Weekly Forex Currency Review 25-09-2009

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Overall confidence in the global economy is liable to falter in the short-term. In particular, there will be fears that the current rebound in activity will fade quickly as underlying credit stresses persist. In this environment, there is likely to be a more cautious market tone which will tend to curb market interest in high-yield currencies and should help ease selling pressure on the dollar.

Key events for the forthcoming week

Dollar:

Underlying confidence in the dollar will remain fragile with continuing fears over a medium-term diversification away from the US currency. The Fed will move gradually towards a tightening of policy, but interest rates will remain at very low levels which will curb dollar support. Degrees of risk appetite will remain important and there is likely to be a generally more cautious tone which should stem capital outflows from the US and also provide some degree of dollar protection.  The US currency will still find it difficult to make strong headway.    

The dollar generally remained under pressure during the first half of the week as rallies quickly attracted selling pressure as sentiment remained weak

There was also a further reported increase in net short dollar positions with the net short position at the highest level since March 2008. The US currency dipped to fresh 2009 lows on a trade-weighted index and also against the Euro.

There was further speculation that G20 would push for the US to boost savings levels in order to help curb global imbalances and would also push for a weaker dollar to boost US exports. An increased savings ratio would, however, also provide structural dollar support, at least in the medium term. There also appears very little incentive for major economies to push for a weaker US currency.

The US initial jobless claims data was slightly better than expected with a dip to 530,000 in the latest week from a revised 551,000, the lowest figure since July.

In contrast, the existing home sales data was weaker than expected with a decline to an annual rate of 5.10mn for August from 5.24mn previously. Prices continued to edge lower over the month, although there was a decline in inventories to below 9 months supply. The decline in home sales helped spark deterioration in risk appetite which stemmed dollar selling.

The Federal Reserve and other major central banks announced that they would lessen the amount of auctions to supply global dollar liquidity. Although this suggests an improvement in credit conditions, the net supply of dollars will also tend to decline which should provide some degree of technical dollar support.

As expected, the Federal Reserve held interest rates in the 0.00 – 0.25% ranges following the latest FOMC meeting. The Fed stated that the economy had picked up following a severe downturn. Policy actions would contribute to a gradual recovery, but that the economy is liable to remain weak. In this context, the Fed expects interest rates to be at very low levels for an extended period. The total amount of bond buying was left on hold, but the period will be extended to the end of the first quarter so the rate of bond purchases will slow.

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The Euro-zone data has continued to suggest a gradual improvement in conditions, but there will also be fears that the recovery will stall quickly and not prove to be self-sustaining given the underlying weaknesses.  The credit conditions will also be watched closely amid fears of a further deterioration in the banking sector. The Euro also remains fully valued at current levels which will limit the scope for further buying support.      

The Euro maintained a generally firm tone over the week with an advance against Sterling a particular feature. The currency was subjected to a correction against the dollar and yen later in the week.

The Euro-zone PMI indices continued to register improvement for September with the services-sector index rising to 50.6 from 49.9, although the manufacturing-sector index stayed below the 50.0 threshold and was also weaker than expected.

The German IFO index rose to 91.3 in September from 90.5 the previous month. The advance was weaker than expected by the markets while Institute officials were generally very cautious over the outlook. The data as a whole was, therefore, a small net negative for the Euro on fears that economic improvement could stall quickly.

In comments on Tuesday, ECB member Weber stated that recent currency moves were not out of line with Euro-zone fundamentals which did not suggest significant alarm. There were, however, comments from a French official on Wednesday expressing concern over the Euro’s level. The comments suggested that the French were looking to put down a marker and there will be greater concerns if the Euro pushes above the 1.50 region.

Yen:  

Capital repatriation should ease at the end of September which will tend to limit yen support. Japanese officials are also likely to take a more cautious tone over the potential for a stronger Japanese currency while institutional dollar support is liable to persist.  Given the lack of attractive alternatives, the yen should be able to avoid heavy selling pressure, especially as investors are likely to be more cautious surrounding risk appetite.

Japanese markets were closed for the first three days of the week which tended to dampen yen moves. The Japanese currency initially maintained a weaker tone with markets less confident that the new government would tolerate or encourage a stronger currency following Finance Minster Fujii’s apparent backing away from a strong yen policy in comments late last week.

Fujii, however, repeated his opposition to currency intervention which put some renewed upward pressure on the Japanese yen late in the week.

The latest Japanese export data was slightly weaker than expected with a small monthly decline and 36% annual drop which will maintain some unease over underlying Japanese competitiveness.

There was further speculation of near-term capital repatriation ahead of the quarter end. There was also evidence of exporters selling dollars after the holiday period and the dollar edged back towards the 90 level before rallying again. 

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Confidence in the economy and Sterling is liable to remain weak in the short ter. There will be continuing fears over the government debt position and expectations that interest rates will need to stay at very low levels. There will also be the perception that the Bank of England will favour a weaker currency to help underpin the economy. The Sterling risks will again be more acute if there is any sustained deterioration in global risk appetite and it is liable to remain on the defensive over the next few weeks. 

Sterling conditions were again choppy during the week, but there was a much more decisive tone towards selling later in the week. The UK currency dipped to lows below 1.60 against the dollar before some respite and was also at the lowest level against the Euro since early April with lows beyond 0.9150.

The Bank of England warned that the sustainable exchange rate may have fallen in a commentary in the latest quarterly bulletin. The bank minutes recorded a 9-0 vote for unchanged interest rates and to hold the Asset Purchase Facility at GBP175bn.

Three members expressed support for a larger package of quantitative easing, but decided to vote with the majority. The bank was slightly more confident over the outlook and warned over the potential medium-term inflation risks, but also still pointed to important downside risks for the economy.

Sterling came under renewed pressure on Thursday following reported comments in a newspaper interview by Bank of England Governor King that the Sterling decline will help rebalance the UK economy. Although similar comments had been made previously, the remarks reinforced market perceptions that the central bank was happy to see a weaker currency, especially after the comments within the quarterly bulletin.

Such a perception can be very dangerous for a currency, especially as markets are already very uneasy over the UK fundamentals with a continuing focus on very high government borrowing levels.

Swiss franc:

The Swiss franc will gain some support when risk appetite deteriorates, especially with a reluctance to use alternative currencies to fund global trades. The National Bank will continue to resist any significant franc appreciation against the Euro given the persistent deflation fears.  In the near term, the franc is still likely to be broadly resilient o selling pressure.      
 
The Swiss franc proved to be broadly resilient over the week and strengthened to highs beyond 1.02 against the dollar before a corrective retreat. The franc also made some headway against the Euro with a test of Euro support just below 1.51.

The trade surplus edged down to CHF1.79bn for August from CHF2.21bn the previous month while exports continued to register some element of recovery. The SECO institute upgraded its GDP forecasts slightly, but remained very cautious over the outlook with only a sluggish recovery likely.

Bank member Hildebrand stated that the economy was showing some positive signs, although conditions remained very fragile. Bank members did not make major comments on the exchange rate during the week, but Jordan repeated that it would continue to fight appreciation.

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The Australian dollar continued to find robust buying support and benefited at times from a weaker US currency, but the external conditions became less favourable later in the week and there was a retreat back to below 0.87 against the US dollar.

The Australian currency gained some support from firmer than expected New Zealand GDP data. There were expectations of further support for high-yield currencies, but risk appetite was slightly more fragile which curbed further buying support.

Commodity prices remained generally on the defensive and risk appetite was also slightly weaker as confidence in the global economy faltered to some extent.

Confidence in the Australian dollar should remain firm in the short-term, butt he net risk will make it very difficult to make further headway.

Canadian dollar:

The Canadian dollar strengthened to test US dollar support levels below 1.07 over the first half of the week before reversing course. There was initial support from firm energy prices and a weaker tone in the US dollar.

In this environment, a weaker than expected retail sales report did not have a substantial impact on the currency as international factors tended to dominate.

Conditions became less favourable over the second half of the week as oil prices sparked lower following an unexpected rise in inventories and a downbeat industry report. With a US recovery, there was a Canadian dollar retreat to 1.0920.

The Canadian currency will remain vulnerable to choppy trading in the short-term and the international risk profile will make it difficult to secure significant gains.

Indian rupee:

The rupee pushed to a six-week high against the US currency over the first half of the week, supported by a firm tone in the local stock market and a weaker US dollar.

The currency again struggled to sustain gains through the 48 level with increased dollar buying by importers a significant factor. Risk conditions were also slightly less favourable over the second half of the week while the US currency staged a fragile rebound which curbed rupee support.

The rupee will continue to gain support when there are wider US dollar losses. The net risks suggest that the currency will struggle to make significant near-term gains.

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The Hong Kong dollar maintained a firm tone close to the 7.75 band limit against the US dollar during the week.

The market conditions became less benign during the week. There was a decline in the local stock market and Chinese equities were also generally weaker. In addition, there was notable weakness in some of the IPO offerings, but the currency still proved to be resilient despite these factors.

The Hong Kong currency should maintain a broadly firm tone even though international risk conditions are liable to be less favourable in the short-term ..

Chinese yuan:

The central bank maintained tight of the yuan during the week and continued to signal to markets that it would not tolerate any significant currency appreciation. The Chinese currency was fixed close to 6.829 on Friday. Medium-term pressures for appreciation continued to build with the NDF spreads widening.

Chinese officials remained generally cautious over the economic outlook with unease over conditions surrounding domestic credit and uncertainty over export trends.

There was also evidence that the authorities were particularly keen to maintain stable conditions ahead of the early October holiday period.

The medium-term pressures for yuan appreciation will continue to build. In the short-term, stability is still likely to be a key priority for the central bank.