Weekly Forex Currency Review 25-04-2008

Overall strategy: The relative US and Euro-zone growth prospects will continue to dominate market sentiment and trends in the short-term. Despite persistent US fears, the evidence of a slowdown in the Euro-zone is likely to unsettle the Euro, especially after the strong currency gains seen over the past few months. The dollar will continue to look to secure a base after heavy losses even though strong gains remain unlikely at this stage.                   

Key events for the forthcoming week

Dollar:

There will be a continuing lack of confidence in the US housing sector and there will also be wider fears that there will be a deterioration in the economy as a whole which would trigger a deep recession. Markets will, however, tend to look forward and there will some optimism over a second-half recovery while there will also be expectations that the Federal Reserve will suspend further rate cuts after April to await fresh evidence. Unease over the European economies should also provide some degree of support to the US dollar, but rallies will tend to be limited with pressure for Asian currency gains.   
      
The dollar weakened to fresh all-time lows against the Euro over the first half of the week, but managed to secure a strong rebound from late Wednesday as the US currency secured a corrective rally.

US existing home sales edged down to an annual rate of 4.93mn in March from 5.03mn the previous month as inventories were higher and prices were lower. There was also a further drop in news home sales to a 17-year low annual rate of 526,000 for the month which reinforced housing fears.

Headline durable goods orders fell by 0.3% in March, but there was a 1.5% increase in underlying orders. Jobless claims also fell to 342,000 in the latest week from 375,000 previously and these could be important leading indicators of stabilisation.

There was a gradual shift in interest rate expectations over the week with markets not expecting a 0.50% cut in rates at the April FOMC meeting. There was some speculation that rates would not be cut at all while there were growing expectations that the Fed would cut by 0.25% and then pause the rate-cutting process. There were no major comments on policy from Federal Reserve officials during the week.

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The German IFO index will increase fears over a sharp slowdown in the Euro-zone economy. The German economy has been resilient and evidence of stresses will be particularly alarming as there will be fears that conditions elsewhere will be even worse. The ECB will maintain a tough policy in the short-term, but a restrictive policy will not support the Euro if there is evidence of deterioration in growth conditions. There will also be further protests against excessive Euro strength which will tend to discourage firm buying support for the currency. 
       
Initially, the Euro struggled to extend gains and was subjected to a sharp correction over the second half of the week, notably against the US dollar.

The Euro-zone PMI indices for April were mixed as there was a dip in the manufacturing index to 50.8 from 52.0 while the services sector reading rebounded.

The German IFO index dipped significantly to 102.4 in April from 104.8 the previous month which reinforced expectations of a sharp slowdown, especially as the important Belgian industrial confidence index also dipped sharply for April. The IFO index is an important indicator and had a marked impact on expectations and sentiment.

ECB officials initially retained a tough stance on inflation with unofficial warnings that interest rates could rise again. There was, however, some element of confusion with mixed messages and the tone was softer over the second half of the week.

Euro-group head Juncker warned that the recent G7 message on exchange rates had been clear and that it had not been understood. Juncker also stated that recent exchange rate moves had been excessive and there were some warning comments from ECB President Trichet over currency trends.

Yen:  

There will be further concern over the Japanese economy, especially with weaker export growth, although the market impact should be limited at this stage. Overall, the yen moves are still likely to remain dominated by levels of risk aversion and credit-related fears. The yen will remain vulnerable to some further selling pressure in the short-term as carry trades secure support and credit spreads narrow. In this environment, the dollar will look to extend gains, although global fears could easily intensify again.
                    
The dollar pushed higher against the yen during the week with a move back above 104.0. The yen dipped to lows around 165.0 against the Euro before regaining ground.

Overall confidence in the Japanese economy remained relatively weak, but the impact was measured. Underlying consumer prices rose 1.2% in the year to March after a 1.0% rate previously, but there was no significant change in interest rate expectations.

Yen moves were still influenced to a high degree by global trends in stock markets and levels of risk aversion. An overall narrowing of credit spreads reduced near-term demand for the Japanese currency, especially as volatilities declined.

The latest capital account data did not suggest strong outflows from Japan which limited aggressive yen selling. The trade surplus dipped sharply in the year to March as export growth slowed under the weight of a four-year low in shipments to the US.

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There will be continuing fears over economic trends with strong pressures on consumer spending as credit conditions tighten and costs increase. The housing sector will remain weak and there will be expectations of further interest rate cuts over the next few months. The Bank of England will, however, want to be cautious on lowering borrowing costs given inflation fears and the scheme to alleviate mortgage-related stresses will also lessen pressure for a further immediate response. The UK currency will also gain some support if credit-related fears remain at lower levels, but rallies are liable to be fragile.    
 
Sterling weakened back beyond the 0.80 level against the Euro before rallying back to near 0.7900 as the Euro stumbled. The UK currency hit tough resistance close to 2.00 against the dollar and weakened back to 1.97.

The Bank of England minutes from April's meeting recorded  a three-way split vote for the first time since 2006. Six members voted for a 0.25% cut in rates while two voted for no change and Blanchflower preferred a 0.50% reduction. MPC member Besley, who voted for no change in rates, stated that the MPC should concentrate on inflation risks and expectations of a May rate cut faded.

The housing data was weak with BBA mortgage approvals falling to a record low as mortgage tightening took effect. Retail sales volumes fell 0.4% in April, increasing speculation over a slowdown in consumer spending, but the previous figures were revised higher. First-quarter GDP slowed to a three-year low of 0.4% for a 2.5% annual increase as financial services growth weakened.

The Bank of England announce its plan to swap mortgage-related securities for Treasury bonds with an initial amount of GBP50bn. The reaction was limited given that the plans had been leaked, although there was a measured drop in Libor rates.

Swiss franc:

The domestic influences will remain of secondary importance in the short-term, but will gradually increase in importance with fears that any sharp slowdown in the Euro-zone would have a negative impact on the Swiss economy. There will also be fears over the banking sector. The franc will lose ground if there is a sustained improvement in risk tolerances, although sentiment could reverse rapidly if financial fears return. Overall, there is scope for further gradual underlying franc losses even though heavy selling from current levels is unlikely.
 
The Swiss franc weakened sharply to lows around 1.0400 as the US currency rallied. The franc also weakened to lows beyond 1.62 against the Euro, the level for 2008.

An improvement in financial-market risk curbed short-term demand for the Swiss currency as international credit spreads narrowed during the week.

The Swiss trade account remained uncomfortable surplus for March at CHF1.25bn with a robust increase in exports. There was still some unease over the risks of a slowdown as the Euro-zone economy weakened..

Producer prices rose over the month with the annual increase at a 16-year high which maintained unease over inflation trends. National Bank Chairman Roth stated that the economy would not be unscathed, but that monetary policy was appropriate.

UBS announced another round of debt write-downs which undermined confidence in the overall banking sector to some extent.

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The Australian currency pushed to a 24-year high against the US dollar during the week with a peak above the 0.95 level.

The first-quarter increase in consumer prices was higher than expected at 1.3% while core prices rose 1.2% to give an annual increase of 4.1%. Following the inflation data, there was some renewed speculation that the Reserve Bank could increase interest rates over the next few months.

The Australian dollar continued to secure support from the elevated level of commodity prices, but there was a significant correction later in the week and the Australian dollar weakened back to below 0.94 as commodities lost ground.

The Australian currency will be vulnerable to a further correction weaker, especially if commodity prices continue to weaken, with yield support curbing losses.

Canadian dollar:

The Canadian dollar generally struggled to find direction over the week in choppy trading. The currency was blocked firmly close to parity against the US currency while there was support close to the 1.02 level.

The Bank of Canada cut interest rates by further 0.50% to 3.00% at the latest monetary council meeting. In the statement following the meeting, the bank stated that further action would be required, but references to another near-term cut in rates was dropped which suggested there could be a pause before cutting again.

The retail sales data was weaker than expected with a 0.7% headline decline for February while there was also an underlying drop in sales for the month.

The Canadian dollar gained support when crude oil prices attacked record levels, but energy prices fell back over the second half of the week.

The Canadian currency is unlikely to make significant headway in the short-term, especially as domestic economic fears will increase.

Indian rupee:

The Indian rupee was unable to hold gains stronger than the 40.0 level against the US dollar and weakened to a 1-month low around 40.18 during Thursday.

The currency was again undermined by the strength of oil prices with prices trading at record highs over the first half of the week The rupee was also undermined by a rise in US money-market yields with some closing of arbitrage positions.

There was uncertainty ahead of the April 29 Reserve Bank policy meeting with some speculation over a move to increase interest rates which provided some support.

The rupee will gain support if risk tolerances remain at a higher level, but the overall tone suggests that gains will be limited at best..  

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The Hong Kong dollar had a generally firm tone over the week, although ranges remained relatively narrow.

The local currency gained some support from gains in the Hang Seng index with the local bourse rising to a three-month high following the Chinese cut in stamp duty.

The export figures were subdued with an annual 7.6% increase in the year to March as shipments to Asia were weaker.

The Hong Kong currency should be able to resist significant losses in the short-term, especially with wider continuing speculation that the peg could be broken. The weaker export trend will tend to curb strong currency gains.

Chinese yuan:

The yuan advance stalled over the week as the US currency secured some wider support in the markets. There was also a squeeze on short dollar positions in offshore markets with an adjustment of expectations as the central bank blocked further strong yuan gains. The local currency consolidated near the 7.00 level.

Following the cut in stamp duty on shares trading, there was speculation that the authorities would be less willing to tighten monetary policy further in the short-term

With evidence of export growth slowing, there was also speculation that there would be increased resistance to further rapid currency gains to help protect the export sector and this dampened support for the yuan.

The yuan is likely to secure further net gains. Economic fears and unease over underlying export trends is liable to slow gains and a partial reversal is a possibility.

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

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