Weekly Forex Currency Review 01-04-2010

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While confidence in the global economy remains firmer, markets will assess the prospects for monetary policy tightening. There will be expectations the Federal Reserve to shift monetary policy ahead of the ECB which will help underpin demand for the dollar while there will be some reluctance to fund carry trades through the dollar. Given underlying structural vulnerabilities, it will be difficult for the US currency to secure firm buying support.             

Key events for the forthcoming week

Dollar:

The US economic data is liable to maintain a mixed tone, but there will be expectations that the economy will out-perform the Euro-zone which should attract investment inflows. The longer-term yield spreads will remain under close scrutiny and the dollar should be able to gain support from higher Treasury yields. There will, however, be some unease over the risk that global central banks will reduce their holdings of US bonds which would also tend to limit the scope for dollar gains.

The dollar was broadly resilient during the week on a trade-weighted basis, but it was unable to make headway against European currencies and was subjected to a correction weaker. There was reduced demand for the dollar on defensive grounds with optimism over the global economy.

The latest US house-price data recorded a small seasonally-adjusted increase for January with the lowest annual decline for three years. The US consumer confidence data was slightly stronger than expected with an increase to 52.5 for March from a revised 46.4 the previous month. There was an improvement in optimism surrounding the labour market which helped maintain some degree of optimism over the economy.

The ADP employment report was weaker than expected with a reported decline of 23,000 jobs for March, in contrast to expectations of a monthly increase. The survey does not include government-related jobs and there were still expectations of a firm employment report on Friday given that there are expected to substantial jobs created in relation to the forthcoming census.

The Chicago PMI index fell to 58.8 for March from 62.6 the previous month which was slightly lower than expected, although it was still a robust reading. 

Regional Fed President Lockhart stated that interest rates may need to rise even if the labour market was still weak and there will be expectations of higher rates later in 2010.  The dollar did secure support on rising US Treasury yields as spreads over German bunds continued to rise.

There was also some evidence that short dollar positions to fund carry trades were being curbed which lessened selling pressure on the dollar.

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Sentiment surrounding the Greek budget situation may improve slightly in the very short-term, but underlying confidence will still be very fragile and fears are liable to return quickly. There will also be wider unease over the Euro-zone economic outlook with fears that there will be further credit-rating downgrades. The ECB stance will remain under close scrutiny in the near term and there will be speculation that the bank will delay any monetary tightening to help offset the impact of budget tightening. 

The Euro was able to resist further selling pressure during the week and secured a corrective recovery against the dollar and yen as some speculative positioning against the currency were scaled back. The Euro consolidated near 1.35 against the dollar.

Following the support deal agreed last week, immediate fears surrounding the Greek debt situation eased. The Greek government also launched a EUR5bn bond issue to take advantage of improved market conditions. There was still a yield premium of 325 basis points over German bunds which indicates that underlying investor confidence is still very fragile and the Greek economic data remained weak.

Provisionally, German consumer prices rose 0.5% in March to give a 1.1% annual increase, in contrast to an expected 0.3% monthly increase. The higher than expected figure could raise some unease within the ECB which could have provided some degree of Euro support.

The flash Euro-zone inflation estimate rose to 1.5% for March which was a 10-month high for the index and will remain some degree of uncertainty over the near-term inflation outlook

Yen: 

The yen will remain vulnerable to carry-related selling, especially if confidence in the global economy holds relatively firm. The trend in yields will also be important and higher interest rates will tend to attract funds into the US currency which will also tend to weaken the yen. Exporter selling will still be a significant feature when the dollar rallies and aggressive yen selling looks unlikely, but there are likely to be investment flows at the start of the new fiscal year which will tend to undermine the yen.

There was a generally weaker yen trend with the dollar still gaining support from higher US Treasury yields. The dollar pushed to a two-month high above 93.50 against the Japanese currency.

The domestic economic data was slightly weaker than expected with a 0.9% decline in industrial production for February, which was the first decline for 12 months, although this was in line with market expectations.

Retail sales rose 4.2% in the year to February. There was also an unexpected annual decline in household spending which maintained pressure for an expansionary Bank of Japan monetary policy to help support the economy.

There was an improvement in the Tankan business confidence index with a headline reading of -14 from -25 the previous quarter, although capital spending plans were still weak.

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There will be a high degree of uncertainty over the budget outlook and underlying confidence in the debt situation will also remain weak. Policy will have to be tightened following the election and there will be speculation that measures to curb the budget deficit will help delay any Bank of England interest rate increases. Given the amount of bad news priced in and the very high number of short speculative positions, Sterling may be able to avoid further heavy selling pressure. There still looks to be little scope for advances given underlying vulnerabilities.

Sterling continued to secure some relief during the week as selling pressure eased and there was a reduction in short positions. The UK currency pushed to highs above 1.5250 against the dollar and also strengthened to a 1-month high near 0.8880 against the Euro.

UK GDP growth for the fourth quarter was revised up to 0.4% from 0.3% previously which provided some degree of Sterling support and the quarterly current account deficit was also sharply lower than expected which should help ease financing fears.

In addition, the Nationwide reported an increase in house prices for March, reversing February’s decline, which helped ease immediate fears over the economy.

The PMI data was also stronger than expected with the manufacturing index rising to 57.2 from a revised 56.5 the previous month

There was still a high degree of market caution surrounding the government borrowing and debt situation and there were further warnings over the medium-term outlook from credit-rating agencies which maintained speculation over a downgrade.

Swiss franc:

The Swiss currency will continue to gain some defensive support from a general lack of confidence in the Euro. The National Bank will remain an important focus and, despite the generally firm tone of recent business surveys, there will be further pressure on the central bank to prevent further gains against the Euro. Volatility is liable to remain higher in the short-term. Given the net global risks, heavy selling pressure on the currency still looks unlikely.

The dollar was unable to sustain a move above 1.07 against the franc during the week and weakened sharply to lows just below 1.05. The Euro also failed to sustain a move back above 1.43 and dipped to test record lows near 1.42.

The Swiss UBS consumption index dipped lower for March which may raise some doubts over the strength of consumer spending.

In contrast, the KOF business confidence index rose to 1.93 for March from a revised 1.90 the previous month which maintained some optimism over the industrial trends. The PMI manufacturing index also rose further to 65.5 from 57.7.

The data may also dampen fears over the impact of franc strength and lessen pressure for National Bank intervention to reverse the recent trend.

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The Australian dollar again tested resistance levels near 0.92 against the US dollar during the week. It retained a firm tone, but was unable to make a move significantly above this level.

Reserve Bank Governor Stevens suggested that interest rates would rise further over the next few months which initially provided some degree of support for the currency

The latest retail sales data, however, was sharply weaker than expected with a decline of 1.4% for February while building approvals also fell which curbed expectations of an April interest rate increase and triggered initial selling pressure on the Australian dollar as rate expectations were scaled back slightly.

Australian dollar sentiment should remain generally firm for now with expectations of carry-related inflows. The currency may still find it difficult to extend gains given the strength of global demand priced in.

Canadian dollar:

The Canadian dollar was unable to mount an attack on parity against the US currency, but was able to resist significant losses and strengthened to highs near 1.01 during the week as underlying sentiment remained firm.

The currency continued to draw support from confidence in the domestic economy while risk appetite was also strong with a firm tone for commodity prices.

The Canadian dollar should remain generally firm given expectations of higher interest rates and firm risk appetite. Resistance levels will still be tough close to parity on speculation the currency is overvalued from a medium-term perspective.

Indian rupee:

The rupee had a stronger tone over the week and strengthened to test 19-month highs beyond the 45 level against the US dollar.

There was confidence in the regional economy which helped support currency sentiment and there were also expectations that the domestic economy would strengthen over the next few months.

There was some speculation that the Reserve Bank would intervene to block currency gains which slowed the rupee’s advance.

The rupee should be able to maintain a relatively firm tone in the near term. It will still be difficult to secure strong gains from current levels. 

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The Hong Kong dollar weakened during the week and retreated to lows around 7.767 against the US currency on Thursday with the currency undermined by rising US yields and some net outflows in search of higher returns.

There was optimism over the regional economy which helped curb Hong Kong dollar selling, especially with robust readings for the Chinese PMI indices.

There will be mixed currency influences from Chinese policy pressures. Overall, the Hong Kong dollar should be able to resist heavy selling pressure.

Chinese yuan:

The spot yuan rate remained confined to tight ranges during the week at around 6.826 against the dollar and there was relatively little movement in the NDF market.

The Chinese PMI data was strong which helped maintain optimism towards the economy. Immediate speculation over a further immediate tightening of policy faded slightly and the central bank maintained a pledge of loose monetary policy.

There was further speculation over a near-term move to let the yuan float more freely and rumours that the currency band would be widened.

Speculation over an adjustment to the yuan regime will remain very high over the next few weeks  There is a certainly a strong possibility of at least a limited policy move with the authorities likely to veto more aggressive moves.