Weekly Forex Currency Review 27-11-2009

Degrees of risk appetite will remain very important in the short-term. The impact of the proposed Dubai debt rescheduling could be contained, but there is likely to be a more cautious stance as pressure for de-leveraging continues. Seasonal considerations will also come into play with pressure for a more cautious stance ahead of the year-end period and this should help protect the dollar from substantial selling pressure.

Key events for the forthcoming week

Dollar:

Although the recent economic data has continued to indicate a fragile improvement in conditions, markets will still be expecting the Federal Reserve to maintain a policy of very low interest rates throughout the next few months which will encourage use of the dollar as a funding currency. Any tightening signal by the Fed could trigger a substantial market reversal. Underlying confidence in the global economy is also liable to weaken which would curb dollar selling pressure, especially if equity markets decline sharply. Reserve diversification fears will limit the scope for dollar gains.

The dollar was subjected to heavy selling pressure in the middle of the week and dipped to lows near 1.5150 against the Euro, the lowest level since July 2008.

The dollar was undermined from comments by regional Fed Governor Bullard. He stated that the Fed’s bond-buying programme should be extended beyond the current period to give greater policy flexibility for 2010. The comments reinforced expectations that the Fed would maintain a policy of very low interest rates. The dollar was also undermined by comments from the Russian central bank that it was set to diversify into the Canadian dollar as part of its reserve management operations.

The news that Dubai World, the government investment company, was looking to reschedule debt payments had a significant negative impact on risk appetite and also provided some significant dollar protection as Chinese equity markets dipped sharply. As risk appetite fell sharply, the dollar regained ground and moved back towards 1.48.

The US data was mixed overall, but with a slightly firmer bias. There was a decline in jobless claims to 466,000 in the latest week from a revised 501,000 the previous week and the four-week moving average was at the lowest level for over 12 months which will maintain optimism over a gradual improvement in the labour market.

Durable goods orders fell 0.6% decline for October following a revised 2.0% increase for the previous month. There will be some unease over a sharp 2.9% decline in non-defence capital goods orders which suggests investment spending will be fragile.

The US housing data was again firmer than expected with new home sales rising to an annual rate of 0.43mn from a revised 0.405mn the previous month. The US housing data was stronger than expected with existing home sales rising to an annual rate of 6.10mn from 5.54mn the previous month, supported in part by the end of tax breaks. Inventories edged lower while prices also declined.

The estimate of US third-quarter growth was revised down to 2.8% from a provisional 3.5%, primarily due to the impact of higher imports and was in line with market expectations. Consumer confidence rose slightly to 49.5 for November from an upwardly-revised 48.7 the previous month as the future expectations index improved, although confidence in the labour market remained very weak.

Confidence in the US financial sector remained generally fragile with the FDIC reporting that the number of banks in difficulties had increased to over 550, the highest level since 1993. The FDIC also reported that the insurance fund had a negative balance which may force it to access a US$500bn Treasury credit line.

The FOMC minutes stated that Fed officials were more optimistic over a durable economic recovery and they were also uneasy over the potential risks of unwanted speculative activity if interest rates were left at low levels for an extended period. There was also some concerns over the potential inflation impact of dollar weakness.

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The ECB has continued to indicate that it will look to withdraw some of the extraordinary market support measures during 2010 and expectations of tighter conditions will tend to provide initial Euro support. Sentiment could reverse rapidly on fears that the central bank will damage any economic recovery by tightening too quickly. There are also still important Euro-zone structural vulnerabilities which will pose an important threat to Euro confidence, especially if there is any further widening of internal bond spreads.

The Euro advance during the week was hampered by significant weakness against the yen. The Euro dipped to lows below 127 against the Japanese currency and reversed weekly gains against the dollar.

The German IFO index was stronger than expected with a rise to 93.9, the highest level since August 2008. Provisionally, German consumer prices fell by 0.2% for November, although the annual inflation rate rose to 0.3% from unchanged the previous month due to the sharp decline in prices last year.

The latest Euro-zone money supply data recorded a  slowdown in annual growth to 0.3% from 1.8% the previous month while private-sector loans fell by 0.8% over the year. The consistent slowdown in lending over the past few months will maintain fears over deteriorating credit conditions within the Euro-zone.

The PMI readings were firm, notably for the services sector with the overall index at a 30-month high despite a disappointing reading for the manufacturing sector.

ECB President Trichet stated that the central bank would gradually phase out the extraordinary liquidity measures. The comments were in line with recent official comments and reinforced market expectations that the ECB move earlier than the Federal Reserve to tighten policy. There were no major protests over the Euro’s level.

Yen:  

Policy comments from the government and Bank of Japan will be watched very closely. Although the central bank has control of monetary policy any sustained tensions between the two sides would tend to undermine yen confidence. The yen will continue to gain some support from fears over the other major currencies, especially the dollar. The yen will also gain some support if there is a sustained deterioration in risk appetite. The overall risks suggest further near-term yen gains are realistic but any further advance could retreat rapidly.

The dollar was subjected to sustained selling pressure, briefly weakening to a 14-year low below 85. Finance Minister Fujii warned that the Ministry was watching currency moves very closely and would be prepared to act against abnormal currency moves. Deputy Finance Minister Noda, however, stated that there were no plans to intervene. Markets remained sceptical that there would be any action to weaken the currency.

There are still important stresses in the Japanese economy with the latest Bank of Japan minutes stating that the special lending facility could be re-introduced next year and this will maintain pressure for yen gained to be capped.  There were also calls for action from the business organisations. There has also been further friction between the government and Bank of Japan over the appropriate response to deflation fears with some criticism of the bank’s policies.

The yen was supported by comments from former very influential government official Sakakibara who stated that the dollar could weaken to the 80 level against the yen.

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The government debt situation will remain under close scrutiny and there will be fears that the deficit will be even wider than forecast. Fears over a credit-rating downgrade could intensify relatively quickly, especially if risk appetite deteriorates sharply and there will be fears over capital flows. Markets will also be expecting the Bank of England to maintain a highly expansionary monetary policy. Sentiment could swing rapidly if the forthcoming inflation data is higher than expected, although Sterling would not be able to sustain strong gains in these circumstances as underlying weakness is likely to continue.

Sterling weakened to November lows beyond 0.91 against the Euro as confidence in the fundamentals remained weak. There were net losses against the dollar with a sharp decline from highs above 1.67.

Third-quarter UK GDP was revised to show a decline of 0.3% from 0.4% previously which was in line with market expectations. There was some disappointment that there was not a bigger revision and Sterling initially retreated from highs above 1.67.

Bank of England Governor King who again implicitly welcomed a weaker currency in testimony on the inflation report. King also stated that the economy faced profound challenges while the news that additional support had been provided to the banking sector during 2008 also undermined confidence

Bank officials were slightly more optimistic over near-term growth prospects and also stated that it was coming to the end of major quantitative easing measures which helped stabilise sentiment during the day. In comments on Wednesday, MPC member Sentance stated that it was too early to talk of monetary tightening.

There were fears that difficulties within Dubai could result in a withdrawal of investment funds from major markets such as the UK and this had a negative impact on Sterling with a wider increase in risk aversion also hurting the UK currency.

Swiss franc:

The National Bank policies will remain a very important focus amid conflicting signals. The potential impact has again been illustrated by rumoured intervention. Although very cautious over the 2010 outlook, the bank has also suggested that the policy stimulus needs to be moderated relatively quickly. The franc will gain defensive support if there is a sustained deterioration in global risk appetite. Unease over the Swiss banking sector is liable to cap gains.

The dollar weakened sharply to lows near 0.99 against the franc before rallying back above the parity level later in the week. The Swiss currency gained ground against the Euro with a high near 1.50. There were rumours of National Bank intervention which helped trigger the dollar rebound in choppy trading.

National Bank Chairman Roth stated that monetary policy will have to be corrected soon which suggests that the bank is more concerned over the medium-term inflation implications of ultra-low interest rates. The comments also hinted that the bank could be more tolerant of franc gains and less willing to intervene aggressively.

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The Australian currency was initially boosted by a fresh record high for gold prices and a weaker US currency. The Australian Reserve Bank was also upbeat on economic prospects which revived expectations of higher interest rates at the December monetary meeting.

The Australian dollar hit selling pressure above 0.93 against the US currency and weakened back to lows below 0.90 later in the week as there was an important deterioration in risk appetite and lower commodity prices.

Australian dollar sentiment will still be strong, but it will be difficult to regain momentum, especially given doubts over international risk conditions.

Canadian dollar:

The Canadian dollar was again unable to sustain gains beyond the 1.05 level against the dollar during the week and weakened to lows near 1.0750 on Friday. Domestic indicators did not have a major impact as trends in risk appetite were dominant. The Canadian currency lost ground as there were sharp declines in equity prices.

Trading conditions are liable to remain choppy in the short-term given uncertainties over risk conditions. The net risks suggest that Canadian dollar losses should be contained unless there is a substantial deterioration in risk appetite.

Indian rupee:

The rupee reversed initial gains and ended at three-week lows near 46.90 against the US currency on Friday. There were still concerns over stock market conditions with debt fears surrounding Dubai having a negative impact on local market sentiment.

There was also some further speculation that the authorities would impose capital controls to curb speculative inflows. There was also some month-end US dollar demand which put some downward pressure on the rupee.

The rupee will be vulnerable to some further selling pressure if there is a serous deterioration in risk appetite. Overall, heavy losses look unlikely in the short-term.

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The Hong Kong dollar maintained a position very close to the 7.75 limit against the US dollar during the week, although currency demand was weaker.

Conditions within the stock market were less favourable as there were sharp declines in the Shanghai market. The HKMA has injected over HK$14bn into the market during November, but injections have been more limited over the past few days.  

The Hong Kong dollar will tend to weaken if there is a serious deterioration in international risk appetite, but losses should be very limited in the near term.

Chinese yuan:

The yuan remained trapped within narrow ranges as the Chinese central bank again resisted any yuan movement in the spot market with the yuan stable despite sharp US dollar fluctuations. There was also some evidence of a dollar shortage.

Expectations of medium-term yuan appreciation continued, but there were no public concessions by Chinese officials following US President Obama’s visit

Sharp declines in the Shanghai market dampened expectations that the authorities would sanction a significant policy shift.

Expectations of medium-term yuan appreciation will remain a very important feature. The central bank is still likely to maintain stability in the short-term and resistance to policy changes will increase if there is a deterioration in risk appetite.