Weekly Forex Currency Review 22-08-2008

Weekly market analysis: August 22nd  2008

Overall strategy:

Conditions within the global economy will remain a very important focus for the currency markets. Although US unease has tended to increase again, a lack of confidence in prospects elsewhere should limit the scope for aggressive dollar selling, especially given the European fears. There is likely to be further caution over carry trades in the near term. 

Key events for the forthcoming week

Dollar:

Overall confidence in the US economy will remain fragile in the short-term and there will be particular concerns over the financial sector. The Federal Reserve will continue to be uneasy over inflation trends, but still appears very reluctant to increase interest rates. The US is still benefiting from robust export growth which will be an important cushion for the wider economy. The capital account is likely to remain stronger in the short-term with the dollar gaining important support from the increased fears over the global economy.  In this context, the dollar should be able to resist heavy losses even if gains are limited.

The dollar pushed to an eight-month high on a trade-weighted basis over the week, but the currency was increasingly vulnerable to a technical correction following rapid gains and dipped sharply on Thursday with the sharpest one-day decline for a month.

The trends in commodity prices were again important with the US currency losing ground as oil and gold prices rallied strongly. There were also renewed fears over the financial sector as the mortgage-finance agencies remained under pressure.

The US housing data recorded a decline in hosing starts and building permits for the month with starts at a 17-year low, reversing the advance seen the previous month which had been triggered in part by a change in building regulations.

The US Philadelphia Fed index improved to -12.7 in August from -16.3 the previous month while the prices component was significantly weaker as commodity prices fell. Jobless claims fell to 432,000 in the latest week from a revised 445,000 the previous month, although this was still at an elevated level.

Producer prices recorded a further strong increase of 1.2% for July after a 1.8% increase the previous month while core prices also rose 0.7% over the month.

Fed members were generally cautious over the outlook in comments during the week, although regional Fed President Fisher maintained his call for an early increase in interest rates. There was little change in interest rate expectations with markets putting the chances of a rate increase this year at around 20%.

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Underlying fears over the Euro-zone economic trends will persist in the short-term with concerns over domestic and export trends. The easing of commodity prices and a moderation in the Euro will provide some relief over trends. Nevertheless, markets will be looking for the ECB to take a less aggressive stance on monetary policy over the remainder of 2008. The Euro area will also remain vulnerable to further net capital outflows which will tend to undermine the Euro. Nevertheless, the rate of selling should ease from levels around the 1.45 level.             
       
The Euro remained under pressure over the first half of the week with a new six-month low against the dollar, but it recovered some ground later in the week and also rallied against the yen from levels near 160.0.

The German ZEW business expectations index recorded a recovery to -55.5 in August from -63.9 previously, but there was a decline in the current conditions index.

The German PMI index for the manufacturing sector weakened to just below the 50.0 level for August while the French data continued to deteriorate. The wider Euro-zone PMI releases provided some relief as they were above expectations, although both were still significantly below the 50.0 level.

The trade account recorded a seasonally-adjusted deficit of 3.0bn for June after a EUR1.0bn shortfall the previous month, maintaining the recent trend for deterioration.

Yen:  

There will be further speculation over recession conditions within Japan, especially as there has been a deterioration in exports. In this context, there will be fears over the outlook for the Asian economy which will also have a negative impact on the Japanese economy. The prospects for carry trades and global growth will remain very important in the short-term. Despite periods of relief, there is scope for a further unwinding of trades which would tend to support the yen and could trigger sharp appreciation at times.
                    
The dollar was again unable to sustain gains above the 110.0 level against the yen and the Japanese currency pushed to highs around 108.10. The yen quickly retreated from the best levels as fresh selling emerged.

The latest capital account data recorded net outflows from Japan, in contrast to the sharp inflows previously. There was further evidence of a reduction in carry trades funded through the yen which helped underpin the Japanese currency at times, but there was also a steady flow of funds out of the yen.

The Bank of Japan left interest rates on hold at 0.50% by a unanimous vote following the latest council meeting. The central bank also downgraded its outlook of the economy in its latest monthly report with concerns over domestic spending exports.

The all-industries index also remained weak in the latest data with a 0.9% monthly decline. There was some market speculation that the Bank of Japan would consider a cut in interest rates over the next few months.

The trade surplus fell sharply in July to JPY91bn, an annual decline of over 80%, but exports did return to positive growth after negative growth the previous month which provided some relief as shipments rose strongly to China.

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Overall confidence in the economy will remain very weak with recession fears continuing to build as consumer spending remains under pressure. Although the competitive position has improved, there has still been a weakening trend in the industrial sector which will further damage economic prospects. There will be further speculation that the Bank of England will look to cut interest rates as soon as possible to help underpin the currency.  Sterling is likely to remain generally on the defensive even if heavy losses from current levels are resisted.  

The UK currency remained under heavy selling pressure early in the week with a further test of support near 1.85 against the dollar, the weakest level for 22 months. Sterling pushed back towards 1.88 late in the week as the dollar, but weakened again on Friday and dipped to lows near 0.7970 against the Euro.

The economic data remained generally weak with the latest CBI industrial outlook survey recording a decline to -13 in August from -8 the previous month with a further decline in export orders and the weakest output plans for 7 years.

UK retail sales rose 0.8% in July for a 2.1% annual increase, but this did not provide a sustained boost to confidence in the economy, especially as the June data was revised down. The investment trends were also weaker than expected with a 1.9% quarterly decline which will maintain fears over the underlying economic outlook. Second-quarter GDP was revised down to a 0.0% from the 0.2% reported originally.

Minutes from the Bank of England's August meeting recorded a three-way split for the second successive month. The majority wanted to leave rates on hold while Blanchflower voted for a cut and Besley for an increase. The bank was generally gloomy over its assessment of the economy and markets were still expecting interest rates to be cut before the end of 2008.

Swiss franc:

There will be further expectations of a slowdown in the Swiss economy. Persistent stresses in the banking sector will also maintain fears that there will be a sharper slowdown in Switzerland given the dependence on financial services. There will also be unease over European export prospects. The most likely outcome is that the National Bank will leave interest rates on hold in the short-term, although there may be some speculation over a rate cut. The Swiss currency should still gain some support on defensive grounds, especially if there is a sustained unwinding of carry trades. The franc will find it difficult to make strong headway against major currencies.  

The dollar continued to attack levels 7-month highs above 1.10 during the week, but was unable to sustain the gains and dipped back to below the 1.09 level. The franc edged lower against the Euro, although ranges were relatively narrow.

The Swiss retail sales data recorded a 0.7% increase in the year to July, although the increase when adjusted for the number of shopping days was stronger at 4.9%. There was a further decline in business confidence according to the latest ZEW survey.

Producer prices rose 0.5% in July with the annual increase at a 19-year high of 4.9% which maintained some inflation fears. National Bank Governor Roth indicated in comments over the week that the monetary conditions had not changed substantially and there were no real expectations of higher interest rates.

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Following heavy losses during the first half of August, the Australian dollar attempted to stabilise against the US currency. From support levels near 0.86, the currency recovered to 0.88 before hitting renewed selling.

Commodity prices continued to play an important role and a sharp rally in gold prices helped propel the Australian currency higher. There was still some evidence of a reduction in carry-trade positions which curbed currency gains.

In the latest minutes, the Reserve Bank of Australia confirmed that it had shifted to a bias towards cutting interest rates and that it would be willing to cut before a decline in inflation given the deterioration in growth conditions. Leading indicators edged stronger over the month, but this failed to have a significant impact.

As growth fears will persist, the Australian dollar is likely to hit considerable selling pressure on rallies much above current levels.

Canadian dollar:

The Canadian dollar found support close to 1.07 against the US currency and strengthened sharply to highs near 1.0420 on Thursday as crude oil prices rallied.

There was a solid increase in wholesale sale while there was a 0.5% increase in retail sales and a 1.4% underlying increase for the month which stemmed immediate fears over the economy.

Consumer prices rose 0.3% in July while there was a 0.% increase in core prices which kept the annual rate at 1.5%. There was little change in interest rate expectations over the week following the economic data releases.

The Canadian dollar has scope to correct slightly further against the US currency, but will struggle to make strong headway from current levels given overall growth fears.

Indian rupee:

The rupee remained on the defensive during the week and tested 17-month lows against the US currency with a retreat to just beyond the 43.50 level. The rupee edged stronger on Friday as a large corporate seller of dollars emerged.

The rupee was initially undermined by general dollar strength and failed to gain any major support when the US currency retreated as sentiment remained weaker.

The rupee was unsettled by a sharp rally in oil prices, although the key area of concern was still net capital outflows as Asia equity markets were generally weak as growth fears increased. Market confidence in the economy was also unsettled by fears over a widening budget deficit.

Overall confidence in the currency is liable to remain weak in the short-term with little scope for a sustained advance in the currency given fears over capital outflows.

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The Hong Kong dollar  found support weaker than 7.81 against the US dollar and pushed back to 7.8070. Markets were closed on Friday due to a typhoon warning.

As the US currency reversed recent gains, there was a dip in arbitrage activity which support the Hong Kong dollar, especially over the second half of the week.

Consumer inflation rose to 6.3% in July from 6.1% the previous month which maintained a firm tone in local money markets which underpinned the currency.

Overall, the Hong Kong dollar should continue to resist loses beyond the 7.81 level against the US currency despite unease over the regional economic trends.

Chinese yuan:

After a weaker tone during the first half of August, the yuan secured renewed gains to 6.83 against the dollar. A generally weaker US currency was the main impetus over the second half of the week, although the central bank also pushed the yuan stronger which renewed market confidence that the authorities would aim for a firmer currency

US Treasury Paulson re-iterated that the US wanted a faster rate of yuan appreciation and this provided underlying support to the Chinese currency.

There were reduced fears over the week that China would slow the rate of currency appreciation to boost growth, although sentiment was still generally cautious given the uncertainty over growth prospects and global economic conditions.

The underlying rate of yuan appreciation is still liable to slow over the next few months as growth concerns are still liable to be a significant market focus.

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