Weekly Forex Currency Review 19-12-2008

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This is the last Weekly market analysis we will be sending out until the  5 January 2009

The Week Ahead

Overall strategy: The aggressive US Federal Reserve policies with a continuing focus on quantative easing will continue to provide a huge boost to liquidity and will also tend to underpin risk appetite in the short-term. Fears over the huge Fed balance-sheet expansion will expose the dollar to selling pressure, although there will also be some hopes for an earlier economic recovery in the US which would provide support. High volatility is liable to be an important near-term feature, especially with reduced year-end liquidity.  

Key events for the forthcoming week

Dollar:

The US economic data has remained very weak, although it is possible that the deterioration is slowing. The aggressive Federal Reserve policy on interest rates will tend to sap dollar support, especially with the Fed also boosting liquidity aggressively through the direct buying of securities. Overall dollar demand is likely to remain lower in the short-term. The dollar’s reserve status should still provide some protection, especially if there is defensive demand for US Treasuries and the currency will also gain some support if the aggressive policies appear to be having a positive impact in supporting the economy.  

The dollar cane under heavy selling pressure during the week and dipped to lows beyond 1.47 against the Euro before a sharp correction back towards 1.40. The US currency also dipped to two-month lows on a trade-weighted index before rallying.

The US data maintained a very weak tone as consumer prices fell sharply by 1.7% in November after a 1.2% fall previously. Core prices were unchanged following a 0.1% decline for October to give a 2.0% annual increase. Housing starts weakened to an annual rate of 0.63mn for November from a revised 0.77mn previously while building permits fell to 0.62mn with both series at 50-year lows.

The Philadelphia Fed index remained extremely weak with a reading of -32.9, although this was an improvement from the -40.0 previously which suggested that the rate of deterioration may be slowing, Initial jobless clams fell to 554,000 in the latest week from 575,000 previously with continuing claims at another 25-year high.

The main attention was on the Federal Reserve FOMC meeting and the Fed sanctioned a further aggressive easing of policy. The Fed Funds rate was cut to a target range of 0.00 – 0.25% from the previous 1.0%, the lowest rate ever recorded. In the statement, the FOMC stated that the economy had weakened further with deterioration in labour markets while financial markets remain quite strained. It also stated that inflationary pressures had diminished appreciably.

As well as the rate cut, the Fed pledged to continue large-scale purchases of agency debt and mortgage-backed bonds. The FOMC is also evaluating the potential benefits of purchasing long-term Treasury Securities. The move to near-zero rates and shift towards quantative easing will continue to undermine dollar confidence. US yields continued to decline with the 10-year yield at a record low.

There were suggestions that a second fiscal stimulus from the next Administration could be at worth least US$675bn.

As far as the US current account is concerned, there was a decline for the third quarter to US$174bn from US$181bn previously which maintained some optimism over a narrower 2009 deficit as import demand weakened

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The Euro-zone economy will continue to weaken in the short-term as the industrial sector remains under pressure. ECB officials have suggested that interest rates could be cut again, but the bank has also signalled some degree of caution which will provide some currency support. The bank move to cut deposit rates will curb Euro support to some extent and it will remain vulnerable to a correction following the recent surge. The Euro should still be able to retain a firm tone given major stresses elsewhere.   
       
The Euro advanced strongly with a major advance against the dollar, Sterling and yen, but was subjected to a sharp correction towards the end of the week.

The European PMI data was marginally stronger than expected, but there was still a further deterioration in the manufacturing sector to 34.5 in December from 35.6 previously while the services sector index dipped to 42.0 from 42.5.

The German IFO index weakened to 82.6 from 85.8 which was a record low since the index was created in 1982. Although IFO officials suggested that interest rates should be cut by a further 0.50%, they did not signal that conditions had deteriorated further.

The ECB did not announce any change to the main financing rate on Thursday, but they did adjust the rate corridor. The deposit rate was cut by 0.50% to 1.0% while the lending rate was increased to 3.0%. The move suggest that the ECB is looking to discourage deposit inflows and this pushed the currency sharply weaker.

ECB Chairman Trichet stated that there was a limit to how far interest rates can be cut. Bundesbank head Weber stated that the ECB had some scope to lower interest rates and that a decline to below the 2.0% level was possible briefly, although he also warned that rates would need to be increased rapidly once economic conditions improved. Officials did not indicate alarm over the Euro’s rise.

Yen:  

There will be further concerns over the economy in the short-term, especially with the key industrial sector under severe pressure. There have also been some warnings over the banking sector and any evidence of more serious difficulties would undermine yen confidence. The Bank of Japan move to cut rates and threat of intervention should also limit yen gains. The Japanese currency should resist heavy selling given the global pressure for de-leveraging.        

The Japanese currency strengthened against the dollar with fresh 13-year highs beyond 87.50 before correcting weaker while it lost ground against the Euro.

The Japanese data remained weak with the Tankan business confidence survey weakening sharply to -24 in the latest quarter from -3 previously while capital spending estimates were also lowered. There were further profit warnings from the industrial sector, especially the car sector, as confidence weakened.

Bank Governor Shirakawa also stated that the bank needed to lower its outlook on the economy with conditions severe following the Tankan survey. Following the monetary meeting, the central bank cut interest rates to 0.10% from 0.30% by a 7-1 margin while there were additional measures to boost credit supply.

The Finance Ministry also indicated alarm over the further yen strengthening and there were warnings over intervention, although no confirmation of any yen selling.

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The economy will continue to weaken in the short-term with unemployment rising sharply while the overall tightness of credit will remain a damaging factor. There will be expectations of further interest rate cuts and speculation that they could be cut to zero. The banking sector and budget position will also be a source of potential currency weakness with confidence liable to remain extremely weak in the short-term. The major difficulties in the global economy should still provide some degree of protection and may help trigger a corrective recovery.

Sterling remained under heavy pressure with a succession of record lows against the Euro with a weak point beyond the 0.95 level before a slight correction. The UK currency resisted heavy losses against the dollar, but hit heavy selling above 1.55.

The labour-market data remained very weak with a further 75,700 increase in jobless claims for November after a revised 51,800 increase the previous month, the fastest rate of increase since 1991.  The December CBI retail sales index was a record low of -55 from -46 the previous month. The official retail sales data was better than expected with a 0.3% increase compared with expectations of a 0.6% decline, although the data quality is questionable, especially with heavy price discounting.

The government budget position continued to deteriorate with a record GBP16.0bn borrowing requirement for November pushing the cumulative figure to GBP56.1bn.

Consumer inflation fell to 4.1% from 4.5%, but markets had expected a larger decline while the core rate increased slightly to 2.0% from 1.9%.  In its inflation letter to the Chancellor, Bank of England Governor stated that inflation would fall back to the 2.0% target in the first half of 2009 while it could dip to below 1.0% over the second half. The comments reinforced market expectations of further cuts, especially with Chief Economist Bean’s comments that rates could be cut to zero.

Bank of England minutes from December's policy meeting revealed discussion over an even larger interest rate cut, although there were concerns over Sterling weakness.

Swiss franc:

The economy will remain under pressure in the short-term as domestic demand slows and the export sector remains under pressure. The National Bank will remain concerned over economic trends and will intervene to push money-market rates down if necessary. There is also the possibility of intervention to weaken the currency if it advances strongly from current levels.

The franc found support beyond the 1.58 level against the Euro and strengthened back to beyond 1.55. The main focus was on the dollar and the franc secured massive weekly gains with a high beyond 1.06 before a sharp correction. There was some speculation over capital repatriation which provide some degree of franc support.

Third-quarter Swiss industrial production fell 5.2% and will reinforce the prospect of the National Bank maintaining very low interest rates to support the economy. A retail sales rise 2.9% in the year to November did not have a substantial impact.

 The SECO agency also downgrading its forecasts for the economy with expectations of a 0.9% GDP decline for 2009, confirming the recent decline in expectations.

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The Australian dollar found support below the 0.65 level against the US dollar and strengthened to test levels above 0.70, but was unable to sustain this advance.

Minutes from the Reserve Bank meeting suggested that interest rates could be cut again in 2009, although international considerations were dominant.

The currency derived support from a weaker US currency and a recovery in risk appetite. These forces were offset by global growth fears while commodity prices also struggled to hold gains with crude prices at a four-year low late in the week.

The Australian dollar should be able to resist heavy selling pressure, but is unlikely to make strong headway until fears over the global economy start to ease.

Canadian dollar:

The Canadian dollar found support weaker than 1.25 level against the US dollar and strengthened sharply to peaks near 1.18 before correcting weaker to 1.22. The currency was boosted by the sharp US dollar losses and a stabilisation in risk appetite. The currency was hampered by a further decline in crude oil prices and growth fears.

Retail sales fell by 0.9% in November and leading indicators dipped sharply which dampened sentiment to some extent, although the impact was limited.

International trends will remain extremely important in the short-term and it will be difficult for the Canadian dollar to make strong gains from current levels.
 
Indian rupee:

The rupee continued to advance over the week as international conditions remained much more favourable with the currency pushing to a six-week high. The rupee edged lower and consolidated near 47 against the US dollar on Friday.

The Indian currency gained support from the generally weak US currency while there was a strong rally in global stocks with the local markets at a five-week high.

The further decline in oil prices alleviated fears over the export trends, although there were still concerns over the export outlook given the global downturn in demand.

There is scope for a further tentative Indian rupee recovery given the improvement in international conditions. Growth fears will still limit the scope for gains. 

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The Hong Kong dollar continued to test the band’s 7.75 upper limit during the week. The HKMA was forced to intervene on many occasions during the week to keep the currency within the band. Indeed, interventions totalled over HK$65bn over the week which pushed total money-market liquidity to a record high.

There was underlying support from general dollar losses and an unwinding of carry trades while there was some evidence of capital repatriation from Chinese funds on fears over Chinese growth trends which supported the Hong Kong dollar. 

The Hong Kong dollar should retain a firm tone for now and sustained capital repatriation would increase speculation over an adjustment in the currency band. 

Chinese yuan:

The Chinese yuan strengthened slightly against the dollar over the week and consolidated near 6.84 on Friday. The currency substantially under-performed on the crosses with sharp losses against the Euro. The capital account will remain an important focus given speculation that capital flows have reversed on economic fears.

The central bank actions continued to suggest that it would resist significant yuan appreciation against the dollar as growth fears persisted. The government cautioned that the economy could not rely in a weak yuan as policy uncertainty continued.

Persistent fears over the Chinese economy will be a negative factor for the Chinese currency and there will be fears over capital outflows. Despite speculation over a policy to promote a weaker yuan, the central bank is more likely to aim for stability

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