising bond yields.  
       
The Euro strengthened significantly over the week with a strong advance against the dollar and Sterling. This primarily reflected a lack of confidence in these alternative currencies rather than any strong enthusiasm for the Euro.

The Euro-zone industrial data remained weak with sharp production declines for Germany, France and Italy for the latest month The latest ZEW business confidence survey recorded a second successive monthly recovery to -45.2 in December from -53.5 the previous month. ZEW officials were still generally downbeat over economic prospects while Euro-Group head Juncker also warned that there might not be a recovery in the Euro-zone economy until 2011.

ECB officials continued to indicate that the decline in inflation would make it easier to cut interest rates, although they re-iterated that the bank would not pre-commit on rates. There were also mixed comments with Stark, for example, stating that the bank did not have a lot of room for manoeuvre following the 0.75% cut this month.

Bank Chairman Trichet suggested that the bank could consider more radical policies such as the buying of bonds if money-market conditions deteriorated further.

Yen:  

The economy will remain weak with domestic and export sectors under pressure. There will also be increased unease over the impact of a rise in financing difficulties faced by Japanese companies. Given the hostile economic conditions, there will be increased sensitivity to exchange rate considerations and there will be pressure for the authorities to intervene and resist further yen appreciation. Sustained yen losses are unlikely until there is an improvement in confidence surrounding the global economy and financial markets.      

The Japanese currency retained a generally firm tone over the week, although there was a diversity of performance as fundamentals attempted to reassert themselves. The yen strengthened to a 13-year high below the 90.0 level on Friday as the US auto-sector bailout plan was rejected and Asian equity markets fell sharply.

There was a 4.4% decline in core machinery orders for October, reinforcing the recent industrial deterioration, while wholesale prices inflation continued to slow sharply. Bank of Japan member Nishimura also warned that credit risks were rising for Japanese companies. Although bank lending increased, this was due to difficulties in obtaining other sources of finance rather than confidence in the outlook The government formally announced a JPY23trn fiscal stimulus package.

Bank of Japan Governor Shirakawa stated that the authorities were closely monitoring the impact of yen gains on the economy. Importantly, he also stated that the Finance Ministry could order market intervention if the yen continued to strengthen.

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The economy will weaken further in the short-term with unemployment rising sharply while there is little chance of a recovery in the housing sector until there is an improvement in credit conditions, although the cuts in interest rates will have a stabilising effect. International confidence in the economy is likely to remain very weak with a particular focus on the escalating budget deficit. Attractive valuations should, however, attract some direct inward investment. The US and Euro-zone difficulties will also provide some degree of Sterling protection, but confidence will remain very fragile at best.

Sterling remained under pressure for much of the week as confidence remained at extremely weak levels. The currency dipped to record lows beyond 0.89 against the Euro, but did secure a small advance against the dollar.

The UK data offered no sign of relief over the economy. Industrial production fell by a further 1.7% in October, the eighth successive decline, to give a 5.2% year-on-year decline. The BRC retail sales report recorded a decline in like-for-like sales of 2.6% in the year to November while housing activity remained at a record-low.

The data reinforced fears over a sharp fourth-quarter GDP contraction as the evidence suggests that all sectors of the economy were in difficulties. These fears were reinforced by the latest NIESR report which estimated that GDP declined by 1.0% in the three months to November after a revised 0.8% fall previously.
Forward - looking data was still weak with the CBI orders index edging only slightly higher to -35 in December from -38 previously. MPC member Sentance warned that there would be a long and deep recession, although he also warned that the sharp interest rate cuts would need time to have an effect. There was some tentative evidence of an improvement in sales according to the latest weekly John Lewis report.

The German Finance Minister attacked the government’s economic policies and this contributed to negative sentiment surrounding the UK economy.

Swiss franc:

The economy will continue to weaken in the short-term with a strong probability that GDP will contract over the next few quarters. The negative comments from the National Bank will also be taken very seriously and will continue to undermine confidence in the economy. The franc will also tend to be unsettled by continuing fears over the banking sector. The Swiss currency will also tend to lose some ground if there is a sustained improvement in risk appetite.   

The franc weakened sharply against the Euro over the week and dipped to lows beyond 1.58, the weakest level for over two months before some respite. The franc still managed to secure a net advance to near 1.18 against the dollar.

The seasonally-adjusted unemployment rate edged higher to 2.7% for November from 2.6 previously while there was a small improvement in the ZEW consumption index.

At Thursday’s policy meting, the National Bank cut interest rates by 0.50% to a band of 0.0 - 1.0% with a central rate of 0.50% which was in line with market expectations.

The bank downgraded its outlook for 2009, forecasting that the economy would contract for the year, and it took a notably pessimistic stance towards the economy as a whole.  The bank stated that it may have to consider alternative quantative measures to support the economy. Bank member Hildebrand also stated that the weakening of the franc was a deliberate policy which further eroded confidence in the currency.

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The Australian dollar struggled for traction over the first half of the week, but then rallied strongly with a move to 0.68 against the US dollar. There was a recovery in commodity prices while general US weakness was supportive.  The Australian dollar failed to hold the gains as equity prices came under renewed pressure.

Business confidence remained at depressed levels according to the latest NAB survey with a warning that the economy was in recession, although the domestic data had only limited impact. Unemployment increased to 4.4% in November while there was a 15,600 decline in employment for the month.

The Australian dollar has scope for limited gains, but is unlikely to make much headway unless there is evidence of stabilisation in the global economy.

Canadian dollar:

The Canadian dollar was subjected to sharp volatility with a wide range against the US currency. The Canadian dollar briefly re-tested October lows just beyond 1.30 against the dollar before rallying to beyond 1.22 and settling near 1.25.

The Bank of Canada cut interest rates by a further 0.75% to 1.50%. The central bank downgraded its assessment of the global economy with substantially les confidence in the economy. The bank, however, did not make any reference to a further cut in rates which triggered some speculation over a pause in rate cutting.

The economic data had only a limited impact with a decline in housing starts according in the latest monthly report. The trade surplus declined over the month as exports to the US remained under pressure and industrial fears persisted.

The Canadian dollar is liable to remain volatile with scope for limited net gains in the short-term with fears over the global economy continuing to limit any advance.
 
Indian rupee:

The rupee secured some significant respite against the US dollar and strengthened to near the 48.20 level with the biggest one-day gain for a month. The dollar was undermined by heavy selling in the NDF market, especially as general sentiment towards the US currency was also weaker

There were tentative flows into the local stock market which also provided underlying rupee support after heavy outflows over the past few months, although risk appetite dipped again on Friday with the rupee near 49.0 as regional pressures returned.

Although volatility levels are liable to remain elevated in the near term, there is scope for a further underlying tentative recovery for the Indian rupee. 

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The Hong Kong dollar regained ground during the week and re-tested the 7.75 upper-limit within the permitted band. Renewed strength for the currency forced the HKMA to intervene again to inject liquidity during Thursday and Friday.

The Hong Kong dollar secured some respite from a recovery in risk appetite while there was also evidence of carry-trade unwinding as US confidence ebbed.

The Hong Kong dollar should retain a firm tone for now with some renewed speculation that there could be an adjustment in the currency band. 

Chinese yuan:

Following the yuan slide the previous week, the Chinese currency regained some ground and settled just stronger than 6.85 against the US dollar on Friday.

The central bank guided the currency firmer and the underlying pressures were easier to manage as the dollar was generally weaker in global markets.

The Chinese economic data was generally weak with consumer inflation dropping to a 22-month low of 2.4% for November while there was an annual decline in exports which reinforced fears over a sharp slowdown in the economy as a whole. There was speculation over resistance to yuan gains given the trade pressures.

Increased fears over the Chinese economy and speculation over further support measures to underpin demand will limit the potential for yuan appreciation with government exchange-rate hints watched very closely.

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