Weekly Forex Currency Review 22-01-2010

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Overall confidence in the global economy is likely to be slightly weaker in the short-term with fears that too strong a recovery has been priced in. In this environment, there will be greater caution over higher-risk assets and there is also scope for some defensive dollar support. The US currency will find it difficult to make further strong headway given the underlying vulnerabilities.

Key events for the forthcoming week

Dollar:

There will be further expectations of a short-term improvement in the economy. There will still be speculation that the Federal Reserve will increase interest rates at only a very slow pace given the underlying economic stresses which will limit support. The US currency will continue to gain some defensive support if risk aversion deteriorates and there will also be a lack of confidence in the other major currencies which will provide net support. There will still be expectations of longer-term diversification away from the dollar which will limit gains.

The US currency made further gains over the week as confidence in the other major currencies was generally weaker. The US currency also broke through some significant technical levels which provided additional support before hitting tough resistance close to 1.40 against the Euro.

The latest US jobless claims was weaker than expected with an increase in claims to 482,000 in the latest week from a revised 446,000 previously. The increase was probably due to seasonal distortions, but the data will be watched more closely next week and another higher than expected figure would cause some unease.

The US housing-starts data was weaker than expected with a 4% decline to an annualised level of 0.56mn for December from 0.58mn the previous month. There was, however, a monthly increase in permits to 0.65mn which maintained some hopes for a recovery in the housing sector during 2010.

Elsewhere, the Philadelphia Fed index was slightly weaker than expected with a decline to 15.2 for January from 22.5 the previous month. There was some unease that the orders component weakened back to near the zero threshold.

The latest US capital account flows data for November recorded a sharp increase in long-term inflows to US$126.8bn from a revised US$19.3bn the previous month. Overall inflows were still subdued, but the data provided some degree of support to the US currency as it suggested that there is still robust interest in US assets.

President Obama proposed fresh regulation for the banking sector which had a significant impact in undermining risk appetite and also tended to hurt the dollar on fears that the banking sector would be damaged.

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Structural vulnerabilities within the Euro-zone will continue to be a very important focus in the short-term and there will be continuing fears over weakness in economies such as Greece. There will also be some speculation that there will be more extreme developments such as a debt default, especially if there is any further widening in yield spreads. There has already been a significant adjustment in expectations which may lessen the risk of further heavy selling pressure on the currency. 

Underlying confidence in the Euro-zone economy and Euro remained weak during the day as underlying stresses continued. There was a further widening of yield spreads between German and Greek benchmark bonds to 12-month highs which again undermined the Euro on fears that there could be a debt default and a forced rescue package. There was notable weakness against the yen and Sterling.

The French Prime Minister stated that the dollar level was destabilising which will maintain the impression that a weaker Euro will be welcomed.

The German ZEW index recorded a decline to 47.2 for January from 50.4 previously which, allied with cautious remarks from officials, reinforced a lack of confidence in the Euro-zone economy. The PMI indices remained comfortably in positive territory, although the services-sector data was weaker than expected.

Yen:  

Underlying confidence in the Japanese economy will remain generally weak in the short-term with continuing fears over the government-debt situation. The Japanese currency will still tend to gain some support when risk aversion rises, especially if confidence in the 2010 economic outlook deteriorates. There will also be a further lack of confidence in other major currencies which will net provide yen support. Exchange rate policies will also remain important and there will be further pressure for yen gains to be resisted.

The yen continued to resist selling pressure during the week and strengthened over the second half as global risk appetite deteriorated. The dollar weakened back to test support levels below the 90 against the Japanese currency. Confidence in the Japanese economy is still weak and a further decline in consumer confidence reinforced pressure on the Bank of Japan to maintain an aggressive monetary policy to ease the deflation threat.

The Japanese government held its view of the economy in its latest report while also warning over the deflation threat. There will still be pressure on the Bank of Japan for further measures to combat the risk of falling prices.

There was a further increase in Chinese bill yields which ensured a cautious tone towards global risk and this provided some degree of yen protection, especially with further doubts over the global economic recovery. There were further warnings by the Central bank of China over the need for loan growth to be tightened during 2010. This was significant in curbing interest in carry trades which also lessened potential selling pressure on the yen

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The recent economic data will maintain speculation that the Bank of England will be pushed towards an early increase in interest rates. Policy uncertainty will, however, be a key feature and expectations are liable to shift several times over the next few months. There will also be fears that the Bank of England will lose control of policy which will tend to undermine Sterling sentiment. There will also be a high degree of unease over the government-debt situation and Sterling rallies will quickly attract selling pressure. 

Sterling maintained a firm tone against the Euro, strengthening to 5-month highs during the week. The UK currency was also generally resilient against the dollar and held above the 1.60 level.

The latest consumer inflation data was even higher than expected with a sharp increase in the year-on-year headline rate to 2.9% for December from 1.9% the previous month and this was a nine-month high for the series. The rate will increase again for the January reading and there will be additional pressure for the Bank of England to increase interest rates.

The labour-market figures were again stronger than expected with a decline in jobless claims of 15,200 for December after a revised 10,800 fall the previous month while the ILO unemployment rate dipped to 7.8%. The data did  mask underlying weakness as there was a decline in employment according to the latest figures which suggests that underlying labour demand is still weak.

The Bank of England minutes recorded 9-0 votes for interest rates and the amount of quantitative easing which was in line with market expectations. Comments from Bank of England Governor King were mixed and did not add to the speculation over higher interest rates as he stated that inflation would moderate during the first half of 2010.

The latest government borrowing data was slightly stronger than expected with a deficit of GBP15.7bn for December after a revised GBP18.7bn the previous month. This provided some degree of support for Sterling, although it was still a record deficit for the month of December.

Underlying sentiment was still fragile. Standard Life, for example, stated that the UK AAA credit rating is extremely vulnerable with the current economic and political situation described as toxic.

Swiss franc:

Euro-zone trends will continue to be watched closely and the Swiss currency is likely to gain some further defensive support from fears over the economy, especially if structural fears intensify. There will also be support if there is a sustained deterioration in global risk appetite. The National Bank will still be concerned over the implications of franc strength and there will be further intervention to curb currency gains if necessary which could trigger sharp reversals at times.

The Swiss currency maintained a strong tone against the Euro, pushing to fresh 10-month highs. The dollar strengthened to the 1.05 area against the Swiss currency before hitting tough resistance. The Euro remained under pressure during the week with a decline to test support below the 1.47 level.

The ECB announced that it would stop the Swiss franc liquidity auctions at the end of January as market conditions had improved. This provided some net support for the Swiss currency on expectations of reduced franc supply.

There was further further pressure on the National Bank to curb franc appreciation, especially as Swiss currency was still broadly firm against the dollar.

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The Australian dollar came under significant selling pressure during the week, dipping to lows just below 0.90 against the US dollar before a limited recovery.

The US currency was generally stronger while there was also fresh concerns over a slowdown in the Chinese economy which triggered renewed selling pressure on commodity prices and undermined the local currency.

The Australian dollar also came under pressure as a deterioration in risk appetite and weak equity prices triggered some reversal in carry trades.

The Australian dollar will remain linked strongly with rends in risk appetite. There should still be solid buying support on dips which will limit further near-term losses.

Canadian dollar:

The Canadian dollar was unable to extend gains over the week and then weakened sharply with lows beyond 1.05 against the US dollar. The currency was undermined by weaker risk appetite and a decline in commodity prices.

The Bank of Canada held interest rates at 0.25% and maintained its intention to keep rates unchanged during the first half of 2010. The bank again warned over the impact of currency strength which undermined the currency. The latest inflation data was weaker than expected which undermined the currency

The Canadian dollar fundamentals will remain firm which should help limit further losses in the near term even if a near-term peak in the currency has been seen.

Indian rupee:

The rupee was unable to advance further over the week and retreated to two-week lows just beyond 46 against the US dollar. There was a generally firmer US currency tone while stock markets also weakened significantly during the middle of the week which undermined sentiment.

There was also some evidence of dollar buying by importers. There was uncertainty ahead of the late January central bank policy review as speculation over a monetary tightening continued.

The rupee is liable to remain more on the defensive in the short-term with unease over a slowdown in the global economy later in 2010 sapping support.

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The Hong Kong dollar came under fresh pressure during the week and weakened to a 15-month low near 7.77 against the US dollar

There was further evidence of capital repatriation by Chinese banks which tended to undermine the Honk Kong dollar. The local stock market was also weaker which undermined sentiment while the US currency was able to sustain a firmer tone.

Although there will be speculation over weaker capital inflows, the Hong Kong dollar should be able to resist more than limited near-term losses.

Chinese yuan:

The Chinese central bank maintained tight control of the spot market while speculation over medium-term changed continued to swirl around the market

The latest economic growth data was close to expectations with fourth-quarter GDP growth of 10.7%. The consumer inflation reading was slightly higher than expected at 1.9% which maintain expectations of a tighter monetary policy

The central bank increased the 3-month bill rate for the second time this month. There was also a directive to suspend lending over the second half of January after very strong expansion during the first half of the month

These monetary moves increased speculation over a policy shift and international pressure for a policy shift continued.

The authorities will still want to resist pressures near-term currency-policy changes. Underlying pressure for a policy shift and a stronger currency will persist.