Weekly Forex Currency Review 28-11-2008

Overall strategy: 

The global economy will continue to weaken in the short-term and there will be fears over deep recessions especially in the US and UK. If central banks can maintain greater stability in financial markets then the cuts in interest rates and fiscal support measures will have an important impact in stabilising sentiment with reduced fears over a slide into depression and deflation. In this environment, defensive demand for the US currency is liable to be weaker, although confidence will be extremely fragile.

Key events for the forthcoming week

Dollar:

There will be further serious fears over the US economy with the latest releases maintaining expectations of a sharp fourth-quarter GDP contraction. There will be expectations that the aggressive monetary easing and Fed action to boost credit markets will help underpin conditions next year and there is also the potential for a further fiscal stimulus. Any positive dollar impact is likely to be offset by increased medium-term fears over the implications of a huge increase in federal borrowing and dollar liquidity. Overall defensive demand for the dollar is also liable to fade despite intermittent strong demand for the currency.

The dollar was generally weaker against European currencies over the week and the Euro tested levels above 1.30 for the first time in thee weeks, but the US currency recovered from its weakest levels.

After severe tensions at the end of last week, equity markets looked to rally and this tended to reduced buying support for the US currency. Sentiment was boosted by the US$300bn support package and loan guarantees for Citigroup. There were still important stresses within the credit markets as fears persisted and widening CDS spreads indicated increased default risks as the global economy weakened.

The US data releases maintained a very weak tone over the week. Durable goods orders fell 6.2% in October while there was a core decline of 4.4% for the month. Elsewhere in the industrial sector, the Chicago PMI index weakened to 33.8 in November from 37.8 previously. This was the weakest reading since the 1982 recession and the orders component in the data was notably depressed which will maintain fears over the industrial outlook.

Jobless claims remained at elevated levels with a decline of  only 14,000 to 529,000 in the latest week, the third consecutive figure above 500,000, while consumer spending also fell in October. The final University of Michigan consumer confidence index recorded a renewed decline even with lower energy prices.

There was a further decline in existing and new home sales while inventories were high and there was a further decline in prices according to the latest data. The data overall maintained fears over a very sharp GDP contraction for the fourth quarter.

As well as the Citigroup package, the Federal Reserve announced a further US$800bn support package for financial markets and the economy. In particular, the authorities want to narrow mortgage credit spreads which would lower interest rates and help underpin the housing sector. In this context, the Fed will buy US$600bn in mortgage-backed securities and will also spend a further US$200bn on supporting credit facilities in consumer-related sectors such as autos and student loans.

There were longer-term fears over the budget outlook and a huge expansion of the Fed’s balance sheet with speculation that they will pose major risks to economic and currency stability. President-elect Obama indicated support for  afresh fiscal package.

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The Euro-zone economy will continue to weaken in the short-term with particular unease over a sharp deterioration in industrial confidence. The ECB will lower interest rates again in December and the evidence suggest that there will be a cut of at least 0.50% to help support the economy. The German economy is weakening, but the Euro-zone as a whole is slightly less vulnerable to credit and housing difficulties and this should provide some degree of support to the Euro, especially with the prospect of a fiscal boost. 
       
The Euro had a generally firmer tone over the week, although it struggled to sustain any momentum as underlying confidence remained very fragile

There was a provisional 0.5% decline in German consumer prices for November which cut the annual increase to 1.4%. There was a also a substantial decline in industrial confidence to a 15-year low according to the latest survey.

The weak industrial and inflation data reinforced expectations of lower interest rates and Bundesbank member Weber maintained his recent dovish conversion with a comment that there was ample room for further interest rate cuts.

The European Commission indicated that there would be a fiscal stimulus of EUR200bn while markets priced in an ECB rate cut of at least 0.50%.

Yen:  

There is little prospect of a significant improvement in the domestic economy and exports will also remain under pressure, especially with a downturn in the regional economy. Immediate fears over repatriation flows may have eased slightly, but there will still be underlying pressures associated with derivatives. The sharp decline in global interest rates will also lessen the potential for capital flows out of Japan. The capital flows data suggests that the yen is unlikely to weaken sharply even if there is a sustained recovery in global equity markets.    

The yen proved generally resilient over the week even though there were robust gains for global stock markets and it consolidated near the 95 level. Fears over the regional and global economy continued to provide some underlying support to the Japanese currency and there was further speculation over derivatives-related currency buying.

Domestically, the services-sector price index fell 1.4% in the year to October which was the largest decline for five years and will maintain deflation fears while the government also downgraded its assessment of exports. There was a reported 3.1% decline in industrial output for October while household spending also fell.

Minutes from the October 31st monetary policy meeting confirmed that that two members had voted for a larger than expected rate cut to 0.25% while Mizuno voted for rates to be left on hold.

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The economy will continue to weaken in the short-term with a large fourth-quarter GDP contraction. The substantial interest rate cuts and fiscal action may provide some degree of support to the economy, but there will still be important difficulties in securing credit. Overall confidence will remain weak and there will be serious fears over the medium-term implications of a sharp rise in the budget deficit. Net capital inflows will also be fragile. In this environment, Sterling will struggle to make significant headway, but with some scope for a limited rebound.

Sterling found support below the 1.50 level against the dollar and pushed to a high of 1.55, but was unable to sustain the advance. The UK currency pushed to a two-week high on a trade-weighted basis as risk appetite was slightly firmer.

Third-quarter UK GDP was unrevised at -0.5% as consumer spending remained under pressure while both the manufacturing and services sectors contracted for the quarter. Overall confidence in the economy remain very fragile given underlying pressures.

The latest mortgage-lending data continued to indicate a weak market with a decline in BBA mortgage approvals of over 50% for the year with monthly approvals falling slightly to 21,600 from 23,400 the previous month. The Nationwide data recorded a slower rate of house-prices decline of 0.4% for November with a 13.9% annual fall.

Bank of England Governor King was generally downbeat over the economy in testimony to the Treasury select committee and stated that the bank would take all action necessary to meet the inflation target. King also warned that further action would be taken if the banks failed to boost lending while he also warned that there could be further severe stresses within the sector.

The government also repeated warnings over banks in the pre-budget report. The Chancellor announced a 2.5% VAT cut for the next 13 months as part of a GBP20bn package to support the economy, but also announced medium-term tax rises.

Swiss franc:

The economy will continue to weaken in the short-term with domestic demand and exports remaining under pressure.  The National Bank has indicated that interest rates will be cut further in the short-term. The financial-sector stresses will also be very important for the Swiss economy and fears over the banking sector are liable to remain an important negative factor for the franc. In this environment, the Swiss currency is liable to remain generally weak.  

The franc remained on the defensive against the Euro over the week with lows beyond 1.55 before some stabilisation. There were net gains against the dollar after recent steady losses and it consolidated around the 1.20 level.

The latest UBS consumption index recorded a further decline to 1.32 in November from 1.64 the previous month, reinforcing expectations of weaker consumer spending. The third-quarter employment data was firm, but is a lagging indicator.
 
Underlying confidence in the Swiss economy remains weaker and sentiment was undermined further by central bank remarks. National Bank member Hildebrand reported that there was a severe economic crisis with GDP contraction likely for 2009. 

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The Australian dollar secured a net advance over the week and strengthened to test levels near 0.66 against the US dollar late in the week.

The currency gained some support from a rise in gold prices during the week while commodity prices looked to stabilise. The net gains in stock markets also provided support, but global growth fears were still an important influence.

There was little in the way of domestic releases with capital spending and private credit holding firm, but markets were expecting a further interest rate cut.

The Australian dollar will need a sustained improvement in risk appetite and some degree of confidence over the global economy to sustain any notable advance.

Canadian dollar:

The Canadian dollar was subjected to volatile trading over the week. From lows near 1.28 against the US currency, the Canadian currency was able to strengthen back towards 1.22. The local unit gained some support from a net advance in gold prices over the week, especially as risk appetite was slightly stronger.

The Canadian retail sales data was stronger than expected with a 1.1% monthly increase as auto sales were robust for the month, although the domestic releases failed to have a major impact with expectations of a deterioration.

There is likely to be further Canadian dollar volatility in the short-term with the currency looking to secure some net advance despite the underlying growth fears.
 
Indian rupee:

The rupee was generally firmer over the first half of the week with gains to 49.50 against the US dollar. There were reports of significant dollar inflows potentially linked to direct investment into India. There was also some evidence of a cautious recovery in regional market sentiment over the week.

The Indian markets were closed on Thursday following the terrorism attacks in Mumbai and there were fears that there would be a negative impact on confidence. As markets re-opened on Friday, the rupee dipped to near the 50.0 level against the dollar before finding support with some central bank support for the currency.

Volatility levels are liable to remain highly elevated in the short-term. There is scope for a limited rupee advance despite the persistent growth fears. 

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Upward pressure on the Hong Kong dollar eased during the week and the currency eased away from the 7.75 band limit with lows near 7.7570.

There was evidence that repatriation flows were easing slightly and this eased upward pressure on the currency with the HKMA able to stay out of the market. The currency regained support on Friday with some evidence of month-end US dollar selling.

There was some relief over the latest export data with a 9.4% annual increase in the year to October, but regional economic fears persisted.

The Hong Kong dollar should retain a firm tone for now, but there is scope for upward pressure to remain slightly weaker which will limit currency support.

Chinese yuan:

The central bank has continued to pledge that yuan stability would be maintained in the near term in order to combat market instability. The bank set the reference rate at an 8-week low of 6.835 on Friday which nudged the yuan weaker in the spot market

The Chinese central bank announced a further sharp cut in interest rates with a 108 basis point cut in the benchmark lending rate to 5.58% while there was also a further cut in reserve requirements to help support the economy.

The yuan impact was lessened to some extent by falling global interest rates as well as the tough control by the central bank, but there was some speculation over a switch in emphasis to push the yuan weaker.

In the near-term, the central bank’s main priority is likely to be maintaining currency stability. The more aggressive monetary easing will limit the scope for yuan gains.  

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