Weekly Forex Currency Review 20-11-2009

The markets will still be looking for alternatives to the US currency as underlying confidence in the economy and dollar remains very weak. Nevertheless, it may be increasingly difficult to find attractive investments and this may provide some net dollar protection, especially if there is further speculation over emerging-market capital controls.

Key events for the forthcoming week

Dollar:

The recent economic data will maintain expectations of a frail economic recovery with the risk of a renewed downturn during 2010once the fiscal support is removed. Markets will also be expecting short-term interest rates to remain at very low levels which will sap yield support for the dollar. There are also likely to be increased doubts over the global economy which will tend to curb selling pressure. Dollar rally attempts are realistic, but will be constrained by fears over medium-term reserve diversification.

Technical trading tended to dominate for much of the week with markets unable to break relatively narrow ranges. The dollar gained some protection as there was a gradually more cautious attitude towards risk with a 1.4820-1.50 range dominating.

The US housing data was again weaker than expected as starts for October declined to an annual rate of 0.53mn from 0.59mn the previous month while building permits dipped to 0.55mn from 0.58mn and this was the lowest rate since May. The NAHB unchanged at 17 for October following a small downward revision for September.

The industrial production data was also disappointing with the October increase held at 0.1% compared with expectations of a 0.4% monthly increase. The industrial and housing data will increase fears that the economy will find it very difficult to secure a sustained recovery.

The Philadelphia Fed index was stronger than expected with a further increase in the headline index to 16.7 from 11.5 the previous month. The employment component remained negative, but was at the highest level for over 12 months.

Elsewhere, jobless claims were unchanged at 505,000 in the latest week which continues to suggest a slow improvement in the labour market even though job creation remains very weak. The net impact of the data was some slight reassurance with risk appetite looking to stabilise.

As far as inflation is concerned, there was a 0.3% increase in consumer prices for October while core prices rose 0.2% for the month. Headline prices fell 0.2% over the year, but this was much less than the 1.3% decline seen the previous month and the low point for inflation has clearly passed which will complicate the Fed’s task.

Regional Fed Governor Bullard stated on Wednesday that based on previous economic cycles it was possible that the Fed will not start raising interest rates until 2012, although he also warned over the risk of leaving interest rates for too low for too long given the risk of asset-price bubbles developing. Bullard is an FOMC voting member during 2010 and the comments reinforced market expectations that short-term interest rates will remain at very low levels over the next few months.

The headline US retail sales data was slightly stronger than expected with a 1.4% increase for October. The September data was revised weaker to show a 2.3% decline while the core data was also slightly weaker than expected.  There were further doubts over the strength of consumer spending as underlying stresses persist.

Fed Chairman Bernanke stated on Monday that the central bank would pay close attention to the implications of changes in the value of the dollar. This was a fairly forthright comment from Bernanke and does signal increased Fed and Administration unease over the dollar’s value. The US currency made initial gains, but could not sustain the advance.  Bernanke also remained cautious over the economy and repeated comments that interest rates would stay low for a prolonged period.

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The Euro-zone economy is expanding and the ECB will be considering a reduction in the aggressive monetary stimulus. There is still a high degree of divergence within the area as economies such as Spain and Ireland are still in recession. Structural fears are also liable to increase further over the next few weeks, especially as there are still important vulnerabilities in the banking sector. In this environment, confidence in the Euro could quickly deteriorate.

The Euro has been generally slightly weaker over the past week as momentum for gains faded and international risk appetite was slightly weaker. There were no major economic data releases over the week. Structural fears were a focus with internal bond-yield spreads widening, notably for Greece.

The Euro-zone recorded a trade surplus for September as exports recorded firm growth and this will help ease any fears that Euro-zone competitiveness is a major issue. Euro-group head Juncker stated that the Euro was not yet at a problematic level which will dampen expectations of any action to curb Euro gains.

Nevertheless, ECB President made pointed remarks, backing Fed Chairman Bernanke’s comments on the dollar and this clearly indicates that the main central banks are more concerned over the dollar situation.

Yen:  

Confidence in the Japanese economy will remain very fragile as the debt burden remains a key vulnerability. There will also be fears that any significant measures to curb the debt burden will further undermine economic activity. The yen will not be as vulnerable to selling pressure to fund carry trades, especially with short-term US interest rates close to Japanese rates.  There will be domestic reservations over any sustained yen strength and yen gains may not be sustained.

The dollar was trapped within narrow ranges against the yen over the week, but there was a slightly weaker bias with lows near 88.50. The Japanese currency also gained some support on the crosses as it tested 200-day moving averages against the Euro.

The Japanese government announced that it would look to sanction a supplementary budget, but it is also very aware over market fears surrounding the debt burden and overall confidence in the economy is likely to remain fragile.

Significantly, 6-month dollar Libor rates dipped to below the equivalent yen rates which will tend to undermine support for the US currency.

The GDP data was stronger than expected with a 1.2% quarterly increase for the three months to September compared with expectations of a 0.7% rise. The data triggered some degree of optimism over growth trends. There were still major concerns over the debt situation with government debt fears still a key focus. Indeed, there has been a further increase in credit default swaps for Japan on fears over the fiscal situation.

The Bank of Japan left interest rates on hold at 0.1% and upgraded its view of the economy. In contrast, the government warned over deflation risks for the first time since 2006. Finance Minister Fujii stated on Thursday that he never meant to support a yen rise with his comments after taking office. He is, however, opposed to a devaluation of the Japanese currency.

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The latest economic data has continued to suggest that the economy will grow during the fourth quarter which will provide some degree of currency support. There will continue to be major fears over the government debt situation, while any measures to tighten fiscal policy in 2010 would increase pressure for low interest rates. Sterling moves will also remain correlated with trends in risk appetite and any spike in risk aversion would tend to undermine the currency. Sterling will continue to gain some support on valuation grounds which should limit depreciation pressure from current levels.

Sterling was unable to sustain its best levels over the week with a retreat back to near 0.90 against the Euro and selling pressure above 1.68 against the dollar with support levels near 1.66 against the dollar under pressure on Friday.

The latest government borrowing data was much worse than expected with a GBP11.4bn for October compared with expectations of a GBP6.1bn figure For the first half of the year fiscal year, the borrowing requirement was GBP85.9bn compared with GBP33.9bn last year. Tax receipts fell 9.1% while spending rose 10.3% over the year. The data maintained longer-term fears over the debt position

The consumer inflation data was in line with market expectations with a headline increase to 1.5% from 1.1% as transport costs increased. The data reinforced market expectations that the inflation rate has hit a low point.

The Bank of England minutes recorded a split vote at the November meeting with 1 member voting for a bigger increase in quantitative easing to GBP215bn while another member wanted no increase in the bond-buying programme. There was a unanimous vote to leave interest rates at 0.50%.

The minutes did not add much to the current debate on interest rates with the data remaining under close scrutiny over the next few weeks. The bank did discuss cutting interest rates on bank deposits which was a negative factor for Sterling. There was also a mood of uncertainty which tended to dampen confidence.

Swiss franc:

The National Bank remains generally cautious over the 2010 outlook which suggests that the bank will also remain uneasy over the implications of franc strength. There will, therefore, be further speculation over intervention to weaken the currency. The franc is not as vulnerable to selling to fund carry trades and selling pressure is liable to be limited in the short-term. 
 
The dollar found support close to 1.0050 against the franc and strengthened to test resistance levels near 1.02, although it was unable to gain any significant momentum. The Euro was trapped within very narrow ranges near 1.51 against the franc.

The latest retail sales report was weaker than expected with a 1.6% annual decline. The trade surplus increased to CHF2.46bn for October as exports recovered.

National Bank Chairman Roth was generally downbeat over 2010 prospects in his latest comments which maintained expectations that the bank could intervene.

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The Australian dollar maintained a robust tone early in the week as underlying sentiment remained very high. There was tough resistance near the 0.94 level against the US dollar and the Australian currency retreated to lows near 0.91 later in the week as risk appetite weakened.

The Reserve Bank minutes suggested that the bank was more cautious over a further interest rate increase at the December meeting which also sapped Australian dollar buying support.

Australian dollar sentiment will remain strong, but there is the risk of a more substantial correction weaker given doubts over international risk appetite.

Canadian dollar:

The Canadian dollar was unable to sustain gains beyond the 1.05 level against the dollar during the week and weakened to lows beyond 1.06 in choppy trading.

The Canadian currency was hampered by a less confident attitude towards global risk which offset the impact of strong gold prices. There were no major domestic influences with markets still wary over the risk of protests against currency strength.

Trading conditions are liable to remain choppy in the short-term. The net risks suggest that Canadian dollar gains are liable to stall near the 1.05 region.

Indian rupee:

The rupee had a generally softer tone over the week, although moves were relatively restrained with rupee support on dips to the 47 region against the US currency.

There was a slightly weaker tone in the local equity market which curbed rupee support. There was also some speculation over possible capital controls to curb capital flows which had a negative impact on confidence.

The rupee will be vulnerable to some further selling pressure if there is a serous deterioration in risk appetite. Overall, heavy losses look unlikely in the short-term.

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The Hong Kong dollar maintained a position very close to the 7.75 limit against the US dollar during the week. The HKMA continued to provide liquidity with 11 consecutive days of intervention in the market to preserve the band limit.  

There were further robust capital inflows with demand for the Hong Kong dollar fuelled by optimism over the regional economy and expectations of medium-term yuan appreciation.

The Hong Kong dollar is likely to maintain a robust tone in the near term unless there is a serious deterioration in international risk appetite.

Chinese yuan:

The Chinese central bank refused to allow yuan appreciation in the spot market with almost no change in the fixing and the spot rate actually fell to a 3-week low.

There was a stream of comments from Chinese officials suggesting that there will be a high degree of caution over allowing the yuan to appreciate. There were no major economic data releases during the week.

There were no major public political breakthroughs in talks between Chinese officials and US president Obama as international pressure for a stronger yuan continued.

Expectations of medium-term yuan appreciation will remain a very important feature, the central bank is still likely to resist pressure for substantial gains in the short-term.