Weekly Forex Currency Review 20-04-2007

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Overall strategy

Global capital flows are vulnerable to significant swings and overall market volatility levels are liable to rise. Confidence in the US economy and currency will remain generally weak in the short-term, with persistent concerns over the housing sector fuelling speculation over lower interest rates, although an interim peak in dollar selling may be close.

Key events for the forthcoming week

Dollar

The latest US growth data has shown some evidence of stabilisation, but sentiment will remain weak in the short-term with investors not convinced that the mortgage-related difficulties can be contained without damaging the wider economy. The dollar will remain vulnerable to selling pressure given the existing yield structure and persistent structural weakness. Only a small recovery in sentiment could trigger a significant recovery given the positioning bias.

The dollar generally remained under pressure over the week and fell to lows beyond 1.3630 against the Euro, very close to the record lows seen at the end of 2004.

US retail sales rose 0.7% in March with an underlying 0.8% increase. Headline industrial production fell 0.2%, but this was due to a sharp drop in utility output on warmer weather and there was a 0.7% increase in manufacturing production.

The housing starts and permits data recorded a 0.8% monthly advance in March, supported in part by improved weather conditions. Manufacturing surveys remained generally disappointing with the Philadelphia Fed index static at 0.2 for April, although the underlying components improved slightly.

Headline consumer prices rose 0.6% in March, but the underlying increase was held to 0.1% which cut the annual increase to 2.5% from 2.7% and boosted expectations that there would be scope for lower interest rates later this year.

The monthly capital account data registered net long-term inflows of US$58.1bn in February from a revised a US$79.6bn the previous month.

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The Euro will continue to be supported by confidence in the Euro-zone economy and expectations of a firm ECB policy stance. There have also not been any significant protests against Euro strength from European officials which will boost market confidence in buying the currency. French political uncertainties may slightly increase caution over Euro buying in the shor- term.

The Euro strengthened over the week as a whole, although there was some significant profit taking against low yield currencies such as the Swiss franc and Japanese yen.

The German ZEW index rose to 16.5 in April from 5.8 the previous month, maintaining the favourable trend for key Euro-zone data.

Remarks from ECB officials were consistently firm over the need for inflation vigilance with further suggestions that interest rates would be increased by June.

There was no significant opposition to currency strength from European officials.

Yen 

Yield considerations will remain negative for the Japanese currency in the short-term with investors looking to sell the yen on significant gains. There will, however, be increased confidence over domestic conditions and rising land prices will increase the potential for a further Bank of Japan interest rate increase late in the second quarter. Any sustained increase in risk aversion would also be likely to result in a fresh closing of carry trades which would strengthen the yen.   
                    
The yen weakened in response to the G7 meetings the previous weekend with lows near 120.0 against the dollar and beyond 162.0 against the Euro. The yen recovered back to beyond 118.0, but was unable to sustain the gains.

The domestic data was stronger than expected with a the services-sector growth index rising 1.0% in February while there was further evidence of rising land prices.

There was some speculation that the Bank of Japan would increase interest rates again at the May meeting.

The yen gained temporary support from a decline in Asian stock markets and strong Chinese data which reinforced expectations of a tighter regional monetary policy.

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Following the strong increase in inflation and average earnings, there will be continuing speculation over at least one further increase in interest rates within the next few months. The underlying risks are liable to increase, especially as the property sector is liable to deteriorate sharply in response to any further monetary tightening. The UK currency will still find it difficult to sustain current levels against the US dollar even with near-term strength.
 
Sterling pushed above the 2.00 level against the dollar for the first time in 15 years, pushing to a 26-year high above 2.01 before a partial retreat. The UK currency weakened to near 0.68 against the Euro.

The headline UK consumer inflation rate rose to 3.1% in March from 2.8% the previous month, the highest rate since the index was launched in 1997. The Retail Prices Index (RPI) also rose to 4.8% from 4.6%. The Bank of England remained confident that the inflation would fall later in 2007.

Headline earnings growth rose to 4.6% in February from 4.2% the previous month due to the impact of bonus payments while the underlying figure held at 3.6%.

Housing survey evidence remained strong with the Rightmove index recording a sharp 3.6% monthly increase in prices for April to give a 15.0% annual increase. Retail sales rose 0.3% in March to give a 4.8% annual increase.

The Bank of England minutes from the April meeting recorded a 7-2 vote for unchanged interest rates. The two dissenting members calling for an immediate increase in rates due to strong inflation risks.

Swiss franc

The Swiss fundamentals will remain robust in the short-term with firm growth and a strong probability of a further National Bank interest rate in June. Short-term setbacks will encourage renewed interest in carry trades. Nevertheless, there is the risk that demand for defensive currencies will increase on a sustained increase in risk aversion, especially if global stock prices drop. The National Bank is also likely to protest against further losses against the Euro.
 
The Swiss franc tested the 1.20 resistance level against the dollar for the first time in four months. The franc also strengthened back to near 1.63 against the Euro, but was unable to sustain the gains as confidence in carry trades returned.

The Swiss economic data remained strong with a 4.5% annual increase in retail sales in the year to February while inflation indicators were subdued.

National Bank Chairman Roth warned that the franc had deviated from fundamentals which helped support the Swiss currency on fears over further verbal intervention.

The franc drew some temporary support from a renewed drop on Asian stock markets.

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The Australian dollar strengthen further to highs near 0.84 against the US currency before a corrective retreat back to below 0.83 as volatility increased. The local currency pushed back to 0.8350 as underlying high-yield support continued.

There was little in the way of domestic data during the week with business and consumer sentiment weakening slightly. Markets were still confident that there would be an interest rate increase in May.

A renewed decline in Asian stock markets triggered a bout of profit taking on carry trades, but confidence recovered quickly as market conditions stabilized.

Sentiment will remain strong, but the currency is still vulnerable to a more substantial correction weaker following recent strong gains.

Canadian dollar

The Canadian dollar strengthened to a high beyond 1.1250 against the US dollar before weakening back to 1.13 in a correction from recent strong gains.

The Canadian inflation data was stronger than expected for the second consecutive month with a headline increase of 0.8% in March as energy prices rose, while there was a core 0.3% monthly increase to give an annual increase of 2.3%.

There was further speculation over higher interest rates following the inflation data.

The data also recorded strong investment inflows for February which helped underpin market sentiment. The Canadian dollar was undermined in part by lower oil prices.

The currency will be vulnerable to at least a partial correction after recent gains.

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The Indian rupee strengthened to highs around 41.65 against the US dollar, a fresh 9-year high for the local currency, before some retreat towards the 42.1 level on Friday.

Interest rates remained high during the week and overnight rates close to 10% supported the rupee as credit conditions remained tight. Demand for dollars increased slightly during the week as oil importers increased their US currency purchases.

The decline in Asian stock markets tended to undermine the currency to some extent on fears over capital outflows, although conditions calmed quickly.

There was evidence of limited Reserve Bank intervention to stem strong rupee gains. Overall the rupee should remain firm, but some further correction is realistic.

Hong Kong dollar

The Hong Kong dollar secured a slightly firmer trend for much of the week with a move to highs around 7.81 although trading ranges remained narrow. The currency retreated to 7.8150 on Friday as lower domestic inter-bank rates encouraged renewed arbitrage activity even with US dollar sentiment weak.

There was further Hong Kong dollar demand related to the local Initial Public Offerings (IPOs). Strong Chinese growth failed to have a big impact.

Overall US dollar demand remained weak, but the drop in Asian stock markets on Thursday had a small negative impact on the currency.

The Hong Kong dollar is likely to find further support close to 7.8150 against the US dollar, but is unlikely to make strong headway.