Weekly Forex Currency Review 29-08-2008

Overall strategy:

Markets will continue to focus on global economic conditions. There has been an important shift in market sentiment towards international conditions and this will continue to provide underlying dollar protection with a reduction in net capital outflows from the US currency. Nevertheless, fundamental doubts should limit the scope for robust dollar gains.  

Key events for the forthcoming week

Dollar:

There will be some optimism over the industrial sector and the data overall suggests that the economy may be stabilising as the housing deterioration slows. There are still substantial barriers to a recovery and a period of sub-par expansion is the best that can be expected, especially as serious underlying stresses in the financial sector will continue. The Federal Reserve is likely to be very cautious over raising interest rates, especially given persistent financial-sector stresses. In this environment, the dollar's prime source of support is still likely to be increased fears over the global economic outlook.

The dollar retained a generally firm tone over the week, but it was subjected to a correction after recent rapid gains and was encountering tough resistance at levels beyond 1.46 against the Euro while stalling on a trade-weighted basis.

The US industrial data offered some support with durable goods orders rising by 1.3% in July while core orders rose 0.7% in contrast to expectations of a monthly decline.

There was also a tentative recovery from near record lows for consumer confidence with an increase to 56.9 in August from 51.9 previously as the expectations component was slightly more positive compared with recent depressed readings.

Both existing and new home sales stabilised close to the previous month's levels. The inventory overhang remained substantial while prices remained weak, although there was some evidence that conditions were starting to stabilise.

The Case-Shiller house-price index recorded a 15.9% decline in prices in the year to June. These was evidence that the rate of decline was slowing and much if the weakness was again focussed in California and Florida with other areas more robust.

Second-quarter GDP was revised up to an annual rate of 3.3% from the provisional 1.9% estimate, primarily due to the impact of higher exports. Initial jobless claims remained above the 400,000 level while continuing claims continued to rise.

Minutes from the July Federal Reserve meeting confirmed the unease over growth trends with expectations of weakening conditions over the second half. The Fed stated that the next move in interest rates would be an increase, but the rhetoric lacked conviction and this pattern continued in comments from Fed officials over the week.

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Confidence in the Euro-zone economy will remain weaker in the short-term, especially as evidence of a downturn in Germany will have an important negative impact on confidence. The ECB will maintain firm rhetoric in the short-term as it will not want interest rate cut expectations to get out of hand, especially as a key focus will be containing wage increases, and this will underpin the currency. The Euro will struggle for strong support given the threat of persistent capital outflows and a further underlying slowdown in conditions.              
       
The Euro was unable to make strong headway over the week, but it did find buying support on dips, and advanced over the second half of the week.

There was further weak German data over the week which maintained negative sentient towards the Euro-zone. The IFO index for August weakened to 94.9 from 97.5 the previous month which was a lower reading than expected and consumer confidence weakened to a fresh five-year low.  In contrast, the employment data was stronger than expected with unemployment falling by 40,000 for July.

As far as inflation is concerned, the provisional German data recorded a 0.3% decline in August prices which cut the annual inflation rate to 3.3%. Wider Euro-zone data failed to have a significant impact with further evidence of a sharp downturn in Spain while the French housing data improved marginally

There was further tough rhetoric from the ECB during the week with council members Weber and Liebscher both warning that it was too early to talk about interest rate cuts while there was the need for strong vigilance at this time.

Yen:  

Confidence in the Japanese economy will remain weak in the short-term with persistent unease over the threat of recession. These fears will intensify if there is evidence of further serious stresses within the Asian economy as a whole. Wider global trends will remain very important for the Japanese currency and further downward pressure on high-yield currencies would increase pressure for a reduction in carry trades. Although there will be strong yen selling on rallies as margin trading will persist, the yen has scope for a firmer tone. 
                    
The yen overall was confined to relatively narrow ranges against the major currencies, although there were sharp intra-day moves. The dollar hit tough resistance above the 110.0 level while the Japanese currency was unable to break 160 against the Euro.

There were further warnings over economic trends from Bank of Japan officials over the week. In contrast, there were comments from a senior LDP official that the Bank of Japan may have to consider an increase in interest rates to boost income for domestic savers. The government also announced a JPY11.7trn fiscal boost

The Japanese economic data over the week was actually stronger than expected with a 0.9% increase in industrial production for July compared with expectations of a further monthly decline while unemployment fell to 4.0% from 4.1% previously.

Core consumer inflation rose to 2.4% in August from 1.9% previously, although there was no significant shift in interest rate expectations following the data.

There was still evidence of yen selling on significant rallies as margin accounts continued to sell the Japanese currency. There were also further fund launches aimed at overseas high-yield bonds which sapped yen support.

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Recession fears will remain a key short-term market focus as the housing sector continues to deteriorate and consumer spending comes under heavy pressure. The Bank of England will still be forced to focus on inflation initially, but there will be further strong speculation over a shift towards lower interest rates later this year. A lack of confidence in the US and Euro-zone economies will continue to provide some important protection to the UK currency. Nevertheless, overall sentiment will remain very weak in the short-term.

The UK currency has remained under heavy pressure as confidence in the economy continued to crumble amid a stream of poor data. Sterling weakened to a fresh 2-year low against the dollar and also fell to a 12-year low on a trade-weighted basis.

The latest BBA mortgage approvals data showed some stabilisation over the month, but approvals were still down by over 60% over the year. There were further very weak results from the house-building sector while Nationwide reported a further 1.9% decline in house prices for August to give a 10.5% annual decline.

There was further evidence of a serious downturn in the retail sector with the latest CBI report recording a net sales balance of -46 from -36 the previous month and this was the weakest figure for over 25 years. In this environment, underlying sentiment towards the UK economy and currency remained at depressed levels.

Bank of England MPC member Blanchflower continued to warn over the UK economic trends and re-iterated more forcibly that there should be sharp interest rate cuts, especially as there was likely to be a rapid medium-term drop in inflation.

Swiss franc:

There will be further expectations of a slowdown in the Swiss economy, especially as the latest survey evidence has indicated a downturn in consumer spending. There will also be concerns over a sharp slowdown in export growth. The National Bank is likely to keep interest rates on hold in the short-term. The Swiss currency should still gain some support on defensive grounds, especially if Eastern European currencies weaken sharply, but these supportive factors are liable to be overshadowed by fears over the Swiss financial sector.    

The dollar again hit tough resistance above the 1.10 level against the franc during the week. The Swiss currency firmed against the Euro, but hit resistance close to the 1.61 region as confidence in the European economy as a whole weakened.

The latest UBS consumption index fell sharply to 1.85 in July from a revised 2.22 the previous month which reinforced fears over a sharp slowdown in the economy. The employment data was still firm with a solid employment increase for the second quarter, although this is a lagging indicator.

National Bank President Roth stated that Switzerland was not suffering from a credit crunch but acknowledged that the economy would be substantially weaker over the second half and he suggested that interest rates would not be increased.

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The Australian dollar weakened to lows near 0.85 against the US dollar during the week before staging a corrective rebound. Gains were limited as caution towards the domestic and regional economy persisted.

There were only limited domestic data releases during the week with a decline in construction output for the second quarter and weaker personal lending offset by stronger than expected capital spending for the same period.

Given the lack of domestic impetus, currency moves were dominated by international factors and caution over global trends curbed support for the Australian currency

There is scope for a further corrective Australian dollar rally in the near term, although gains will quickly attract selling pressure as fears over slower domestic and international growth are likely to persist.

Canadian dollar:

The US currency was generally weaker against the Canadian dollar over the week with pressure for a correction after the recent sharp gains. The dollar consolidated close to the 1.05 level with buying support on dips towards the 1.04 level.

Canadian currency moves continued to be influenced by trends in commodity prices, although the impact was slightly less than had been seen in previous weeks.

The second-quarter current account remained in comfortable surplus at CAD6.8bn from a revised CAD4.5bn previously, although this was slightly lower than expected.

The domestic fundamentals are still holding relatively firm which should lessen the risk of heavy Canadian dollar selling. Commodity-price changes are liable to trigger further volatility even if there is a period of near-term range trading.

Indian rupee:

The rupee has generally remained under pressure over the week and weakened to fresh 17-month lows beyond 44.25 against the US currency before a partial recovery.

The rupee was undermined by further sales of domestic securities by overseas funds as regional sentiment continued to deteriorate. There was month-end demand for the US currency which was a negative rupee influence while oil prices were volatile.

There was evidence of central bank intervention to support the rupee on dips beyond 44 against the dollar and this helped ease selling pressure on the currency.

Overall confidence in the economy and region is liable to remain fragile with little scope for a sustained advance in the currency given the fact that the underlying capital account is liable to remain weaker.

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The Hong Kong dollar was trapped in narrow ranges over the week and settled close to 7.8070 against the US currency on Friday.

There were domestic and regional growth concerns which dampened sentiment especially as there was a reported second-quarter GDP decline. Underlying confidence in the Hang Seng index was also fragile which limited currency support.

Overall, the Hong Kong dollar should continue to resist loses beyond the 7.81 level against the US currency despite unease over the regional economic trends.

Chinese yuan:

The Chinese currency weakened slightly over the week with a slightly firmer tone initially followed by renewed losses to 6.840 on Friday.

The central bank set the yuan central rate sharply higher on Thursday and, although this primarily reflected a weaker US currency, there was speculation that the bank was sending a signal that it wanted further appreciation.

There was, however, still conflicting speculation as to whether inflation or export growth would prove to be the greater priority for the Chinese authorities. These concerns were fuelled by growing doubts over the regional and global economy.

The underlying rate of yuan appreciation is liable to slow over the next few months, especially as there will be increased concerns over the regional economy with the potential for reduced speculative capital inflows.

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