Weekly Forex Currency Review 26-03-2010

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Euro-zone vulnerabilities will remain a key focus in the short-term with confidence remaining weak and there will also tend to be heightened awareness of sovereign debt vulnerabilities. In this environment, the dollar can secure defensive buying support, but there will also be unease over longer-term US credit ratings which will tend to limit the potential for strong, independent US currency support.             

Key events for the forthcoming week

Dollar:

The US economic data should maintain optimism over a further gradual improvement in the economy. Expectations of a near-term policy tightening by the Federal Reserve will remain low, but the dollar will be in a position to gain support from higher US bond yields. There will be background fears over the US budget debt situation, but an increase in global sovereign debt concerns could still trigger further defensive dollar support. Speculation over reserve diversification may limit the scope for independent dollar strength.

The dollar weakened at times over the week, but had a generally firmer tone with notable advances in the middle of the week and the US currency pushed to a 10-month high against the Euro before a retracement.

There US economic data failed to have a major impact on the market. The headline US durable goods data was marginally weaker than expected, but the underlying data was still robust and there was an upward revision to the previous month’s data. Initial jobless claims were lower than expected with a decline to 442,000 in the latest week from 454,000 the previous week which maintained a degree of optimism towards the US economy.

The US existing home sales data was close to market expectations with a decline to an annual rate of 5.02mn for February from 5.05mn previously. The existing home sales data was marginally weaker than expected while US house prices were also reported to have fallen in January. The overall impact was limited with markets still expecting the Federal Reserve to tighten monetary policy before the ECB.

There were further comments from Federal Reserve officials suggesting that the language suggesting low interest rates for an extended period should be modified which maintained some degree of uncertainty.

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Sentiment surrounding the Greek budget situation is likely to remain very fragile in the short-term, especially with persistent doubts over the effectiveness of proposed support measures. There will also be fears that tensions will spread to other countries and there will be unease over the threat of further credit-rating downgrades. There will also be expectations that the ECB will be forced to delay any monetary tightening measures. In this environment, it will be very difficult to secure a sustained improvement in Euro sentiment. 

The Euro was on the defensive for most of the week as underlying confidence in the economy and currency remained weak with persistent selling pressure.

The Euro-zone economic data was stronger than expected with gains for the PMI indices while the German IFO index rose to 98.1 for March from 95.8, but the Euro was able to secure only very short-lived relief. The monetary data was generally weak with money supply contracting slightly according to the latest release.

A key feature was persistent uncertainty over a Greek support package which undermined investor confidence as economic and political stresses persisted. In particular, there was wrangling over the need for IMF involvement in the proposed deal. In this environment, overall confidence in the Euro remained weak and there was further speculation over an underlying medium-term asset allocation switch away from the currency.

During Wednesday, the Euro was subjected to further downward pressure as there was further negative news from the Euro-zone. Fitch announced a downgrading of Portugal’s credit rating to AA- from AA due to structural budget deficit fears. The downgrading reinforced a lack of confidence towards the Euro with particular fears that tensions would spread to Spain

During Thursday, the Euro gained initial support from an ECB announcement over collateral arrangements. The bank announced that BBB-rated securities would be accepted beyond the scheduled end-2010 deadline and this provided some degree of reassurance that Greece would be less vulnerable.

At the start of the 2-day EU summit there was evidence of an agreement to provide a support package for Greece with the French government reluctantly agreeing to German demands for IMF involvement. Initial relief for the Euro was soon reversed as ECB President Trichet called possible IMF aid for Greece very bad, although Trichet was more conciliatory in remarks on Friday.

Yen: 

The yen will remain vulnerable to carry-related selling, especially if confidence in the global economy holds relatively firm. The Japanese currency will also tend to be sold if US yields sustain the recent widening over equivalent Japanese rates. Exporter selling will be a significant feature when the dollar rallies, but capital repatriation will be less of a factor with most flows ahead of the fiscal year-end now completed. The yen may still be able to resist aggressive selling given doubts over the other major economies.

The dollar was trapped close to the 90 area over the first part of the week, but then secured a strong advance with a peak near 93 against the Japanese currency. The yen also retreated from its best levels on the crosses.

The dollar advanced strongly in European trading on Wednesday with a daily gain of close to 2% against the yen. The US currency gained some benefit from a weaker Euro, but there was also independent yen weakness as it also lost ground against the Euro with a rise in US bond yields triggering a flow of funds out of the yen.  Yield factors continued to support the dollar later in the week.

The depreciation also reinforced speculation over carry-related outflows from the Japanese currency following reports of heavy retail selling over the past few weeks. T

Core consumer prices fell 1.2% in the tear to February, maintaining some unease over deflation trends and there was pressure for the Bank of Japan to maintain a very loose monetary policy.

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The government budget will not alleviate underlying fears surrounding the debt situation and there will be strong expectations that further measures will be required soon after the election to prevent a deterioration in market confidence. The recent economic data has mixed and there is likely to be some optimism surrounding near-term growth levels, although this could fade very quickly, especially if bank lending appears to weaken further. Overall, it will be difficult for Sterling to secure any sustained relief over the next few weeks.

Sterling was on the defensive against the dollar and re-tested 2010 lows close to 1.48 against the US currency. Sterling was little changed against the Euro for the week as a whole, retreating back to the 0.90 area after briefly posting 2-week highs near 0.8880.

The headline UK consumer inflation rate was slightly lower than expected with a decline to 3.0% from 3.5% the previous month. This tended to undermine Sterling slightly on reduced fears over the near-term inflation outlook and speculation the Bank of England may have greater scope for additional quantitative easing if the economy appears to be deteriorating again.

The latest CBI retail sales survey weakened to a headline 13 from 23 the previous month while the survey was cautiously optimistic over March’s outlook. The February retail sales report was significantly stronger than expected, with a 2.1% increase but this followed a revised 3.0% decline the previous month.

The UK budget was broadly in line with market expectations. The government downgraded slightly its GDP growth estimates for 2010 and 2011, but was also able to project slightly lower government borrowing estimates for the next two years. The deficit was still forecast to be near 12% of GDP over the next two fiscal years which continued to expose Sterling to the risk of renewed selling pressure.

Markets were generally unconvinced and uneasy over the lack of budget detail which prevented any significant support for Sterling. Renewed sovereign debt fears also tended to be a negative factor for the UK currency

Swiss franc:

There will be continuing optimism surrounding the Swiss economy in relation to the Euro-zone. The Swiss currency will also continue to gain defensive support from a general lack of confidence in the Euro. The National Bank will remain an important focus and there will be increased pressure on the central bank to prevent further gains against the Euro given the franc’s moves to record levels. Volatility is liable to remain higher in the short-term with the franc still in a position to avoid heavy selling pressure.

The dollar secured a net advance against the franc with notable gains in mid week to a high near 1.0750, although the gains were more measured that against other major currencies. The franc maintained a very strong trend against the Euro with gains to a record high beyond 1.4550 before a slight correction weaker.

National Bank member Jordan repeated recent comments that the central bank would act decisively to curb excessive franc appreciation. There were similar comments from other bank members, but the currency-market impact was still limited as markets took less attention of verbal intervention.

There were unusual comments on the economy during Thursday with government ministers and the president both expressing unease over franc strength. The government has little influence, but there will be additional pressure on the central bank to curb franc strength.

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The Australian dollar again tested resistance levels near 0.92 against the US dollar during the week, but was unable to break the technical level and retreated back towards 0.9070 as a firmer US currency curbed support.

The Reserve Bank commented that interest rates would need to rise to historically more normal levels which reinforced speculation over a further increase in interest rates within the next few months.

Australian dollar sentiment should remain firm for now with expectations of carry-related inflows. The currency may still find it difficult to extend gains, especially if global risk appetite comes under pressure.

Canadian dollar:

The Canadian dollar was unable to mount an attack on parity against the US currency and dipped to the 1.0250 against the dollar as the US unit secured a wider rebound, although it was still generally firm on the crosses.

Underlying sentiment was supported by a firm tone in global stock markets as risk appetite held steady. 

The Canadian dollar should remain generally firm given expectations of higher interest rates within the next months. Resistance levels will still tend to be tough close to parity on speculation the currency is overvalued from a medium-term perspective.

Indian rupee:

The rupee had a generally weaker tone and dipped to test 3-week lows near 45.75 against the US dollar. The decline primarily reflected general US currency strength and the rupee sentiment was broadly firm as the local stock market was resilient.

There was also evidence of exporter dollar selling which curbed the US currency’s advance later in the week.

The Reserve Bank of India increased interest rates for the first time since 2008, but this actually weakened the rupee slightly on unease over the growth implications.

The rupee will find it difficult to appreciate strongly, especially if the US currency maintains a firm tone. Losses should be measured given regional optimism.

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The Hong Kong dollar was able to resist significant selling pressure during the week, although it did drift weaker to the 7.7620 area against the US currency.

Immediate speculation surrounding further Chinese monetary tightening eased slightly during the week which also helped calm nerves surrounding potential capital outflows. Speculation over a shift in the yuan’s policy was still an important factor

There will be mixed currency influences from Chinese policy pressures. Overall, the Hong Kong dollar should be able to resist more than limited selling pressure.

Chinese yuan:

The spot yuan rate remained confined to tight ranges during the week and there was relatively little movement in the NDF market.

There was further international pressure for a stronger yuan and speculation that China would be named as a currency manipulator in the mid-April report due from the US Treasury. 

The Bank of China head stated that the yuan issue was complicated and the comments from officials overall continued to suggest that policy changes would be considered. There was further opposition to a one-off revaluation.

Speculation over a yuan revaluation or a move back to a floating currency with gradual yuan appreciation will continue to be a very important market focus. Pressure will ease slightly if the dollar can maintain a firmer market trend.