Weekly Forex Currency Review 01-10-2010

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Official currency policies will continue to be an important focus in the short-term. There will be increased speculation that individual countries will look to pursue devaluation policies in order to boost competitiveness and aim to support growth through export gains. Any increase in market tensions would also risk a surge in currency-market volatility.              

Key events for the forthcoming week

Dollar:

There will be further speculation over additional monetary easing by the Federal Reserve, especially after the weak consumer confidence data and there will be some expectations of a move at the November FOMC meeting despite some reluctance to shift policy ahead of congressional elections. The dollar will, therefore, lack yield support and there will little confidence in the fundamentals. The dollar will, therefore, tend to remain vulnerable unless there is a serious deterioration in international credit conditions. Unease over the global economy should provide some degree of protection to the dollar.

The dollar came under heavy pressure during the week and struggled to secure more than limited respite as confidence in the US economy remained weaker. The dollar dipped to an eight-month low on a trade-weighted basis.

The US housing data was slightly weaker than expected with the Case-Shiller house-price index registering a 3.2% annual increase from 4.2% the previous month. The consumer confidence data was significantly weaker than expected with a decline to 48.5 in September from 53.2 previously and this was the lowest figure since February with consumers pessimistic over the employment outlook.

There was increased speculation that the Federal Reserve would adopt further quantitative easing at the November FOMC meeting despite some reluctance to adjust policy in the run-up to congressional elections. Regional Fed President Rosengren, who is an FOMC voting member this year, stated that further quantitative easing would depend on forthcoming economic data. There were media reports that the Fed would provide smaller, but open-ended bond buying support.

Later in the week, there was a decline in jobless claims to 453,000 in the latest week from 469,000 previously while second-quarter GDP was at 1.7% from 1.6%. In addition, the Chicago PMI index rose to 60.4 from 56.7, maintaining the recent run of erratic readings for the regional PMI indices.

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There has been some relief over the latest economic data releases, especially with still firm data from Germany and there has been firm investor demand at recent bond auctions. There are still very important stresses within the financial sector with a particular focus on the Irish banks as bailout costs rise. There will also be pressure for the ECB to maintain an expansionary policy and sentiment towards the Euro could deteriorate rapidly if there are renewed fears over sovereign credit ratings. The Euro will find it difficult to secure strong gains.

The Euro maintained a robust tone during the week, notably against the dollar with five-month highs above 1.3650 and also advanced firmly against Sterling.

The European financial sector remained an important influence during the week, especially with a lack of key economic data. There was a particular focus on Ireland with Moody’s downgrading the credit rating of Allied Irish Bank by three notches.

The Irish government also revised up its estimates of likely bailout costs for the banks to over EUR30bn and the data suggested that the Irish budget deficit could rise to above 30% of GDP.  Potential damage to the Euro was contained as credit-default swaps elsewhere in the area were broadly stable or slightly narrower.

The Euro-zone flash inflation data recorded a rate of 1.8% for September which was slightly higher than expected and increased speculation that the ECB would look to move away from extraordinary liquidity early next year. There were, however, still very important concerns surrounding the financial sector and German retail sales fell for the second successive month.

Yen:   

Markets will continue to focus on the possibility of further intervention by the Bank of Japan. There will be pressure for yen gains to be resisted, but there will also be a suspicion that the action will be ineffective. There will be unease over the global economic trends and there are unlikely to be strong capital outflows from Japan. The yen will also gain further short-term protection from the lack of US dollar yield support. In this environment, dollar gains resulting from any intervention are still liable to fade quickly.

The dollar failed to make any impression and retreated to post-intervention lows near 83 against the yen before finding some degree of support

There was further speculation that the Bank of Japan would decide on further quantitative easing at next week’s policy meeting. There were also media reports that the Bank of Japan was looking at ways to weaken the yen through policies other than intervention. The yen weakened only briefly following the reports.

Domestically, the headline Tankan business confidence index improved to 8 from 1 the previous month which was marginally stronger than expected. The rate of improvement has, however, slowed and companies were less confident over the fourth-quarter outlook which dampened confidence.

The other Japanese economic data was mixed as stronger than expected releases for housing starts and retail sales, together with a dip in unemployment, were offset by a third successive decline in industrial production. Doubts over the manufacturing sector maintained pressure for yen gains to be resisted.

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There will be further unease over the UK growth trends with particular doubts surrounding the outlook for consumer spending as fiscal tightening takes effect. There will be further speculation over that the Bank of England will decide on further quantitative easing, but there will also be expectations of splits within the MPC. Overall, it will be difficult for the central bank to maintain confidence in the economy and currency with volatility likely to be a key feature. Weakness in other key economies will still continue to provide important Sterling protection.  

Sterling volatility was a key feature during the week. The UK data was mixed, but with a firm bias. Second-quarter GDP was confirmed at 1.2% while the current account deficit was lower than expected at GBP7.4bn from a revised GBP11.3bn previously. The latest CBI retail sales survey was much stronger than expected with a rise to 49 for September from 35 previous and this was the highest figure since 2004.

Money-supply growth remained weak while there was also a decline in consumer credit for the month. Total consumer lending was stronger than expected with a reported gain from mortgage lending, despite weakness in mortgage approvals.

In its latest report, the IMF was broadly supportive of the coalition government’s stance to tighten fiscal policy substantially. It described the reductions as essential and the IMF remarks were significant in maintaining Sterling confidence

The positive sentiment garnered from the data releases was more than offset by very dovish comments from MPC member Posen. He stated that there was a clear case for further asset purchases by the Bank of England and that inflation was likely to substantially undershoot the 2.0% target in the medium term. The comments revived speculation that the Bank of England could adopt further quantitative easing.

The UK currency recovered from the initial plunge following Posen’s comments and re-tested resistance near 1.59 against the dollar with Sterling demand against the Euro ahead of a scheduled EU payment. Once this payment was completed, Sterling support weakened and there was notable stop-loss Euro buying as traders pushed Sterling weaker. The UK currency fell to a four-month low near 0.8680 against the Euro and also re-tested support below 1.57 against the dollar.

Swiss franc:

There will further unease surrounding the Euro-zone financial sector which will continue to provide some support for the Swiss currency. There will also be the potential for renewed franc buying if Euro-zone ratings fears intensify. The Swiss data has held broadly firm, although with some evidence of slowing momentum over the past few weeks. The franc is likely to resist more than limited selling pressure given the net global risk profile.  

There was a decline in defensive franc demand against the Euro as European banks required reduced liquidity from the ECB. The dip in franc demand came despite a high degree of unease over the Irish banking sector. The dollar tested record lows near 0.97 against the Swiss currency before finding some support.

The franc continued to gain underlying support from speculation that several G7 countries would pursue additional quantitative easing.

The KOF business confidence index was almost static at 2.21 for September and this does suggest that momentum is slowing, although it remained historically strong. There was a slowdown in retail sales growth for September while the PMI index remained at a high level for the month.

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The Australian dollar continued to challenge resistance levels during the week and pushed to fresh 2-year highs above 0.9720 against the US dollar. There was a slightly more reserved tone over the second half of the week and it corrected slightly weaker.

The week was again dominated to a large extent by US currency vulnerability which helped underpin the local currency

The domestic data did not provide any support with a decline in house sales and building approvals, maintaining the run of weak data surrounding the construction sector. There was also a PMI manufacturing reading to below the 50 level.

Given the underlying global and domestic risk profile, it will be difficult for the Australian dollar to extend gains even with sentiment remaining firm in the near term.

Canadian dollar:

The Canadian dollar was confined to narrower ranges as the currency hit resistance stronger than 1.0250 against the US dollar while support levels beyond 1.0360 held.

The Canadian dollar tended to underperform on the crosses with a negative impact from doubts over the North American economy and unease over commodity-prices.

The domestic data offered no support with a slight GDP decline for August while Bank of Canada Governor Carney voiced concerns over the debt outlook.

The fundamentals suggest that Canadian dollar selling should be contained, but it will be difficult to advance very far given the international risk profile.

Indian rupee:

The rupee maintained a firm tone during the week and strengthened to a 18-week high beyond 45.00 against the US currency and the Indian currency gained close to 3.5% during the third quarter.

The rupee gained support from a generally weaker US currency during the week while there was optimism over capital inflows as the local bourse maintained a firm tone.
Selling pressure on the dollar was again tempered to some extent by demand from oil importers, but underlying dollar sentiment remained weak.

The rupee should be able to prove broadly resilient given longer-term capital inflows and optimism over longer-term regional economic prospects.

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The Hong Kong dollar tested highs close to 7.7550 against the US currency, but was unable to break through this level and briefly tested lows near 7.7650.

There was also general optimism over emerging-market capital inflows which helped underpin the Hong Kong dollar. The currency also gained initial support from a weaker US currency, but liquidity tended to decline late in the week ahead of the Chinese market holidays

The Hong Kong dollar should be able maintain a relatively firm tone in the short-term, especially with further speculation over further Federal Reserve quantitative easing.

Chinese yuan:

The yuan again tested resistance beyond 6.70 against the US dollar during the week, and, although momentum slowed sharply following a series of strong gains, the Chinese currency still secured the largest monthly gain since the 2005 revaluation.

Here were further tensions surrounding the yuan exchange rate with the US House of Representatives passing a bill which called for a stronger currency and also threatened and increase in tariffs.

The PMI indices remained above the 50 level and there was some evidence that further underlying yuan gains would be tolerated. Pressure for yuan gains eased late in the week as there was caution ahead of the Chinese market holidays.

There is likely to be a quieter phase of trading in the near term with a week-long Chinese market holiday. The yuan should be able to maintain a firm tone.

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