Weekly Forex Currency Review 14-11-2008

Overall strategy: 

There will be serious fears over the global economy as growth conditions continue to deteriorate. The major industrial economies will continue to promote lower interest rates and fiscal measures to alleviate stresses. In this context, the G20 meetings will be watched closely. There is also likely to be an increasing focus on the US fundamental vulnerability, especially with a serious budget deterioration, and this is likely to represent a major test of underlying dollar confidence.

Key events for the forthcoming week

Dollar:

Confidence will remain very weak in the short-term  with consumer spending under pressure and the probability of a sharp GDP contraction for the fourth quarter. There will be additional pressure for the Federal Reserve to sanction a further cut in interest rates. The borrowing requirement will continue to rise strongly and confidence in the Fed as well as the Treasury is also at risk over changes to the bailout plans. In this environment, there is an increased risk that confidence in the dollar will weaken. The US currency will still gain important near-term support on defensive grounds as global fears intensify.

The dollar retained a firm bias for much of the week, notably against Sterling, but was unable to hold the best levels against the Euro. Although fears over the global economy provided support, there were increasing doubts over the US fundamentals as the week progressed following a stream of troubling data releases.

Initial US jobless claims rose to 516,000 in the latest week from a revised 484,000 the previous week and this was the highest figure since 2001. Continuing claims also increased further and reached the highest level for over 25 years. The data suggested both an increase in layoffs and continuing difficulties in finding new jobs. The latest retail surveys continued to suggest that spending had weakened during October.

The trade deficit narrowed to US$56.5bn for September from US$59.1bn the previous month. There was a decline in exports and imports for the month. There were market concerns over the implications of declining trade volumes. The monthly budget deficit for October was also a record US$237.2bn as spending rose sharply while revenue fell 7.5% over the year which illustrated the negative impact of a weaker economy.

Treasury Secretary Paulson announced that the focus of the TARP rescue plan would be shifted away from buying bad loans from the banking sector. Instead, there would be increased support for bank capital levels with a greater emphasis on supporting consumer-orientated sectors. There was additional pressure for assistance to the main US auto-makers which continued to face severe financial stresses.

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There will be expectations of recession in the Euro-zone as a whole, especially after the weaker than expected German data. The evidence also suggests that the ECB will continue to cut interest rates at the December meeting. Overall confidence will remain very fragile but the more measured ECB stance and reduced vulnerability in the household sector, notably within the German economy, should still provide some degree of Euro protection.   
       
The Euro remained under pressure at times, but managed to recover from its lowest levels and secured gains on some crosses, notably against Sterling.

The German preliminary third-quarter GDP data was weaker than expected with a decline of 0.5% after a revised 0.4% drop previously. This met the definition of recession and there will be expectations of a further fourth quarter contraction. The French data offered some slight respite, but the Italian data was weak.

The German ZEW business confidence index recorded a slight recovery to -53.5 in the November reading from -63.0 with the decline in energy prices sparking some improvement, although there were still major concerns over the outlook.

The ECB monthly report stated that the outlook for price stability had improved further. The comments from ECB officials continued to suggest that the bank would be willing to cut interest rates again as growth fears have increased with markets expecting another cut by the central bank in December.

Yen:  

The economy is liable to weaken further in the short-term  with particular fears over the export sector given that the global downturn will hurt the industrial sector. In this environment, there will be increasing unease over the impact of a stronger currency and the Finance Ministry is likely to voice greater opposition to yen gains. The Japanese currency will continue to gain important defensive support when market stresses intensify and heavy selling is unlikely. 

The Japanese currency tested levels below 95.0 against the dollar and 120 against the Euro as equity markets were subjected to heavy selling pressure. A rally on Wall Street triggered a dollar recovery to 98 while the Euro also rallied against the yen.

Reports that Japan would supply US$100bn of reserves to help IMF support programmes helped improve risk appetite slightly, although caution prevailed.

The latest trade data for the first 20 days of October recorded a decline in exports of close to 10% over the year which maintained fears over the Japanese outlook. Core machinery orders also declined sharply for the third quarter as a whole despite a rise for September. Consumer confidence dipped to a record low for October.

Japanese Finance Minister Nakagawa stated that there was a need to avoid rapid exchange rate moves at all costs and this reinforced speculation over possible action to stabilise currencies at the weekend G20 meetings.

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The economy will continue to weaken and there is liable to be a sharp decline in fourth-quarter GDP, especially with evidence of rising job losses. The Bank of England will be under pressure to cut interest rates further which would erode the already sharply diminished yield appeal. The government and central bank will need to be very careful as there is an increased risk that confidence in policy-makers and the economy could deteriorate substantially further. The US and Euro-zone vulnerability should still provide some degree of protection.

Sterling came under heavy selling pressure as economic fears intensified and marts digested the huge interest rate cut seen last week. The UK currency weakened to record lows beyond 0.86 against the Euro and a six-year low below 1.46 against the dollar as the trade-weighted index dipped sharply to a 12-year trough.

The economic data continued to indicate a sharp deterioration in conditions. The latest BRC retail sales report recorded a 2.2% decline in like-for-like sales for October while the RICS survey indicated that house prices were still falling steadily.

The labour-market data recorded a further 36,500 increase in unemployment for the month following a revised 36,300 increase the previous month. This put the unemployment total at the highest level for over 10 years.
 
In the quarterly inflation report, the Bank of England downgraded its growth forecasts sharply from the August report and suggested that there would be a relatively severe recession with GDP set to record an annual decline of around 2.0% during the course of 2009. Bank Governor King also warned over the risks of a deep recession.

There was also a sharp downgrading of inflation forecast with the bank forecasting that inflation would be slightly below the 2.0% target level in two years time assuming interest rates at current levels. The report suggested that interest rates would be cut further despite warnings over the impact of Sterling weakness on import prices.

Bank of England MPC member Sentance stated that it would take time for the interest rate cuts to take effect and that the bank would consider at the next meeting whether a further cut is required. Given the precipitous Sterling decline, there was speculation that the MPC may adopt a  slightly more cautious stance in December.

Swiss franc:

The economy will continue to weaken in the short-term  and there will be a particular focus on the export sector given the impact of European weakness. The financial sector will also remain an important area of concern as the serious stresses will have a wider negative impact on the economy. The National Bank is likely to cut interest rates further and could consider intervention if there is a surge in the franc against the Euro. The franc will struggle to secure strong support given unease over the domestic economy.

The dollar pushed to fresh 2008 highs against the franc during the week with a challenge on the 1.20 level. The franc tested levels below 1.48 against the Euro, but failed to hold the gains and weakened back to beyond 1.50.

Swiss consumer confidence weakened to a five-year low during the third quarter which reinforced expectations of a sharp economic slowdown. The annual producer prices inflation rate edged lower to 2.9% in October with a 0.6% monthly decline in prices while the ZEW business confidence index remained weak at -88.5. The easing of inflation pressure and weak growth will maintain pressure for lower interest rates.

There were further National Bank warnings over the outlook which reinforced market unease over the Swiss economic trends. The ECB continued to provide swap facilities with the National Bank to help boost liquidity within the franc market.

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The Australian dollar failed to make a serious challenge on the 0.70 level against the US dollar and then weakened sharply to lows near 0.63 as equity markets came under heavy selling pressure. The currency was also undermined by renewed downward pressure on metals prices as fears over the global economy intensified.

The Australian central bank intervened in the market to stabile the local currency when it retreated sharply to below the 0.64 level against the US currency and there was a rebound late in the week as equity markets rallied.

The domestic data releases were mixed as consumer confidence recorded a recovery while there was a further deterioration in the housing sector.

The Australian dollar will look for a net corrective advance, but volatility will remain high and it will be difficult to secure any significant traction in the short-term .

Canadian dollar:

The Canadian dollar was again subjected to high volatility over the week. From levels near 1.15, the Canadian currency weakened to beyond 1.24 before recovering again.

The currency moves were again correlated to a high degree with movements in stock market and commodity prices with selling pressure evident as fear increased.

Housing starts were stronger than expected following firm employment data at the end of last week, but this failed to have a significant impact as confidence remained fragile. The government announced further measures to underpin the housing sector.

The currency failed to gain significant support from an IMF projection that it would be the only major economy to avoid recession in 2009.

There is likely to be further Canadian dollar volatility in the short-term  and there is scope for some net gains as G7 countries look to stabilise conditions.

Indian rupee:

In a week of high volatility, the rupee was unable to sustain the corrective recovery against the dollar and registered the sharpest one-day decline for 12 years as it weakened back towards the 49.50 level with only limited central bank support.

The Indian currency was again undermined by the impact of domestic stock market weakness with further capital outflows. There were reports that exports had weakened sharply during October which unsettled sentiment towards the economy and currency with speculation that there would be a further cut in interest rates.

Volatility levels are liable to remain highly elevated in the short-term . The rupee has scope to secure near-term support close to 50.0 against the US dollar. 

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The Hong Kong dollar has continued to trade close to the 7.75 band limit against the US currency with market tensions still at elevated levels. HKMA chief warned that inter-bank volatility would be likely to continue and that further capital injections could be required to protect the currency band.

There was further unease over economic trends, especially with further evidence of a slowdown in the Chinese industrial sector, while the Hong Kong third-quarter annual GDP data was below 2.0% which reinforced economic fears.

The Hong Kong dollar should retain a firm tone for now and speculation over a move to widen the currency band will persist, although stability may well take priority.

Chinese yuan:

The yuan has continued to trade within narrow ranges around 6.83 against the US dollar over the week. The economic data was mixed as there was a larger than expected trade surplus of US$35.2bn for October while retail sales were still firm. In contrast, October annual industrial production growth slowed sharply to 8.2%.

There was further speculation that monetary policy could be relaxed further as officials promoted action to boost the economy with officials concentrating on averting deflation. Fiscal policy was also a key focus as the government announced a US$586bn stimulus package to help boost the economy.

There will be further growth fears and a continuing bias towards lowering interest rates will tend to curb currency support. The principal concern of the Chinese authorities is likely to be to maintain yuan stability as market turmoil continues.

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