Weekly Forex Currency Review 16-05-2008

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Overall strategy: The major currency pairs will continue to be influenced strongly by trends in energy prices in the short-term. There has been a strong inverse relationship between oil price and dollar moves over the past few weeks. Any sustained decline in energy prices would, therefore, make it easier for the US dollar to advance. The Euro-zone economy will also remain a key short-term focus for markets with fears over a sharp slowdown in growth.                      

Key events for the forthcoming week

Dollar:

The latest US data releases have reinforced the possibility that the economy is not deteriorating further, but there is still clear weakness in certain sectors and the optimistic case has fragile foundations at best. The Fed is uneasy over inflation trends, especially with the risk of rising inflation expectations and there is a strong possibility that they will reject any further near-term cuts in interest rates. The overall shift in expectations and improvement in yield support should continue to underpin the dollar, although it will also still be influenced strongly by oil prices. Overall, there is scope for a further limited dollar recovery.   
 
The dollar was trapped within narrower ranges during the week as investors struggled to secure a decisive direction. The trade-weighted index still had a slightly firmer tone over the week as a whole with the US currency also being influenced by trends in oil prices. The dollar hit resistance below 1.54 against the Euro and settled around 1.55

The growth-orientated data continued to suggest that the economy is not deteriorating further, but there were still notable areas of weakness. Headline US retail sales fell by 0.2% in April, but there was a 0.5% increase in underlying sales which suggested that spending was still relatively resilient and building materials registered an increase.

Industrial production dipped 0.7% in April following a revised 0.2% increase the previous month. The Philadelphia Fed index recovered to -15.6 in May from -24.9 the previous month and the six-month business expectations index strengthened sharply for the second successive month which signalled a potential recovery.

Consumer prices rose 0.2% for April while the underlying increase was 0.1%. Both were slightly below expectations, but the core annual increase was still 2.3% which maintained inflation fears.

In comments over the week, Fed officials took a generally firm stance on inflation. Futures markets continued to indicate that the Fed would leave interest rates on hold at the June meeting while there was some speculation over a small increase in Fed funds rates for the fourth quarter.

The March report recorded long-term inflows of US$80.4bn from US$63.6bn the previous month, although there was an outflow of shorter-term capital as financial market conditions were very stressful during the month.

There was further speculation that the US authorities were leading efforts and co-operating with European officials to help push the dollar stronger and there was some increase in rhetoric in favour of US currency gains. There appears to have been a greater realisation that the global economy is being damaged as the weak dollar contributes to higher oil prices.

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The Euro-zone economy was still performing well in the first quarter, but the indicators are much less encouraging and there is the probability of further deterioration as credit conditions are tightening. The ECB will be determined to maintain a tough stance on inflation to help curb wage demands, but they are likely to edge towards a looser policy within the next few months. Anticipation of this shift is likely to undermine the Euro, especially as investment flows into the Euro-zone are liable to weaken.
       
The Euro continued to stage a corrective recovery from recent losses, but it struggled to make strong headway as rallies quickly attracted selling pressure. 

The first-quarter GDP data for Germany was stronger than expected with a robust 1.5% increase and there was a stronger than expected 0.7% increase in Euro-zone GDP growth for the quarter. There was a 0.2% decline in Euro-zone industrial output for March, although there was still a small annual increase.

Inflation trends remained an important influence over the week. The headline Euro-zone inflation rate was confirmed at 3.3% for April from 3.6% the previous month, but the core rate was lower than expected at 1.6% compared with an expected 2.0%.

ECB officials continued to focus on the inflation risks in their comments over the week. Members such as Weber retained a very aggressive stance on policy, although there was some evidence of a slight shift in rhetoric within some ECB members.

European government officials also promoted a weaker Euro over the week with the French finance minister stating that the currency was overvalued by at least 10%.

Yen:  

The domestic economic data has remained weak and, despite robust first-quarter growth, there are likely to be increasing fears that a sharp slowdown in Asian demand will be a further negative influence on the Japanese economy. Overall yen moves will continue to be correlated strongly with the degrees of risk aversion and the improvement in risk appetite will tend to weaken the yen in the near term. The Japanese currency is likely to resist heavy selling pressure given that underlying caution will prevail. 
                    
The Japanese currency was unable to sustain the gains seen against the dollar at the end of last week and weakened to test support levels beyond 105.0.

Japanese economic data remained generally weak as machinery orders declined by a further 8.3% in March following a sharp decline the previous month and orders were at their lowest level for close to three years. The government also downgraded its assessment of economic conditions in its latest survey.

The first-quarter GDP data provided some degree of relief as there was a bigger than expected 0.8% increase as net exports made a positive contribution.

The yen was still influenced strongly by degrees of global risk appetite during the week. The Japanese currency was still undermined by an overall increase in global risk appetite over the week with some flow of funds into high-yield currencies

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Confidence in the economy will remain very weak in the short-term with expectations of a slide into recession due to a combination of housing-sector weakness and downward pressure on consumer spending. The Bank of England will look to maintain a tough policy on interest rates in order to curb inflation, but the yield considerations will only provide limited Sterling support while economic fears persist. In this environment, the UK currency is unlikely to see firm buying support in the short-term.
 
Sterling had a generally weaker tone over the week as confidence in the economy deteriorated. The UK currency dipped to lows below 1.94 against the dollar and 0.7985 against the Euro before stabilising later in the week.

The headline consumer inflation rate increased to 3.0% in April from 2.5% the previous month and compared with expectations of a 2.6% rate.  The core inflation increased to 1.4% from 1.3%. There was a further strong increase in producer prices for the month with an annual increase of 23% and the output prices data showed that these price increases were being passed on to the consumer level.

The Bank of England increased its inflation forecasts in the latest quarterly inflation report, warning that the rate was likely to be over 3.0% over the next few months and could push to 4.0%. The bank also downgraded its growth forecasts and warned that conditions within the economy were liable to deteriorate.

The bank warned against rapid interest cuts in interest rates and there was some speculation that the bank would not cut rates again over the remainder of 2008.

Swiss franc:

There is evidence of a sharp slowdown in the economy and this will have some negative impact on the franc with speculation over a second-half interest rate cut. Unless there is a major deterioration in the banking sector, international trends will still tend to dominate and franc support will be weaker if risk appetite remains higher. There are still significant risks surrounding the international financial sector and this will tend to curb aggressive franc selling.
 
The Swiss currency was unable to sustain the gains seen at the end of last week. From highs near 1.6050 against the Euro, the franc weakened back to test support levels beyond 1.63. The franc also dipped to lows around 1.06 against the US dollar.

An underlying improvement in risk appetite lessened support for the Swiss franc over the week as global equity markets attempted to rally.

The latest SECO indicator of consumer confidence weakened sharply to +2 from +14 the previous month which increased fears over a sharp slowdown. The latest retail sales data was strong which offset these fears and global factors dominated.

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The Australian dollar dipped to lows below 0.93 against the US currency during the week, but was able to recover back to 0.94 on Friday as there was a recovery in commodity prices and some improvement in risk appetite.

There was further evidence of a slowdown in the housing sector with a sharp dip in home loans for April while the NAB business confidence index also continued to weaken in the latest survey.

The increase in wages was also lower than expected which curbed expectations of any further increase in interest rates.

The domestic uncertainties are likely to cap Australian currency gains even if there is any further increase in commodity prices and volatility levels are liable to increase.

Canadian dollar:

The Canadian dollar continued to challenge levels stronger than parity against the US currency during the week and peaked around 0.9960 before consolidating near 1.00.

There were no major domestic developments over the week with the Canadian dollar gaining some support from greater confidence in the North American economy, although there was a further decline in manufacturing shipments.

The Canadian dollar was strongly influenced by levels of oil prices and global risk appetite with the net improvement in risk appetite offering some support to the local currency on short-term investment inflows.

The Canadian currency will gain support from any reassessment of the North American economy, especially if oil prices remain strong, but will struggle to sustain gains beyond parity against the US currency.

Indian rupee:

The rupee has remained generally under pressure over the past seven days and dipped to a 13-month low of 42.75 on Thursday. After a temporary recovery, the rupee weakened again to near 42.80 on Friday as confidence remained weak. 

The currency was again unsettled by the high level of prices with crude at a record level which also continued to increase fears over the trade account.

There was also some arbitrage between the spot market and the forward NDF offshore market as rupee confidence in the futures markets was generally weak.

A slightly weaker trend for Asian currencies also had a negative impact on the Indian currency during the week, although the improvement in risk appetite provided some degree of support to the currency.

Rupee sentiment has continued to deteriorate, but it should be able to resist substantial losses from current levels with some potential for investment capital inflows.

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The Hong Kong dollar continued to have a slightly weaker trend during the week and dipped to lows around 7.8025 which was the lowest level since the middle of February. Low inter-bank rates were a negative influence on the local currency.

The currency found some support weaker than the 7.80 central rate as arbitrage activity waned when it dipped beyond this level and it was near 7.80 on Friday. 

The Hong Kong currency should continue to find near-term support close to the 7.80 level against the US currency as narrow ranges are likely to prevail. 

Chinese yuan:

The yuan was trapped in relatively narrow ranges during the week, although the currency did find support at levels weaker than 7.00 against the US currency.

Senior central bank officials stated that the yuan was exhibiting a pause for breath after the recent advance. There was also evidence that the Chinese authorities were wary of speculative capital inflows and looking to promote stability.

The central bank first-quarter report did not signal a significant change in exchange rate policy. There were calls by European officials to let the yuan appreciate against the Euro as well as the dollar.

There are likely to be further doubts over the economy with unease over export trends and a possible reversal in speculative inflows. The yuan is unlikely to make strong headway against the dollar in the very short-term, although substantial losses look unlikely given the pressure to curb inflation. 

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

Launched in 2006, dbFX is available in multiple languages and accessible in over 70 countries around the world. Deutsche Bank was  ranked the No.1 Foreign Exchange Bank in 2007 by Euromoney magazine  for the third year running. The platform can be accessed here