Weekly Forex Currency Review 31-10-2008

Overall strategy: 

In the short-term, the potential for relief in the credit markets will be offset by fears that the global economic conditions will deteriorate further. Given that markets are looking ahead, there should be some net scope for an improvement in risk appetite, but the very serious market and economic stresses will still be very important with volatility staying elevated.

Key events for the forthcoming week

Dollar:

Confidence in the US economy will remain weak in the short-term with continuing fears that the credit-related shocks will trigger a deep recession after the third-quarter contraction. There will be some optimism that the Fed action to cut rates will help underpin conditions, especially if there is a second fiscal stimulus. From a medium-term perspective there will be fears that dollar stability will be sacrificed to help alleviate the economic downturn. There will also be the threat of reserve diversification.  The dollar will still secure short-term support on defensive demand as credit conditions remain tight.

The severe financial stresses and fears over the global economy continued to have a very important impact on the currency markets over the week as the authorities battled to restore some degree of stability. There was a gradual reduction in Libor rates over the week, but credit default spreads were still at very elevated levels.

The US currency remained very strong initially and regained ground late in the week after a sharp mid-week decline for the currency

Volatility remained a key market feature with the dollar at one point weakening the most on a daily basis for 13 years following the rapid gains seen over the previous two weeks. From highs near 1.2350 against the Euro, the dollar weakened as defensive support for the currency lessened, but found support beyond the 1.30 level.

The US economic data remained generally gloomy. Consumer confidence weakened sharply to 38 in October from a revised 61.5 previously and this was the lowest figure on record as present and future expectations components both fell sharply.

GDP recorded a 0.3% annualised decline for the third quarter after a 2.8% increase the previous quarter as consumer spending weakened sharply. Although this was slightly better than expected, it was the first contraction for seven years

There was a recovery in headline durable goods orders, but underlying orders fell. There was a rise in existing and new home sales for September while inventories edged lower and prices fell significantly over the year. Initial jobless claims held steady at 479,000 in the latest week.

Following the FOMC meeting, the Fed announced a further 0.50% cut in interest rates with the Fed funds rate at 1.00%, equalling the lows seen during 2004. In the statement following the decision, the FOMC referred to fact that activity appeared to have slowed markedly while downside risks to growth persisted.

The Fed stated that it will act as needed to promote sustainable economic growth and price stability which will maintain expectations that rates could be cut even further. It is also significant that there was a unanimous vote which suggests that growth fears took centre-stage and markets priced in the potential for further rate cuts.

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The Euro-zone economy will continue to weaken in the short-term and the ECB comments continue to suggest that the bank will sanction another sizeable interest rate reduction at the November council meeting. The Euro will remain vulnerable on cyclical grounds, but some resilience in Germany will provide some protection. The principal Euro risk is likely to come from widening internal stresses and bond spreads which will create medium-term fears. There should still be some longer-term inflows on valuation grounds, especially from global central banks, which should limit losses. 
       
The Euro weakened to 30-month low against the dollar early in the week and also dipped to six-year lows against the yen before staging a significant rally following the sharp losses seen over the past few weeks.

There was a small rebound in German consumer confidence in the latest survey. In contrast, Euro-zone confidence as a whole weakened for the month. Business confidence also deteriorated sharply according to the latest EU Commission survey, reinforcing expectations of a sharp slowdown in the economy.

The comments from ECB officials continued to suggest that the central bank would look for a further cut in interest rates at the November council meeting.

There was a further widening of bond spreads between individual Euro-zone countries as underlying stresses remained an important background focus with some fears that the Euro area could rupture. The German government stated that it would announce bold fiscal measures to help tackle the economic downturn

Yen:  

The economy is liable to weaken further with a lack of support from domestic or export demand.  The Bank of Japan will continue to provide as much support as possible in the form of lower interest rates. The near-term currency moves will remain correlated strongly with degrees of risk aversion and fears over the global economy will continue to provide some yen support. Nevertheless, fears should ease slightly which would curb yen support. The Japanese Finance Ministry is likely to threaten intervention if there is a renewed yen surge. 

The Japanese currency pushed sharply higher as fears dominated early in the week, but it struggled to sustain the gains as markets responded to further official measures to underpin markets. From highs near 91 against the dollar and 112 against the Euro, the yen weakened to beyond 98 and 130 respectively before securing renewed gains.

The Federal Reserve announced new swap facilities with several Asian countries which helped stabilise sentiment to some extent.

There was a rebound in industrial production for September, but there was a quarterly decline and officials are very concerned over deteriorating conditions. Bank of Japan member Nishimura, for example, stated that downside economic risks were rising.

There was a statement from G7 members expressing concern over recent currency instability and this prompted increased speculation over intervention to curb the yen while sources indicated that rate cuts would be discussed. The Bank of Japan cut the benchmark interest rate by 0.20% to 0.30% with Governor Shirakawa casting the decisive vote after a 4-4 tie.

The government and Bank of Japan expressed increased fears over the economic outlook while the government announced at US$275bn fiscal support package.

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The economy is likely to weaken further in the short-term as the credit tightening takes effect with consumer spending still under pressure and a serious recession. The evidence strongly suggests that the Bank of England will sanction a further substantial interest rate cut at the November meeting. The drop in yield support would be offset by hopes that a deep recession can be avoided and by falling yields elsewhere. The UK currency will also gain some support if there is an improvement in risk appetite. Overall confidence will still remain very fragile in the short-term which will certainly limit Sterling support.

Sterling re-tested six-year lows below 1.53 against the dollar early in the week before securing a sharp corrective rebound later in the week. The UK currency advanced against the Euro, but failed to hold above 1.65 against the dollar.

UK consumer lending remained weak in September at GBP2.4bn, indicating the economic stresses, although there was a recovery from the very weak levels of GBP0.4bn previously. The Nationwide Bank reported a further 1.4% decline in house prices for October to give a 14.6% annual decline. The latest CBI retail survey recorded a second successive reading of -27 as spending remained weak.

MPC member Blanchflower maintained his downbeat stance towards the economy and his calls that a significant rate cut is required to prevent a deep recession. The comments from other Bank of England officials maintained expectations that the central bank would cut rates significantly at the November meeting

Two main UK banks took advantage of the government guarantees to raise substantial funds through new bond offerings while Barclays looked for private-sector support. The government suggested that borrowing would be increased.

Swiss franc:

The economy will continue to slow in the short-term and the National Bank will be increasingly uneasy over the impact of franc strength within Europe given the risk of a sharp slowdown in exports. In this environment, the bank may consider a further cut in interest rates ahead of the scheduled December meeting. The near-term trends will still be dominated to a large extent by trends in risk aversion.  There will still be important stresses within central Europe which should certainly act to contain franc losses, but demand is liable to fade slightly.

The Swiss currency advanced strongly against the Euro early in the week and pushed to the highest level since the Euro was formed nine years ago. The franc also found further support weaker than the 1.17 region against the dollar.

The latest UBS consumption index edged higher for October, but overall confidence in the economy continued to weaken.

The National Bank announced that it would offer additional 3-month currency swaps to the market in an attempt to secure greater control of the repo market and push Libor rates back towards the 2.50% target level.

There was further speculation that the bank will look to lower interest rates ahead of the December policy meeting, especially with markets expecting lower ECB rates.

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There was further very high volatility over the week. The Australian dollar was influenced strongly by trends in risk aversion and commodity prices. From lows near the 0.60 level, there was a recovery as stock markets rallied and metals prices also corrected from very sharp losses, but rallies attracted fresh selling pressure.

The Reserve Bank intervened in the market to buy the Australian currency during the week on three consecutive days to help stabilise the currency. The comments from central bank officials suggested that there would be some reluctance to cut interest rates aggressively in the short-term.

Volatility is likely to remain the key short-term market feature. Overall, there is scope for a further underlying corrective recovery.

Canadian dollar:

The Canadian dollar weakened to lows just beyond the 1.30 level against the US currency as it remained prone to extreme volatility. It then corrected back to near 1.18 as there was a rally in commodity prices and a recovery in risk appetite.

The domestic influences were limited with government assurances over the economy failing to have a major impact in offering support as unease persisted

Volatility is likely to remain a key short-term feature for the Canadian dollar with the potential for a further limited underlying correction stronger from recent heavy losses.

Indian rupee:

The rupee continued to test levels beyond the 50.0 level against the dollar early in the week and dipped to a fresh record low near 50.3 before finding some support.

A recovery in regional stock markets provided some degree of relief to the rupee after the battering seen during the week as a whole. Trading was subdued by the market holidays on Tuesday and Thursday with the rupee rebounding to 49.30 on Friday.

Degrees of risk appetite and global growth fears will tend to remain dominant for now with only a limited rupee recovery unless there is a sustained recovery in confidence.

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The Hong Kong dollar remained close to the 7.75 strongest limit against the US currency for much of the week with movement generally limited.

The HKMA matched the 0.50% interest rate cut seen by the US Fed. Inter-bank rates eased slightly over the week which lessened demand for the local currency to some extent, although there was still corporate demand for the local currency

The Hong Kong dollar should retain a firm tone in the near term even if there is no major challenge on the 7.75 intervention limit.

Chinese yuan:

The Chinese yuan  edged weaker against the dollar during the week with the currency generally resisting central bank attempts to keep the currency stable and it consolidated near 6.83 against the US currency on Friday.

The central bank announce the third interest rate cut in six weeks with a further 0.27% decline in the key one-year lending rate to 6.66%.

The Chinese authorities will remain concerned over the growth outlook and will have a continuing bias towards lowering interest rates which will tend to weaken the currency. The principal concern is likely to be to avoid yuan instability. 

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