Weekly Forex Currency Review 24-09-2010

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Official currency policies will continue to be an important focus following the Bank of Japan intervention to weaken the yen allied with persistent fears surrounding G7 growth prospects and debt burden. There will be increased speculation that countries will look to pursue devaluation policies in order to boost competitiveness and support growth conditions.               

Key events for the forthcoming week

Dollar:

The Federal Reserve statement will continue to have an important impact in the short-term. There will be further speculation over additional quantitative easing by the central bank and this will maintain a lack of yield support for the US currency which will tend to keep the dollar on the defensive, especially as the economic data has remained generally uninspiring. From a longer-term perspective, there will also be fears over currency depreciation given the federal debt burden. Degrees of global risk appetite will remain important and there is still some scope for dollar demand at times when international fears increase.

The dollar was generally vulnerable during the week with the currency suffering primarily from a lack of yield support. The US data was mixed with the principal focus on the Federal Reserve meeting and the dollar weakened to the lowest level against the Euro since April.

The US housing data was slightly stronger than expected with a gain in starts to an annualised rate of 0.60mn compared with 0.55mn previously and there was also a limited gain in permits for the month. The existing home sales data was slightly stronger than expected with a rise to 4.13mn for August from a revised 3.84mn previously, but this only recovered part of the sharp decline to 13-year lows seen for July and the house-builder confidence index remained weak.

The US jobless claims data was weaker than expected with a rise to 465,000 in the latest week from a revised 453,000 previously and underlying confidence in the US economy remained generally weak.

As expected, the Federal Reserve left Fed funds interest rates unchanged in the 0.00-0.25% range following the latest FOMC meeting with an 8-1 vote as Hoenig again dissented. The statement was generally cautious over the economic outlook and continued to suggest that interest rates would remain at very low levels for an extended period. There were also comments that it was prepared to provide additional stimulus if required.

Although there was no further quantitative easing by the Fed, the generally dovish statement undermined the dollar as US Treasury yields continued to fall.

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There has been solid demand for peripheral bonds in recent auctions, but it has been very difficult to dispel underlying fears and credit-default swaps have continued to widen which suggests that underlying market confidence remains weak. These fears will increase if there is further evidence of a slowdown in the Euro-zone economy, especially as fears surrounding the banking sector would intensify again. The Euro moves will also tend to be correlated with trends in risk appetite with the Euro vulnerable to selling pressure if confidence in the global economy deteriorates, but heavy selling should be avoided.

The Euro was able to secure solid gains over the week and pushed to a five-month high against the struggling dollar while there was a solid advance on the crosses.

There was a series of broadly successful debt auctions within the Euro-zone with solid demand for Spanish, Irish and Greek bonds in the latest offerings. Solid demand for securities boosted confidence that the weaker peripheral countries would be able to fund their deficits and this also cushioned the Euro.
There were still some underlying reservations of the underlying financial-market stresses which limited Euro buying support.

The flash Euro-zone PMI manufacturing index fell to 53.6 for September from 55.1 the previous month. The services-sector reading was at the same level which reinforced fears over a significant slowdown in the Euro-zone economy, especially with a sharp slowdown in the German economy. Fears were eased by a firmer than expected German IFO business confidence index.

Confidence in the economy was also undermined by much weaker than expected Irish second-quarter GDP data. There was a renewed 1.2% contraction over the three-month period, contrary to expectations of a modest increase. The data triggered a further widening of credit-default swaps and also undermined confidence in the Euro, especially as there was fresh speculation.

Yen:   

Markets will continue to focus on the possibility of further intervention by the Bank of Japan. There will certainly be further unease over the threat of deflation within the Japanese economy which will increase pressure for action. There will, however, be little G7 support for a sustained campaign to weaken the Japanese currency. The yen will also gain be default from the very low US yields and there is also likely to be a general reluctance to push capital out of Japan. In this context, the yen is still likely to be broadly resilient to heavy losses.  

The dollar drifted weaker over the week with an initial lack of buying support due to nervousness ahead of the FOMC meeting and the US currency failed to gain support from slightly stronger than expected US housing data.

There was no additional dollar yield support following the FOMC meeting and the US currency was also unable to secure any buying support. The dollar dipped to lows near 84 which put renewed pressure on the Bank of Japan.

Prime Minister Kan stated that the authorities were prepared to intervene again while central bank governor Shirakawa stated that the bank could provide additional support for the economy.

There were strong suspicions that the Bank of Japan intervened again during Asian trading on Friday. The dollar jumped higher, especially after rumours that Bank Governor Shirakawa had resigned, but it was unable to sustain the advance above 85.20 against the yen.

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Underlying unease over growth trends is likely to increase as economic data has remained generally weaker than expected. There will be particular concerns over the housing sector while the fiscal tightening will also be a significant drag on the economy.  Sterling will be particularly vulnerable if there are renewed stresses within the banking sector. Trends in risk appetite will be important and the UK currency will find it difficult to make strong headway given the global outlook. Weakness in other key economies will still continue to provide important protection for Sterling and limit scope for losses.

Sterling was on the defensive against the Euro during the week with two-month lows beyond 0.8550. The currency was resilient against the dollar despite weak economic data as it tested resistance above 1.57.
The latest Bank of England lending data was weaker than expected with a further year-on-year decline in business lending while the money supply data was weak. The data maintained concerns over a renewed credit crunch and the weak housing data gradually had a greater impact on the currency.

The Rightmove organisation reported a further decline in asking prices for houses for September. The UK government borrowing data was weaker than expected with a GBP15.3bn deficit for August compared with an expected GBP13.5bn the previous year while the shortfall was also larger than expected.

The higher than expected deficit renewed fears over structural weaknesses within the UK economy. Mortgage approvals falling to the lowest level since April 2009 which reinforced fears over the housing sector and maintained unease over the UK economy.

There were mixed comments from Bank of England MPC members with Dale, for example, stating that the economy faced major headwinds.

There were reports of Asian buying which cushioned the currency to some extent while Moody’s stated that the UK AAA credit rating should be able to withstand the challenges.

Swiss franc:

There will be persistent doubts surrounding the global economy with particular unease surrounding the Euro-zone financial sector. The franc has proved broadly resilient to selling pressure even when European bond demand has been firm and this suggests that there is still significant safe-haven demand for the franc.  Buying support is still likely to be curtailed by increased doubts surrounding the Swiss economy following the cautious National Bank tone.

Franc support weakened at times, but it was able to resist heavy losses and secured a net advance against the Euro. The dollar remained under pressure and weakened to 30-month lows near 0.98 against the Swiss currency.

There was a reduction in defensive Swiss franc support following the successful Euro-zone debt auctions which helped alleviate immediate fears over the Euro-zone debt sector.

The Swiss trade account for August was weaker than expected, but there was a solid performance for exports which will lessen pressure for a weaker franc to boost competitiveness.

There was fresh defensive demand for the Swiss currency following the Irish banking-sector fears as yield spreads within the Euro-zone widened.

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The Australian dollar maintained a firm tone during the week and pushed to 2-year highs near 0.96 against the US currency.

The currency drew initial support from generally hawkish comments from the Reserve Bank Governor which reinforced expectations over a further increase in interest rates before the end of 2010.

The currency secured a further boost from the dovish US Federal Reserve statement which intensified negative dollar sentiment and also increased the premium on yield which helped support the Australian dollar. The currency also proved resilient when risk appetite faltered.

Confidence in the Australian dollar is likely to remain broadly firm in the short-term. Given the underlying global and domestic risk profile, it will be difficult for the Australian dollar to extend gains.

Canadian dollar:

The Canadian dollar briefly strengthened to highs beyond 1.02 against the US currency, but was unable to sustain the gains and weakened sharply to lows beyond 1.0350 before stabilising.

The domestic data was generally weaker than expected with a decline in retail sales which dampened confidence in the local economy while the inflation data was in line with expectations.

The net risks suggest that selling pressure on the Canadian dollar should be contained, but it will be difficult to advance very far given the international risk profile.

Indian rupee:

The rupee maintained a firm tone during the week and strengthened to a four-month high near 45.45 against the US currency.

The rupee gained support from a generally weaker US currency during the week while there was optimism over capital inflows as the local bourse strengthened to a 32-month high during the week.

Selling pressure on the dollar was tempered later in the week by demand from gold and oil importers, but underlying dollar demand was weaker.

The rupee should be able to prove broadly resilient given longer-term capital inflows even if it proves difficult to extend gains in the near term.  
 

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The Hong Kong dollar maintained a consistently firmer tone during the week and pushed to a high beyond 7.7580 as underlying US currency sentiment remained weak.

There was also general optimism over emerging-market capital inflows which helped underpin the Hong Kong dollar.

The Hong Kong dollar should be able maintain a relatively firm tone in the short-term, especially with the US Fed maintaining a highly-expansionary policy.

Chinese yuan:

The yuan maintained a firmer tone during the week and there were consistent gains with a peak just stronger than 6.70 against the US currency.

International tensions were an important factor over the week as US President Obama was strongly critical of China’s exchange rate policies. There were also talks between Obama and Chinese premier Wen with the Chinese delegation stating that the yuan was not to blame for China’s trade surplus.

Markets were looking ahead to the Chinese PMI data due for release the following week and there was domestic opposition to rapid yuan gains.

The central bank is likely to be more tolerant of Chinese yuan gains, especially if the US currency remains more fragile, butt here will be opposition to rapid gains.

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