Weekly Forex Currency Review 30-07-2010

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Confidence in the US economy is likely to remain generally weaker in the short-term, especially with fears over a renewed slowdown. A key focus over the next few weeks will be whether fears are concentrated in the US area or whether there will be wider fears over the European and global economy. The net risks suggest that dollar losses should be limited given the global risk profile.                  

Key events for the forthcoming week

Dollar:

The US economic data has been mixed, but there has been a generally subdued tone. Markets will also continue to take note of generally cautious remarks from Federal Reserve officials and this will maintain speculation that there could be additional policy action by the central bank within the next few months. Overall confidence in the US fundamentals will certainly remain fragile. The degree of confidence in the global economy will remain extremely important for dollar direction and unease over conditions should provide some degree of protection as capital outflows are subdued.
   
The dollar maintained a generally weak tone during the week as confidence in the US fundamentals remained fragile. There was only limited defensive US currency demand and it dipped to 2-month lows on a trade-weighted basis.

The US housing data was slightly stronger than expected with the Case-Shiller house-price index recording a 4.6% increase in the year to May. In contrast, the consumer confidence data was weaker than expected with a retreat to a 5-month low of 50.4 for July from a revised 54.3 as confidence in the labour-market deteriorated.

The US durable goods orders data was weaker than expected with a headline 1.0% decline for June while there was an underlying 0.6% fall for the month, although the core capital goods reading recorded a gain which limited any negative impact.

A decline in jobless claims to 457,000 in the latest week from a revised 468,000 the previous week did not have a major market impact. There were still fears over an underlying deterioration in the US economy which curbed dollar support.

The Fed’s Beige Book was mixed as some districts reported improved conditions, although the gains were limited and two districts commented that conditions had stalled. Credit conditions remained generally tight while the commercial real-estate market remained weak. The report maintained a sense of doubt over the US economic trends with little expectation of any near-term tightening.

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The latest Euro-zone data has been stronger than expected which will increase near-term confidence in the economic outlook. Policy-makers have also managed to stabilise immediate confidence surrounding the banking sector which will provide some degree of Euro support. There will still be very important reservations over the debt profiles of weaker members and financial-sector fears could return very quickly. With the currency outlook also geared to global economic trends, the Euro will still face important barriers to further gains.

The Euro maintained a firmer tone with the run of better than expected run of economic data compounded by reduced structural fears. The Euro strengthened to a 12-week high close to 1.31 against the dollar as there was some month-end demand for the currency.

There was relief over the banking-sector stress test results with 7 of the 91 banks deemed to have failed, although there were doubts whether the capital raising assumptions were realistic.

German consumer confidence rose to 3.9 in the latest month from a revised 3.6 for June, maintaining the recent run of favourable data. There was a further decline in German unemployment

There was an annual increase in Euro-zone money supply for the first time since January. There were also stronger than expected gains for business confidence which helped underpin sentiment towards the economy. There were still fears that the rest of the Euro area would lag behind the German economy.

The ECB did report that there had been a further tightening of credit conditions during the second quarter and this will raise some doubts over the financial-sector outlook. Similarly, ratings agency Standard & Poor’s stated that European banks were still vulnerable and this tempered Euro optimism to some extent.

Yen:  

The yen will continue to gain some protection from doubts over the US economy and a suspicion that the global economic growth will also disappoint. Trends in risk appetite will also be important and the yen will gain when global confidence deteriorates. The Japanese fundamentals will remain under close scrutiny and there will be further speculation that the Bank of Japan and Finance Ministry will take further action in an attempt to block significant yen appreciation. The yen will find it difficult to sustain a robust advance.

The yen was able to resist significant selling pressure against the dollar and the US currency tested support below 87 later in the week with a decline to 8-month lows just below 86.50. The yen dipped to 12-week lows against the Euro before finding some respite.

Domestically, the Your Party which secured gains in the recent Upper-House elections and could enter a coalition with the government called for aggressive measures to curb deflation which would include a weaker yen.

Markets remained on high alert for comments and potential verbal intervention from Bank of Japan and Finance Ministry officials, especially as the dollar dipped towards the pivotal 85 fundamental and technical area against the Japanese currency.

The retail sales data was slightly stronger than expected with a 3.2% increase in the year to June. Markets were still sensitive to the deflation threat as consumer prices continued to decline. The latest industrial production data was also weaker than expected with a 1.5% decline for June.

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Sterling will continue to gain some near-term support from stronger than expected economic data, but confidence is likely to fade, especially with unease over the impact of a tighter fiscal policy and doubts over the housing sector. Comments from Bank of England officials will be watched very closely and expectations that rates will be kept at very low levels will limit the potential for fresh buying support. Sterling developments will also be influenced strongly by trends in risk appetite and downside risks will increase if confidence in the global economy deteriorates.  

Sterling maintained a firm tone during the week and strengthened to a 3-month high above 1.5650 against the dollar on a combination of domestic and technical support factors.

The latest CBI retail sales data was much stronger than expected and this triggered a fresh surge in the UK currency. The survey recorded a figure of +33 for July from a figure of -5 previously and retailers were also optimistic over the August outlook

In contrast, the Nationwide reported a 0.5% decline in house prices for July, the first decline of the year. The mortgage lending data was also weaker than expected with a drop in approvals to the lowest level since February. The consumer lending data disappointed as well with a monthly decline in consumer credit.

With incomes under pressure and weak credit growth, there was surprise over the recent strength of consumer spending data. There were expectations of a slowdown in the housing sector and doubts over the economy are liable to increase.

In testimony to the Treasury Select Committee, Bank of England Governor King did express some concerns over the inflation outlook. King was still cautious over the economic outlook and stated that policy could be tightened or loosened over the next few months with the outlook still very uncertain.

On a short-term view, the Governor suggested that interest rates would not be increased, although it is also clear that there will be divided opinion within the central bank which will maintain potential Sterling volatility.

Swiss franc:

The franc will lose some defensive support if there is a sustained improvement in sentiment surrounding the Euro-zone and reduced fears over credit rating downgrades. There will still be some underlying defensive demand for the Swiss currency given unease over the structural vulnerabilities within Europe and further speculation over National Bank reserve diversification. Given the net risk profile, the franc is unlikely to be subjected to heavy selling pressure.

The Euro strengthened to a high just above 1.38 against the Euro as the correction from recent record lows continued. The Euro was unable to sustain the gains and weakened sharply to lows near 1.3520 during Friday. From highs above 1.0620, the dollar dipped sharply over the second half of the week to test support levels below 1.04 as it dipped to fresh 7-month lows.

There were strong rumours that the Swiss National Bank was looking to diversify its foreign-exchange reserves with reports of Euro selling which contributed to the sharp franc gains on the crosses as it also secured strong gains against Sterling.

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The Australian dollar found support close to 0.88 against the US dollar and strengthened to test highs above 0.9050 before encountering profit taking with lower commodity prices having a negative impact and there was selling pressure above the 0.90 level over the second half of the week.

The latest consumer inflation data was weaker than expected with a 0.6% increase for the second quarter compared with expectations of a 0.9% increase and this dampened expectations of any further increase in interest rates which initially curbed buying support for the currency.

The Australian dollar moves will continue to be influenced strongly by trends in risk appetite. Given the underlying global and domestic risk profile, the Australian dollar will find it difficult to make much headway.

Canadian dollar:

After a series of challenges on US dollar support levels, the Canadian currency advanced to a peak near the 1.0250 area. There was considerable selling pressure near this level with a retreat back towards 1.04.

The Canadian dollar was unsettled at times by a drop in oil and commodity prices while doubts over the strength of US demand also had some negative impact.

Volatility levels are liable to remain higher in the short-term. The Canadian can certainly prove to be resilient, but is likely to find it difficult to make much headway given doubts over the global growth outlook.

Indian rupee:

The rupee resisted losses during the week and gradually strengthened to a 1-month high just beyond 46.50 against the dollar. The rupee gained support from a generally weaker US currency while capital inflows remained firm.

The Reserve Bank increased the repo rate to 5.75% at the latest monetary review and also stated that further action would probably be required which strengthened expectations of further increases over the next few months.

The rupee should be able to prove broadly resilient given longer-term optimism towards fundamentals.  It will be difficult to extend gains much further.

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The Hong Kong dollar was confined to narrower ranges during the week with the currency hitting resistance close to 7.7650 against the US dollar while there was support weaker than the 7.77 level.

A generally weaker tone for the US currency provided support for the local currency, but there were some reservations over regional and global growth considerations.

The Hong Kong dollar trends will be influenced by developments in risk appetite. Given the fragile US dollar, the local currency should be able to resist substantial losses over the next few weeks.   

Chinese yuan:

The yuan edged firmer against the dollar during the week with an advance to the 6.776 area. The Chinese currency gained support from a generally weaker US currency while there was still tight official control.

Senior PBOC advisers stated that they did not expect big yuan moves in the near term and the central bank also suggested that relatively tight control of the market would continue. The IMF continued to state that the yuan was substantially under-valued.

The PBOC was also generally cautious over the domestic growth outlook with fears over a slowdown in the property sector. There was also some nervousness over the forthcoming PMI data at the beginning of August.

The central bank is likely to maintain a considerable degree of control over the currency moves and there is likely to be further resistance to more than limited yuan gains unless there is widespread selling pressure on the US currency.

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