Weekly Forex Currency Review 16-10-2009

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Overall dollar confidence will remain generally weak in the short-term with two key vulnerabilities. There will be expectations of a medium-term shift away from the currency by central banks and selling pressure is liable to be compounded by very low short-term interest rates. Nevertheless, there will be clear dangers in an overly negative stance towards the US currency at current levels, especially with very important European vulnerabilities.

Key events for the forthcoming week

Dollar:

Overall confidence in the dollar will remain weak in the short-term with further speculation that there will be central bank and institutional diversification away from the US currency. There will also be strong reservations whether the Fed will be in a position to raise interest rates in the near term. There is still an important risk that risk appetite will deteriorate again given that markets are at risk of being over-confident towards the global economy. The US currency is also attractively valued against European currencies which will maintain the potential for a sharp corrective recovery.

The dollar remained under pressure during the week as a whole as underlying confidence in the currency remained weak while positive risk appetite curbed defensive. The dollar dipped to 14-month lows on a trade-weighted basis and also weakened to near 1.50 against the Euro.

The headline US retail sales data was slightly stronger than expected with a 1.5% decline for September following a revised 2.2% increase the previous month. As expected, there was a sharp dip in auto sales and there was an underlying monthly increase of 0.5% following a 1.0% gain for the previous month.

The New York manufacturing PMI index was sharply stronger than expected with a reading of 34.6 for October from 18.9 the previous month. In contrast, the Philadelphia Fed index was slightly weaker at 11.5 from 14.1 the previous month. The industrial data as a whole will maintain optimism over near-term trends even with longer-term uncertainties still a feature.

Initial jobless claims also declined to 514,000 for the latest week from a revised 524,000 previously and this was the lowest reading since early January which will maintain optimism over a slow improvement in the labour market. Without tougher rhetoric from the Federal Reserve, the dollar is finding it difficult to gain support from firm data, especially with firm global risk appetite lessening defensive demand.

Consumer prices rose 0.2% for September which was in line with market expectations while there was also a 0.2% increase in core prices. There was a 1.3% annual decline in prices as food prices fell over the year for the first time in over 40 years, but underlying inflation was at 1.5% which does not suggest a serious deflation threat.

The FOMC minutes from September’s policy meeting revealed important differences over the economy’s direction and appropriate policy responses. There was no support for higher interest rates at the meeting despite evidence of improving economic conditions with fears that pre-emptive action would damage any recovery. Some members wanted the quantitative easing policies to be ended early while others were looking for an extension of mortgage-security buying.

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Although the Euro-zone will continue to recover in the near term, overall confidence is liable to be fragile with fears that growth will quickly stall, especially as there are still important issues surrounding the lack of credit. Euro-zone officials are also liable to be increasingly uneasy over the impact of Euro strength with protests liable to increase, especially if the Euro advances to above the 1.50 level against the dollar.     

The Euro was generally firm against major currencies during the week, although it did suffer sharp losses against Sterling later in the week.

The latest German ZEW survey dipped to 56.0 for October from 57.7 the previous month which was below market expectations and maintained expectations that the Euro-zone economic recovery is liable to stall relatively quickly.

French Finance Minister Lagarde stated that currency levels will need to be discussed and markets remained on high alert for comments on currency values from key Euro-zone officials.

ECB President Trichet remained cautiously optimistic over the Euro-zone economic outlook, although markets mainly concentrated on his remarks surrounding currencies. Trichet stated that excessive currency movements were an enemy which suggested that the tone of rhetoric has become slightly stronger.

Yen:  

The yen’s correlation with risk and equity markets has faded slightly, but it is still the case that the currency will tend to lose ground when there is an improvement in risk appetite. Official policies will remain an important focus and there will be strong resistance to any intervention policy. Nevertheless, there will also be verbal warnings against yen strength which will slow any advance. Overall, the dollar should be able to resist heavy selling pressure even though rallies should be limited.   

After a generally firm tone over the first half of the week, the yen weakened significantly over the second half with notable weakness against Sterling.

In comments on Wednesday, a Finance Ministry official stated that intervention was undesirable and that the yen moves were primarily a function of dollar weakness.

Finance Minister Fujii stated that countries should avoid competitive devaluations and there was further pressure for the authorities to block yen gains. After initially edging firmer on Thursday, the dollar pushed to highs around 90.75 with the yen generally weaker on the crosses as risk appetite remained stronger.
As expected, the Bank of Japan held interest rates at 0.1% following the latest policy meeting. The bank upgraded its forecast for the economy, but declined to comment on corporate funding policies.

The monthly Reuters Tankan index edged lower to -35 for October from -33 the previous month, the first decline for seven months. Although the government increased its economic assessment, there was unease over the impact of currency strength on the industrial sector with further sensitivity to the yen’s level.

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Overall confidence in the economy is likely to remain weak in the short-term with persistent fears over the government debt situation. There will also be expectations that interest rates will stay at very low levels over the next few months which will encourage the use of Sterling as a funding currency. The other major currencies also have important vulnerabilities and this will lessen the risk of very heavy selling pressure on the UK currency. There will also be further corrective recoveries, but there is still liable to be underlying depreciation.

Sterling remained under pressure in the first half of the week and dipped to 7-month lows against the Euro near the 0.94 level. There was an aggressive bout of short covering later in the week which helped trigger a sharp recovery with a move to above 1.63 against the dollar and 0.9150 against the Euro.

There was a subsequent decline to below 1.58 following a report by the CEBR institute which stated that interest rates were likely to stay at very low levels for at least three years with borrowing costs not likely to move above 2% until 2014.

The latest RICS housing survey recorded an increase in prices for September with the index at a 28-month high while the retail sales data was also stronger than expected. The currency was still trapped near 1.58 against the dollar in Asia.

The headline consumer inflation rate was weaker than expected with a decline to 1.1% for September from 1.6% previously which was the lowest annual rate for five years. The other inflation data was slightly stronger, but the net impression was that there will be greater scope for the Bank of England to keep interest rates very low.

The latest labour-market data was better than expected with the claimant count rising 20,800 in the latest month compared with expectations of a 25,000 increase while the unemployment rate held at 7.9%. The claimant count increase was the slowest since May 2008 which provided some degree of Sterling relief, although the overall unemployment rate at a 14-year high.

There were also comments from Bank of England officials which suggested that there would be less scope for further quantitative easing with the bank potentially suspending the programme in November, although uncertainty was a key feature.

Swiss franc:

The National Bank will remain very sensitive to the deflation risk and there is likely to be further intervention to prevent significant franc appreciation, especially if the dollar also remains weak in global markets. The Swiss franc is not being used as much as a global funding currency and this will increase the chances of franc resilience in the short-term. Nevertheless, it will be difficult for the franc to extend gains.
 
The dollar remained weak against the franc and tested a series of 2009 lows during the week with a trough below 1.0150. The franc was strong against the Euro after the Euro’s failure to break above the 1.52 region. The franc maintained an underlying firm tone despite generally firm risk appetite.

The Swiss ZEW business confidence index strengthened again to 65 for September from 58 the previous month which will maintain some degree of optimism over the Swiss economy, although the impact was measured.

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The Australian dollar maintained a very strong tone during the week as the domestic and international backdrop was favourable. There was a peak above 0.9250 against the US dollar.

Risk appetite was still firm with expectations of a flow of funds into high-yield currencies which underpinned the Australian dollar. Reserve Bank Governor Stevens maintained a generally hawkish tone on monetary policy and clearly suggested that interest rates would be increased again in the near term.

Australian dollar sentiment is liable to remain very strong in the short-term. There will, however, be the threat of a sharp correction following recent sharp gains.

Canadian dollar:

The Canadian dollar again maintained a very strong tone against the US currency over the week and strengthened to highs near 1.02, a fresh 2009 high for the local currency, before a limited correction weaker.

Initial gains were triggered by the much stronger than expected labour-market data at the end of last week. Risk appetite was also generally strong during the week and a generally fragile US dollar helped support commodity prices. 

The Canadian currency will remain vulnerable to choppy trading in the short-term and the international risk profile will make it difficult to secure significant gains.

Indian rupee:

The rupee maintained a firm tone over the week and tested levels beyond 46 against the US currency before correcting weaker as importer buying increased. The underlying backdrop remained favourable with robust risk appetite and a generally weaker US currency.

There were, however, some fears that the currency advance would undermine corporate earnings and there was also some speculation that the Reserve Bank would cap gains which dampened buying support.

The rupee will still gain support when there are wider US dollar losses, but it is likely to be a near-term peak, especially as central bank reservations are liable to increase.

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The Hong Kong dollar has maintained a very firm tone close, locked close to the 7.75 band limit against the US dollar for most of the week. There was further HKMA action in the market to prevent Hong Kong dollar appreciation.

Regional stock markets were firm and risk appetite was also robust which helped maintain a flow of funds into Hong Kong, especially with overall confidence in the dollar weak.

Short-term confidence is liable to remain firm in the very short-term with further intervention required to preserve the currency band, especially if the US currency continues to exhibit wider weakness.

Chinese yuan:

Chinese markets re-opened following the series of holidays, but the central bank maintained tight control of the market with the yuan close to 6.827 against the dollar.

The economic data provided some net support with trade volumes significantly higher than expected in the latest monthly data.

The US Treasury again called for a faster pace of yuan appreciation in its semi-annual report with a slightly tougher stance, but again did not call China a currency manipulator. The currency regulator SAFE stated that major yuan appreciation pressures were unlikely over the next few months, but there was a gradual increase in market expectations for a stronger currency.

Underlying pressures for yuan appreciation will continue. The central bank is likely to be slightly more tolerant of very limited appreciation in the near term.