Weekly Forex Currency Review 21-11-2008

Weekly market analysis: November 21st 2008

09.25 AM GMT Overall strategy: Confidence in the global economy will remain extremely weak in the short - term as fears over a deep recession will intensify. In this environment, risk appetite is likely to remain very frail, especially with underlying pressure for de-leveraging still an important feature. The US currency is continuing to gain some defensive support, but it may prove increasingly difficult to sustain a robust tone given the further US deterioration.

Key events for the forthcoming week

Market analysis

Dollar:

There will be further serious fears over the US economy, especially as the latest data releases have continued to suggest that the downturn is accelerating. There will be fears over a very weak December employment report and fears over the financial sector. The evidence suggests that the Federal Reserve will cut interest rates again and take an aggressive stance to combat any deflation threat. There will be major unease over the longer-term implications for the currency of the monetary and fiscal policies. In the near term, the dollar will continue to gain some defensive support from severe fears over the global economic outlook.

After a depressed retail sales report at the end of last week, concerns over the US and global economy continued to intensify over the week following a stream of weak data releases and downward pressure on asset prices.

Markets were unsettled by the change of emphasis on the TARP rescue fund towards the consumer sector and away from buying mortgage-related securities which undermined confidence in the banking sector. Continuing negotiations over support for the auto sector also damaged sentiment.

G20 members pledged action to support the global economy at their weekend meeting, but there were no fresh public commitments. Although there was evidence of serious deterioration within the US, the dollar held firm on increased global fears and defensive demand for the currency with tests beyond 1.25 against the Euro.

The US inflation data recorded sharp monthly declines in prices as consumer prices fell by 1.0% in October, the sharpest decline for 40 years, and producer prices declined by 2.8% over the month. Although there was an increase in core producer prices, there was a 0.1% decline in core consumer prices for the month.

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Housing starts continued to decline in the latest month with an annualised rate of 0.79mn from 0.83mn the previous month while the permits data recorded a steeper decline to 0.71mn. The latest NAHB survey also weakened to a fresh record low of 9 in October from 14 previously with reports that financing in the sector has seized up.

The industrial data was generally weak with the New York manufacturing index weakening to a fresh record low. There was a rebound in industrial production as the impact of hurricanes faded following the sharp decline the previous month. The Philadelphia Fed index also weakened further to -39.3 from -37.5 the previous month, maintaining the recent run of very weak survey data.

Initial jobless claims rising sharply for the second successive week to 542,000 in the latest week from a revised 515,000 previously. This was the highest figure since 1982 and will reinforce fears over a sharp downturn, especially with continuing claims also rising very fast during November.

The capital account trends remained important for the US currency and the September data recorded an increase in net long-term capital flows as international investors continued to buy US Treasury bonds. There was also further evidence of underlying capital repatriation as global fears persisted.

Euro:

The Euro-zone economy will continue to weaken in the short - term and the ECB is likely to cut interest rates further at the December meeting with speculation over a more aggressive stance from the bank. The Euro is likely to gain some support from expectations that the ECB will maintain a medium-term focus on price stability. The core Euro-zone economy may also prove relatively resilient. There will, however, be fears over any further widening of bond spreads and serious stresses within countries such as Spain and Italy.

The Euro was mixed over the week, but failed to sustain rallies against the dollar and yen as risk appetite remained very fragile.

There was little in the way of major Euro-zone data over the week with the trade account remaining in deficit for the latest month. The flash PMI data for November indicated a further deterioration with a manufacturing reading of 36.2 while the services index weakened to 43.3 from 45.8 with both series at record lows

ECB officials continued to suggest that inflationary risks had eased. Bundesbank head Weber, traditionally a very hawkish council member, stated that a further rate cut could not be ruled out. He also stated that the central bank would need to move more quickly than usual to normalise monetary conditions.

Mersch was more cautious over a substantial rate cut and chairman Trichet also took a more measured view, but the comments still suggested that rates would be cut. Markets continued to expect a further interest rate cut at the December meeting with some speculation over a move ahead of the meeting.

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The economy is liable to weaken further in the short - term with particular fears over the export sector, especially given the spate of warnings from the industrial sector. There will be further pressure on the Bank of Japan and Finance Ministry to take more decisive efforts to support the economy. There will also be further speculation that there could be intervention to stem yen appreciation, but any losses will be short-lived without an improvement in risk appetite.

The yen weakened intermittently during the week, but quickly regained ground and advanced against all the major currencies. The Japanese currency continued to gain support from the underlying increase in risk aversion and de-leveraging in the global markets as fear dominated. There was a peak beyond 94 against the dollar.

The latest data recorded a further 0.1% GDP contraction for the third quarter after a revised 0.9% decline the previous quarter, effectively confirming a recession in Japan.

The trade data recorded a deficit for the second time in three months with notable weakness in exports. There was a 7.7% annual decline in shipments and exports fell to Asia for the first time in six years. There were strong profit warnings from the main Japanese carmakers as global sales continued to weaken.

The Bank of Japan held interest rates at 0.3%, but did indicate that it would add liquidity more aggressively to combat year-end liquidity stresses.

Sterling:

The economy will continue to weaken for now and there is liable to be a sharp fourth-quarter contraction despite the stronger than expected retail sales report. Given that credit conditions remains extremely tight, the Bank of England is likely to cut interest rates again at the December meeting. The persistent Sterling weakness may generate some caution over a very aggressive cut. The UK currency will also gain some protection from the serious difficulties faced by all major economies, but will need banking stability for improved confidence.
Sterling secured some temporary respire in mid week, but rallies quickly met selling pressure and there was renewed downward pressure late in the week as risk appetite continued to deteriorate with a renewed slide below 1.50 against the dollar.
Retail sales fell by 0.1% in October after a revised 0.5% decline the previous month, in contrast to expectations of a more substantial decline. There was further weak fiscal data in the latest monthly government borrowing report.
The latest inflation data recorded a sharp decline in the headline rate to 4.5% from 5.2% previously while the core rate also dipped to 1.9% from 2.2% previously.
The Bank of England MPC committee voted 9-0 for the 1.50% November rate cut. The MPC indicated that cuts of at least 2.00% would be needed to meet the revised forecasts for the economy, but they were wary of cutting by such a substantial margin in one move, especially given the threat of a very negative Sterling reaction.
The comments from MPC members also suggested that interest rates would be cut further, although Sterling weakness was again a notable feature in their comments.
Swiss franc:

The economy will continue to weaken in the short - term with both domestic and export prospects weaker. There will also be serious fears over the financial sector given the importance of the banking sector. The National Bank has suggested that interest rates will be cut further which will undermine the currency. The fundamental weaknesses will also limit any defensive support for the Swiss currency on elevated levels of risk aversion.

The Swiss currency weakened significantly over the week as domestic economic fears intensified. The franc weakened to 2008 lows against the dollar beyond 1.2250 while it also dipped to lows beyond 1.5350 against the Euro.

The trade account remained in comfortable surplus, but there was a further significant decline in exports which reinforced fears over the economic trends.

In a surprise move, the National Bank announced a further sharp 1.0% in official interest rates to 1.0%. The bank has now announced three unscheduled rate cuts since the last formal policy meeting in September.

Bank Chairman Roth stated that the bank needed to take immediate, pre-emptive action on rates and a big move was required for it to be effective. He also suggested that there was scope for rates to be cut further.

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The Australian dollar attempted to rally in mid week, but was unable to sustain the advance and weakened to lows near 0.60 against the US currency, re-testing the lows seen during October as market fears intensified.

The Reserve Bank was generally cautious over the global economy and suggested that interest rates could be cut significantly further to combat a slowdown. The central bank confirmed that it had intervened heavily during October to help protect the local currency and it also moved to intervene during the current week.

The Australian dollar will need an improvement in risk appetite and some degree of stability in the global economy to sustain any significant near-term gains.

Canadian dollar:

The Canadian currency was again subjected to very high volatility over the week and, after securing brief gains, it weakened sharply towards 1.30 against the US dollar.

The currency was undermined by a further decline in commodity prices as crude oil dipped to lows below the US$50 p/b level for the first time in close to two years. The currency was also unsettled by a renewed spike in risk aversion.

Comments from Bank of Canada Governor Carney suggested that the bank would look to lower interest rates further given the sharp reduction in inflation pressures. Stronger than expected wholesale sales data did not have a significant impact.

There is likely to be further Canadian dollar volatility in the short - term with the currency looking to secure some respite after recent sharp losses.

Indian rupee:

Volatility levels remained high and the rupee dipped to fresh all-time lows beyond 50.50 against the US currency. The currency was undermined by renewed downward pressure on the stock market as capital outflows persisted and confidence deteriorated.

There were also renewed concerns over the trade outlook, especially with a severe decline in global confidence. The rupee recovered from lows as the central bank intervened aggressively to provide support and held close to 50.2 on Friday.

Volatility levels are liable to remain highly elevated in the short - term. Despite further concerns, the rupee should be able to resist aggressive selling from current levels.

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The Hong Kong dollar has continued to trade close to the 7.75 band limit against the US currency. The local currency has remained strong despite increasingly aggressive interventions by the HKMA to provide additional liquidity with fund injections of over US$4bn over the week. Hibor rates fell to the lowest level for six months.

The regional economic fears and downward pressure on stock markets failed to curb the underlying currency strength with evidence of capital repatriation and de-leveraging as global fears intensified.

The Hong Kong dollar should retain a firm tone for now and speculation over a move to widen the currency band will persist, although stability will take initial priority.

Chinese yuan:

The yuan has continued to trade within narrow ranges around 6.83 against the US dollar over the week as the central bank has continued to promote stability to help counter the possibility of disruptive capital flows.

Sentiment toward the yuan was undermined by further fears over the Korean won and a loss of confidence in the Asian economy as a whole.

In its latest report, the central bank called for convertibility of the yuan to be speeded up. The bank was also generally downbeat on economic prospects which curbed support for the Chinese currency and increased speculation over lower interest rates.

In the near-term, the central bank will continue to maintain stability. There will be speculation over plans for renewed appreciation in 2009 following the central bank's comments on exchange rate policy.

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