Weekly Forex Currency Review 13-02-2009

As the global downturn persists, two areas will be extremely important for markets. There will be a focus on central bank policies to assess which institutions will move decisively towards a quantitative easing approach and the currencies of these economies will tend to weaken in the medium term. There will be additional pressure for attractive exchange rates which will increase the threat of trade friction and competitive devaluations.

Key events for the forthcoming week

Dollar:

The economy will continue to weaken in the short-term. The budget and financial initiatives from the Administration will remain an important focus. The dollar will continue to gain some defensive support when confidence in the US and global economy deteriorates. The overall US fundamentals will remain extremely weak with the huge financing requirement an important negative dollar factor There is also likely to be some optimism that the economy can stabilise.  In this context, the US currency will struggle to sustain any significant gains.   

The markets failed to find a consistent theme over the week and this also led to indecisive trading conditions in the main currency pairs. Confidence generally waned over the week and this gave the dollar a firm tone as defensive demand remained a feature, although net gains were limited in choppy trading conditions.

After the huge 598,000 employment drop in last week’s payroll report, the economic trends remained a key focus. Retail sales data was stronger than expected with a headline 1.0% increase for January, in contrast to expectations for a further monthly decline, and this was the first increase for seven months. Underlying confidence was still fragile following a revised 3.0% decline the previous month.

The labour-market data remained weak with initial jobless claims falling only slightly to 623,000 in the latest week from a revised 631,000 previously. The extremely high claims level maintained fears over employment conditions and the impact on future spending.  There was also a significant decline in business inventories which increased speculation over a downward revision to fourth-quarter GDP while the NAR reported that house-prices had retreated to a five-year low.

The trade deficit fell for the fifth successive month to a six-year low of US$39.9bn from a revised US$41.6bn. There was a further sharp monthly decline in imports and exports, reinforcing fears over a deep downturn. Although the underlying deficit improvement offered some dollar support, recession fears tended to remain dominant.

US Treasury Secretary Geithner announced the new Financial Stability Plan to support the US banking and wider financial sector. There will be further support of the banks through asset purchases while the Treasury will look to boost consumer credit, potentially with support of over US$1.5trn.

In testimony, Fed Chairman Bernanke took a generally very cautious tone over the economic trends. There were no specific announcements on the buying of long-term US Securities. Congress moved towards approving a slightly smaller US$798bn fiscal stimulus package as the Federal budget deficit continued to rise rapidly. The lack of policy detail from the Treasury and Fed, combined with budget uncertainties, contributed to renewed uncertainty and weak risk appetite. 

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The Euro-zone economy will remain under pressure in the short-term.  The comments from ECB officials continue to suggest that the bank will cut interest rates again in March. The potential Euro damage will be limited by the fact that interest rates have been cut sharply in all the major economies.  The Euro will be unsettled by a lack of confidence in the banking sector, especially with fears over the Eastern European economy. The ECB still looks the most likely central bank to resist a policy of currency debasement which will offer important protection.      
       
The Euro had a mixed tone over the week  There were reports of institutional buying at lower levels which provided some degree of support and it did rebound from medium-term technical support levels against major currencies.

The German trade surplus weakened for December, but the monthly decline in exports was slightly lower than expected at 3.7%. The Euro-zone industrial data remained weak with a 2.6% decline for December with a 12% annual decline which was a record annual fall for the region while business confidence weakened for the month. German GDP fell a sharp 2.1% in the fourth quarter of 2008.

There were further stresses within Eastern Europe and this remained a negative factor for the Euro, especially with weak confidence surrounding the financial sector and speculation that Baltic currency pegs would come under further pressure.

There were a series of comments from ECB officials over the week. The tone consistently indicated that there was scope to cut interest rates at the March council meeting with the bank continuing to give very strong policy signals. There was, however, further opposition to a policy of pushing rates towards zero.

Yen:  

Although the most recent data has been slightly firmer than expected, the industrial sector will remain in very severe difficulties in the short-term. With fears over deflation returning, there will be additional pressure for new quantitative easing by the Bank of Japan. There will also be demands for yen appreciation to be resisted which could trigger friction with other G7 members. The yen will still tend to resist substantial selling pressure unless there is a sustained improvement in global risk appetite.        
  
The Japanese currency was trapped in relatively narrow ranges against the dollar over the week with dollar support below the 90 level. The Japanese currency secured small net gains on the crosses as confidence remained fragile.

The Japanese machinery orders data was stronger than expected with the monthly decline held to 1.7% compared with expectations of decline of over 8%, but there were further profit warnings from key Japanese companies. Wholesale prices fell 0.2% in the year to January, the first decline for five years, reinforcing deflation fears.

There was some speculation over capital repatriation to Japan given a heavy schedule of US Treasury bond coupon payments. In contrast, there were reports that the postal savings fund was a substantial dollar buyer at lower levels.

Markets remained on alert over exchange rate comments from key Japanese and international officials with G7 meetings due at the end of this week. There was some further speculation that Japan would push for yen gains to be capped given the severe domestic industrial stresses.

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The economy will continue to weaken in the short-term as employment remains under pressure. The Bank of England comments suggest that it is moving closer to additional measures such as direct quantitative easing to lessen the deflation threat.  Such a policy would pose important risks to the UK currency.  Sterling should still be able to gain some support on valuation grounds while weak prospects throughout G7 will also offer some relative support. Even if Sterling resists selling pressure, it will be difficult to secure more than a limited recovery.

Sterling had a generally weaker tone over the week with a reversal of gains seen over the first 10 days of February. The UK currency weakened to lows near the 1.41 level against the US dollar and 0.91 against the Euro before correcting sharply stronger. The domestic influences and global trends in risk appetite were both very important.

The UK data offered some support with a surprise 1.1% BRC like-for-like retail sales increase for January. The goods trade deficit was also lower than expected at GBP7.4bn for December from a revised GBP8.1bn previously. Primarily, the improvement reflected weak imports, although the was some support from exports.

The UK unemployment claimant count rose by 73,800 in January after a revised 79,900 increase the previous month which created some relief given fears over an even higher increase. Nevertheless, the unemployment rate was still at a 9-year high.

In its quarterly inflation report, the Bank of England stated that inflation was likely to fall substantially below the 2.0% target in the medium term, potentially with a level of around 0.50% in two years time. Bank Governor King also warned that the UK was experiencing a deep recession as forecasts were downgraded again.

The report stated that there was little scope for further stimulus through interest rate cuts with an increased focus on the possibility of quantitative easing. King stated that this would remain under discussion and that there could be a decision to implement such a policy at the March MPC meeting. This will be a very important market focus.

Swiss franc:

Confidence in the Swiss economy will remain weak in the short-term, especially with continuing stresses on exports. The National Bank will maintain a policy of very low interest rates, especially with inflation at a two-year low. The central bank is also likely to continue the policy of verbal intervention to limit currency appreciation. The bank stance will severely limit the potential for franc gains even if the currency gains interim support on a spike higher in risk aversion.   

The franc was trapped in relatively narrow ranges against the dollar despite choppy market conditions. The franc secured net gains against the Euro. The Swiss currency gained support when risk appetite faded over the week with choppy trading.

Swiss consumer prices fell 0.8% in January which pushed the headline inflation rate down to a two-year low of 0.1%. This reinforced expectations that the National Bank would maintain a very low interest rate policy, especially as producer prices also fell.

There were fewer warnings over the possibility of intervention to weaken the Swiss currency, although it remained a significant background factor.

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The Australian dollar pushed to highs above the 0.68 level against the US currency, but was unable to sustain the gains as risk conditions deteriorated again with sharp changes in direction during the week.

Confidence was damaged to temporarily by the opposition’s stance against the fiscal stimulus proposals, although there was approval late in the week and global shifts in sentiment were very important for sentiment.

There was a further deterioration in business confidence according to the latest NAB survey while the housing data was firmer. Although unemployment rose to 4.8% in January from 4.5%, the employment data was stronger than expected with a 1,200 increase in the month after no change the previous month.

Trading conditions will tend to remain erratic, but there is scope for a limited Australian dollar advance as fears over the global economy ease slightly.

Canadian dollar:

The Canadian dollar found support weaker than the 1.25 level against the US currency during the week, but struggled to make strong headway in choppy trading conditions.

The currency was undermined by global growth fears and low risk appetite while firm gold prices only provided limited support to the currency.

Domestically, the trade account recorded a shortfall of CAD0.5bn for January and this was the first monthly deficit for over 30 years as exports remained under pressure.

Overall, there is scope for limited Canadian dollar gains as a substantial amount of Canadian deterioration has been priced in, although volatility will remain high.
 
Indian rupee:

The rupee moves were again influenced strongly by conditions in the global economy and overall risk appetite. A brief period of improved confidence allowed the rupee to strengthen to 3-week highs near the 48.50 level.

Although it was unable to sustain the gains, there was support towards 48.90 as risk conditions improved again. Industrial output fell 2.0% in the year to December, maintaining fears over the growth outlook.

Overall, there is the potential for limited rupee gains with international fears easing slightly which should underpin capital flows into the local stock market.  

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The Hong Kong dollar continued to edge stronger over the week with highs beyond the 7.7520 level, but it eased away from near the band limit against the US dollar.

There was evidence of improved confidence surrounding the economy and some defensive capital inflows on expectations for banking stability, although there was again strong evidence of two-way flows with confidence surrounding the local stock market still relatively fragile.

The Hong Kong dollar should be able to maintain a relatively steady tone with the potential for a renewed focus on the need for HKMA intervention to protect the band. 

Chinese yuan:

The Chinese yuan was again confined to familiar and narrow ranges near 6.8350 against the US currency over the week as the central bank retained tight control.

The economic data remained an important focus with exports falling sharply by 17.5% in the year to January. The impact was limited by the fact that shipment levels had been distorted by the timing of the New Year holiday.

In contrast, the other data recorded a strong increase in loans during January which maintained some hopes for a recovery in the economy.

The economic and political trends will continue to be monitored very closely in the short-term.  The yuan will gain some support from hopes over an economic recovery, although confidence could reverse very quickly.

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