Weekly Forex Currency Review 21-08-2009

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Underlying confidence in the US dollar remains generally fragile with expectations of longer-term depreciation fuelled by quantitative easing, substantial debt issuance and reserve diversification. In the shorter-term there is still scope for the US currency to make headway, especially as markets are likely to adopt a more cautious attitude towards risk on fears that valuations have been pushed too high.  

Key events for the forthcoming week

Dollar:

There will be expectations of a further gradual short-term improvement in the economy.  Confidence will, however, still be fragile with particular doubts surrounding the consumer sector. There will also be fears over the commercial property sector and the risk of further deterioration in the banking sector. The dollar moves will still be linked closely to trends in risk appetite and there will be defensive support for the US currency if sentiment towards the global economy deteriorates. Overall confidence in market direction is liable to remain low and the dollar should be resist heavy selling from current levels.   

The dollar pushed higher over the first half of the week, but again struggled to make any significant headway and came under renewed selling pressure. Defensive demand for the dollar faded during the week as equity markets attempted to rally while underlying confidence in the currency remained weak.

The US New York Empire manufacturing index strengthened to 12.1 in August from -0.6 the previous month which provided some degree of reassurance over the manufacturing sector. The Philadelphia Fed index also improved to 4.2 from -7.5 the previous month, maintaining the positive tone.

In contrast, the jobless claims data was weaker than expected with initial claims rising to 576,000 from  a revised 561,000 the previous month while continuing claims also increased. The jobless data does lag behind the economy as a whole and the manufacturing data has been firmer, but there were fears that the economy will stall quickly under the weight of credit contraction and consumer debt levels.

The construction-related data was slightly weaker than expected with housing starts edging slightly lower to an annual rate of 0.58mn from 0.59mn the previous month while permits were also slightly lower at 0.56mn. The headline data was held back by notable weakness in the multiple-units sector while there was still evidence of an underlying improvement in conditions.

The latest US Treasury capital flows data recorded net long-term inflows of US$90.7bn for June after revised net outflows of US$19.4bn the previous month. Overall capital flows were still negative for the month and monthly data will inevitably be volatile.  There was firm buying of US Treasuries for the month which may ease fears over reserve diversification to some extent, although there was a decline in Chinese holdings over the month.

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The improvement in Euro-zone business confidence will maintain expectations of a recovery in economic conditions which will also help boost confidence in the Euro. There are, however, still important areas of vulnerability and there will also be fears that credit conditions will tighten.  Any renewed deterioration in the Eastern European financial sector would also have an important negative impact on Euro confidence as banking fears would intensify.  Overall, the Euro will still find it difficult to gain strong gains from current levels.   

The Euro resisted more than limited selling pressure during the week and was able to secure modest advance as global risk appetite improved from initial lows. The Euro consolidated just above 1.42 against the dollar.

The Euro was unsettled temporarily by a sharp drop in Chinese equity prices which undermined international risk appetite while there was also a sharp fall in German producer prices which reinforced speculation over deflation pressures.

The German ZEW business sentiment index rose to 56.1 in August from 39.5, the highest headline reading for over two years, although ZEW officials were cautious over the outlook due to the underlying vulnerabilities. There were also further concerns over the threat of a credit crunch developing over the next few months which limited any positive Euro impact.

Yen:  

The short-term yen movements will continue to be influenced strongly by trends in risk appetite. The Japanese currency will still gain defensive support when risk conditions deteriorate. There will tend to be domestic opposition to substantial yen gains and comments from opposition officials will also be watched very closely given potential comments on reserve management policies. Overall, the yen will struggle to sustain significant gains.      

The yen strengthened against the US dollar over the week and tested US currency support levels below the 94 level. The Japanese currency was broadly resilient on the crosses and firmed towards 93.50 on Friday. Markets remained on high alert over comments from Finance Ministry officials as the yen gained ground, although there were no clear attempt at verbal intervention.

Domestically, there was a reported 0.9% GDP growth for the second quarter following two quarters of sharp contraction. The GDP increase was slightly below expectations and confidence in the economy remained generally fragile as private spending remained weak.

Campaigning for the August 30 general election officially started on Tuesday and markets continued to monitor comments on currencies and reserve diversification from key opposition officials. Comments on longer-term economic reform policies were also watched closely during the week.

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The Bank of England strategy will continue to unsettle Sterling in the short term, especially with the bank governor pushing for an even more aggressive programme of bond buying at the August meeting. There will also be increased fears over the government debt situation if the economic recovery seems to be stalling.  Trends in risk appetite will also be important with Sterling much more vulnerable to selling pressure if there is a sustained deterioration in risk appetite. Overall, the UK currency is likely to remain vulnerable to selling pressure
 
Sterling was subjected to sharp selling pressure at times, but was able to resist heavy losses for the week as a whole with some buying support below 1.64 against the US dollar. Trends in risk appetite continued to have an important influence as selling pressure on Sterling intensified when equity markets fell sharply. In contrast, the recovery in risk appetite helped the UK currency rally

The retail sales data was marginally stronger than expected with a 0.4% monthly increase for July after a revised 1.3% increase the previous month. The Rightmove index recorded a 2.2% decline in house prices for August, breaking the recent run of favourable economic data, although the series can be prone to seasonal volatility.

The government borrowing data was substantially worse than expected with a GBP8.0bn monthly deficit for July. For the first 4 months of the fiscal year, the borrowing requirement rose to GBP49.8bn from GBP15.8bn. The borrowing data will reinforce underlying fears over the debt position and will provide a stern test of market confidence in the UK economy and currency.

The latest consumer inflation data was higher than expected with the annual rate unchanged at 1.8% compared with expectations of a decline to 1.5% while there was a 1.4% annual decline in the RPI index with housing costs still showing a substantial annual decline. The higher than expected inflation rate initially dampened expectations of more aggressive Bank of England monetary policies.

The Bank of England minutes recorded a 9-0 vote for unchanged interest rates at the August policy meeting. There was a 6-3 vote in favour of the GBP50bn expansion of the quantitative easing.  The dissenters wanted a larger GBP75bn increase in the programme, in contrast to expectations that members voting against were more likely to want a pause in the bond buying scheme. The pressure for a more aggressive quantitative policy undermined Sterling.

Swiss franc:

The National Bank policies will remain extremely important in the short-term and the bank’s statements continue to suggest strongly that there will be intervention to prevent significant appreciation, especially against the Euro. The Swiss currency will still tend to gain some defensive support when risk appetite deteriorates.  Nevertheless, the overall risk profile suggest that any franc gains will not be sustainable.   
 
The dollar was unable to sustain a move above 1.08 against the Swiss franc during the week and weakened back towards 1.06 later in the week on wider  losses for the currency. The franc moved stronger against the Euro.

There was a recorded 0.9% annual increase in retail sales for June following a 1.4% decline the previous month. The trade account remained in comfortable surplus for July with a recovery in exports providing some underlying support to economic confidence. The ZEW business confidence index also strengthened to a 3-year high according to the latest survey.

Swiss National Bank member Jordan stated that bank would not tolerate a rise in the franc against the Euro and that the bank will maintain the policy of unconventional easing in the short term.

Jordan’s comments were particularly blunt for a central bank official as pledged that the franc would not be allowed to strengthen through the 1.50 level against the Euro.  Markets, therefore, remained on high alert for further intervention by the bank

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The Australian dollar dipped sharply during the week as risk aversion sparked sharply higher when global equity markets came under selling pressure. The currency found support below the 0.82 level against the US dollar before attempting to recover ground as risk conditions and commodity prices remained the dominant influences.

The Reserve Bank has continued to indicate that interest rates will be increased over the next few months which provided underlying support for the Australian dollar. A ratings warning over state debt levels undermined the currency late in the week.

The near-term Australian dollar performance will continue to be influenced strongly by degrees of risk appetite and commodity prices. Given the degree of recovery priced in, it will still be difficult to make strong headway.

Canadian dollar:

The Canadian dollar weakened sharply early in the week to test support levels near 1.1120 against the US currency. Trends in risk appetite dominated with the Canadian unit unsettled by a sharp decline in equity prices while crude oil also spiked lower towards the US$65 p/b level.

The domestic data continued to have no significant impact as international trends dominated and the Canadian dollar recovered ground later in the week.

The Canadian dollar will remain vulnerable to choppy trading in the short term, although it should prove broadly resilient against the US currency.

Indian rupee:

The rupee dipped sharply on Monday as global equity prices came under significant selling pressure. The currency suffered the sharpest one-day decline for 5 months with the rupee at a six-week low just beyond the 49.0 level against the US dollar.

There was a partial recovery later in the week as the US dollar retreated while there was also a rebound in risk appetite which underpinned the rupee.

Trends in global risk appetite continued to dominate, although the currency was also hampered by importer and oil refiners dollar demand

The rupee will gain support when global risk appetite improves. Nevertheless, the net risks suggest that the currency will find it difficult to make much headway. 

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The Hong Kong dollar weakened during the week as regional equity markets were subjected to sharp selling pressure and it briefly weakened to 2-month lows near 7.7515 against the US dollar.

Movements in historic terms were still very limited and there was a recovery later in the week as equity markets attempted to regain their composure.

The Hong Kong dollar should maintain a broadly firm tone unless there is a serious deterioration in confidence surrounding the Chinese equity markets and economy

Chinese yuan:

The yuan moves were still very limited during the week as the central bank maintained tight control with the currency close to 6.83 against the US dollar.

The Chinese currency edged slightly weaker when domestic stock markets weakened sharply, although the volatility in equity markets also tended to reaffirm the bank’s determination to maintain stability in the local currency market.

The underlying issue of reserve diversification remain an important market influence. There was a reported decline in China’s US Treasury bond holdings, while officials suggested that any move away from the US currency would be extremely slow.

Despite expectations of medium-term reserve diversification and Chinese currency appreciation, the central bank is likely to maintain the near-term policy of targeting stability, especially with unease over trends in domestic asset prices.