Weekly Forex Currency Review 16-04-2010

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There will be reduced dollar demand on defensive grounds in the short-term as confidence in the global economy and risk appetite remains generally firm. Underlying credit conditions will still be important and there is scope for renewed fears over the outlook within the next few weeks which would tend to curb enthusiasm towards risk and slow any flow of funds into high-yield instruments.               

Key events for the forthcoming week

Dollar:

The latest US economic data will reinforce expectations of a steady improvement in the economy. Optimism will be tempered by unease over structural vulnerabilities and the risks posed by a sustained contraction in credit while the potential dollar risks posed by the budget deficit will also come into greater focus. There will also be continued doubts as to whether the Federal Reserve will make an early move to tighten monetary conditions. There will also be reduced defensive dollar demand if global appetite remains strong. The net risks suggest that the US currency should be able to resist heavy selling pressure.

The dollar found it difficult to make headway over the week, primarily due to reduced defensive demand for the US currency as risk appetite was generally firm. The US currency did find support at lower levels.

The US retail sales data was stronger than expected with a 1.6% in headline sales for March after a revised 0.5% increase previously. There was also a solid 0.6% increase in underlying sales which maintained optimism over the near-term economic outlook.

The business survey evidence was robust with the New York manufacturing index rising to 31.9 for April from 22.9 the previous month while the Philadelphia Fed index also strengthened to 20.2 from 18.9 and this was the highest level since December 2009 which will maintain optimism towards the manufacturing sector.

In contrast, the jobless claims data was weaker than expected with a further increase in initial claims to 484,000 from 460,000 the previous week. Seasonal factors may again have played a part, but the second successive week of higher claims could raise some fresh doubts over employment trends.

The consumer prices data failed to have a significant impact with a 0.1% increase in prices for March while the core rate was slightly weaker than expected with no change in prices for the month to give a 1.1% annual increase. Despite important medium-term reservations, the data did not increase market fears over inflation.

Fed Chairman Bernanke issued a generally cautious commentary on the US economy. He was confident that the economy was improving, but also expressed concerns that growth was being held back by significant restraints. Again, there was no evidence of an early move to tighten policy which tended to limit dollar support. Other Fed officials were also generally cautious over the prospect for higher interest rates.

The Fed’s Beige Book reported that conditions had improved in all bar one of the Federal Reserve districts. Retail sales had generally improved, but credit demand remained weak. 

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Sentiment surrounding the Greek budget and debt situation may stabilise in the near term following the loan scheme, but underlying unease over the outlook will continue, especially with fears that budget cuts will prolong the domestic recession. Confidence will also deteriorate again quickly if there is evidence of a renewed downturn in the Euro-zone economy. In this environment, the Euro will find it difficult to secured a sustained recovery. 

During Sunday, the EU announced details of the previously-announced support package with Greece able to borrow EUR30bn from Euro-zone countries in the first year of any deal at a rate of 5% compared with market rates near 7%. A further EUR15bn in IMF funds would also be available.

The news triggered a further spike higher in the Euro with a three-week high near 1.37 against the dollar as there was a sharp squeeze on short positions with the Euro also securing the largest daily gain since September.

There was also a tightening in yield spreads with the spread on Greek 10-year bonds declining to around 335 basis points over German bunds from a peak over 450 basis points the previous week. There was firm demand in the Greek auction, but underlying confidence in the Euro and Euro-zone economy remained weak.

There were also fears that market tensions would spread to Spain and Italy while there was some opposition to the support measures within Germany which unsettled confidence. Confidence deteriorated late in the week with bond spreads widening again as there was speculation that Greece would formally apply for aid. The Euro weakened back towards the 1.35 area against the dollar.

Yen:  

A Chinese yuan revaluation would provide near-term support for the yen and any renewed deterioration in risk appetite would tend to trigger a flow of funds back into the yen. The yen will remain vulnerable to investment outflows and carry-related selling, especially if confidence in the global economy holds relatively firm. Overall, the Japanese currency will find it difficult to sustain any significant gains given the underlying yield structure.

There was interest in selling the Japanese currency during the week, but the currency still proved to be broadly resilient as retreats quickly attracted selling pressure. The dollar failed to push above 94 and weakened back to the 92.50 area. The yen also regained ground on the crosses.

There has been a sharp increase in short yen positions over the past few weeks and there was some reluctance to sell the yen further while there has also been some evidence of existing positions being scaled back

The latest Japanese banking-sector data was weaker than expected with a 1.8% annual decline in bank lending over the year compared with 1.5% previously which will maintain some degree of unease over the financial sector and economy, although the immediate market impact was limited.

There was further strong speculation over a Chinese currency revaluation in the very near term and this provided some significant degree of yen protection.

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There will still be a high degree of uncertainty over the budget and government-debt outlook and underlying confidence will remain fragile. The currency may be in a position to resist heavy selling pressure in the short-term, especially as there are still a high number of short speculative positions. Concerns over the Euro-zone outlook may also provide some net protection for the UK currency. There still looks to be little scope for sustained Sterling gains given the underlying vulnerability.

Sterling again proved to be more resilient as the selling pressure seen over the past 2 months continued to ease. The UK currency pushed to monthly highs against the Euro and strengthened to highs near 1.55 against the US dollar before correcting weaker.

The UK growth-orientated economic data was mixed with the BRC retail sales report recording growth of 4.4% in the year to March, although this may have been distorted by the timing of Easter. The RICS house-price index halved to 9 for April which will increase speculation that price rises will stall this year.

The trade data was better than expected with a sharp decline in the deficit to GBP6.2bn for February from GBP8.1bn the previous month. There was a sharp recovery in exports following a decline in January when shipments had been undermined by poor weather conditions.

There was one opinion poll which suggested the vote distribution in the forthcoming election would increase the chances of a decisive outcome and this provided some support, but uncertainty remained at a high level.

The Greek loan deal is liable to have a mixed impact on Sterling. The deal may have curbed wider sovereign debt risk which would tend to underpin the UK currency. In contrast, there was also the risk that the underlying fears will now tend to be concentrated more on the UK which would tend to undermine Sterling as markets would be more concerned over the risk of a credit-rating downgrade.

Swiss franc:

The Swiss currency will continue to gain some defensive support from a general lack of confidence in the Euro with the franc resisting sustained selling pressure even after the Greek support package. The National Bank will remain an important focus and there will be further pressure on the central bank to prevent further gains against the Euro. The dollar should be broadly resilient against the Swiss currency.

The dollar found support close to 1.05 against the franc during the week and re-tested resistance levels just above 1.06 before consolidating.

The Euro spiked higher against the Swiss currency at the beginning of the week, but there was resistance close to 1.45 and weakened sharply before settling just above the 1.4320 level.

There was no evidence of concerted National Bank intervention during the week, but the speculation over potential action was important in curbing potential buying support for the currency.

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The Australian dollar maintained a firm tone against the US dollar during the week and tested resistance levels above 0.93, although progress was limited. The currency gained initial support from generally robust risk appetite, although confidence faded later in the week.

The domestic data releases were generally weaker than expected with a decline in home loans and business confidence and this had some impact in curbing demand for the Australian currency.

Australian dollar sentiment should remain generally firm for now with expectations of further carry-related inflows. The currency may still find it difficult to extend gains, especially given the important risk of Chinese policy action.

Canadian dollar:

The Canadian dollar strengthened to test US dollar support levels beyond parity and pushed to a high around 0.9960, although it did encounter significant selling pressure at higher levels. The Canadian currency benefitting from high commodity prices and risk appetite before retreating as there was a more cautious attitude towards risk. 

There was no major data releases during the week, but the currency did derive support from expectations that the Bank of Canada will move more quickly to increase interest rates within the next 2-3 months.

The Canadian dollar should remain generally firm in the short-term given expectations of higher interest rates and firm risk appetite. It will remain difficult to extend gains given the amount of favourable news priced in.

Indian rupee:

The rupee maintained a firm tone over the week and re-tested 19-month highs beyond against the US currency. Stronger than expected growth data sparked optimism towards the regional economy which also boosted confidence in the Indian currency. The decision to revalue the Singapore dollar and further speculation over a Chinese move to let the yuan strengthen also helped support the Indian currency.

There was US dollar buying from oil importers and this helped cushion the US currency while there was also speculation of central bank intervention.

The rupee should be able to maintain a relatively firm tone against the dollar in the near term, especially if there is a move to revalue the Chinese currency. 

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The Hong Kong dollar was unable to make further gains over the week and edged lower to near 7.7620 against the US dollar.

The local currency drew some support from optimism surrounding the regional economy while further speculation over a Chinese yuan revaluation also boosted the Hong Kong dollar. In contrast, risk conditions gradually weakened after a firm start.

There will be mixed currency influences from Chinese pressures and any yuan revaluation would tend to be a net positive for the Hong Kong dollar. Volatility levels are liable to be higher in the short-term.

Chinese yuan:

The spot yuan rate remained firm and continued to test the strongest level for six months. There was no announcement of a change to the currency regime.

The Chinese economic data remained robust with first-quarter GDP growth of 11.9% which was slightly above expectations.

There was further speculation over a move by the Chinese authorities to adjust the yuan regime, potentially combining a small currency revaluation with a move to targeting the currency on a trade-weighted basis.

The Commerce Ministry continued its policy of battling against major policy changes with comments that a stable yuan was helpful for exports and controlling speculative capital inflows.

Speculation over an adjustment to the yuan regime will remain very high. There is a certainly a strong possibility of at least a limited policy move and this could be sanctioned within the next few days.