Weekly Forex Currency Review 02-07-2010

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The global economic trends and stresses within the financial sector will continue to have an important short-term impact. There are likely to be persistent fears over a tightening of credit conditions, which will provide some degree of dollar support, but the US currency has failed to benefit over the past few days. There has certainly been an important loss of support on yield grounds as US growth fears have increased and all major currencies have important vulnerabilities.                  

Key events for the forthcoming week

Dollar:

The US economic data will reinforce fears that the economy will decelerate significantly during the second half of 2010, especially as there will be reduced fiscal support. There will be further speculation that the Federal Reserve will resist higher interest rates and will also decide to implement further buying of bonds to underpin the economy.  These factors will tend to erode dollar support, especially given the decline in bond yields. There is still the potential for defensive US currency support, especially if global banking-sector liquidity tightens further. The dollar should, therefore, be able to resist heavy losses.

The dollar gained support over the first half of the week from defensive demand as risk appetite faltered. The US currency was unable to take full advantage and then came under renewed selling pressure with particular losses within Europe.

The US economic data was weaker than expected with jobless claims rising to 472,000 from a revised 459,000 the previous week. The ISM index for the manufacturing sector declined to 56.2 from 59.7 the previous month. There was a sharp decline in the prices component while the employment index held comfortably above the 50 level.

There was also a sharp 30% decline in pending home sales for May with sales weakened by the ending of tax credits. The ADP employment data was weaker than expected with private-sector payroll growth at 13,000 for June compared with expectations of a figure near 60,000.

The US consumer confidence data was significantly weaker than expected with a decline to 52.9 for June from a revised 62.7 previously as the expectations component weakened sharply while optimism surrounding the jobs market also faded.

The data overall maintained expectations over a slowdown in the economy during the second half of 2010. There will also be additional speculation that the Federal Reserve will need to take additional measures to support the economy.

Fed officials were also generally downbeat on employment prospects in comments during the week and this maintained expectations of low interest rates which will curb dollar yield support. There was speculation that additional bond buying may be required within the next few months.

In contrast to recent sessions, the dollar failed to gain any significant support when risk appetite deteriorated on Thursday. Demand for the currency was sapped by falling yield support and unease over the economy.

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Underlying confidence in the Euro-zone economy will remain very fragile with further speculation over a renewed downturn for the region as a whole as fiscal policy is tightened. There will also be expectations that recession will persist in the weaker economies. The ECB will remain under pressure to maintain a loose monetary policy and there will be demands for additional quantitative easing. Speculative Euro selling may ease given the weight of recent sales, but any further stresses in the banking sector would put further sustained downward pressure on the Euro and a strong rebound looks unlikely.

The Euro was subjected to renewed selling pressure over the first half of the week as structural fears persisted. There were fears over the banking sector as it faced debt roll-overs while there was unease over further credit-rating downgrades.

There was a three-month auction for funds on Wednesday and demand for funds from the ECB was lower than expected at EUR130bn compared with some fears that there could have been demand close to EUR200bn. There was further relief surrounding the European tender results during Thursday which also eased fears surrounding the Euro-zone financial sector and also helped underpin the Euro.

There was evidence of position adjustment and stop-loss Euro buying which propelled the currency sharply higher to a peak above 1.25 during Thursday with the currency also securing a correction on the major crosses.

Yen:   

The yen will continue to gain support when risk appetite deteriorates, especially as there are likely to be increased doubts over the global economy which will limit interest in carry trades. Speculation over further global central bank bond buying will also reinforce unease over US and Euro-zone fundamentals and underpin the Japanese currency. The Finance Ministry will remain uneasy over the implications of sustained yen gains and there is a strong probability of at least verbal intervention which will limit the potential for sustained yen gains.

The yen secured solid support during the week as deteriorating global risk appetite and falling stock markets triggered fresh demand for the Japanese currency.

China’s PMI data recorded a significant slowdown for June with the HSBC measure dipping to near the 50 level and this provided some further yen protection on renewed fears over fresh deterioration in the global economy. There were greater reservations over carry trades which curbed any yen selling pressure.

Domestically, the headline Tankan business confidence index strengthened to +1 for the quarter from -14 previously and this was the strongest figure for 2 years. The data provided some degree of yen support even though there were still reservations over the capital spending outlook.

A small monthly decline in industrial production and unemployment rise to 5.2% limited yen support to some extent as confidence remained fragile.

The dollar remained under pressure during the US session on Thursday as weaker than expected US data further undermined yield support. The US currency dipped to fresh 8-week lows just below 87 against the yen before finding some degree of support. The Euro recovered from near 10-year lows against the yen.

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Following the UK budget tightening markets remain more optimistic over the UK ability to maintain its AAA credit rating and this will provide Sterling support. There will be uncertainty over growth trends with mixed signals likely to continue in the short-term. Similarly, interest-rate expectations are also liable to fluctuate frequently over the next few weeks which will contribute to Sterling volatility. Sterling will tend to remain more vulnerable when risk appetite deteriorates and the Bank of England will find it difficult to sanction any significant tightening which will limit Sterling support.  

Sterling found it difficult to sustain a trend during the week as it was buffeted by cross-rate pressures and international developments. Sterling dipped to lows below 1.49 against the dollar before recovering back to a high above 1.5150. In contrast, Sterling retreated from a 19-month high beyond 0.81 against the Euro.

Domestically, the PMI index for the manufacturing sector edged lower to 57.5 for June from 58 the previous month which will maintain expectations over a slowdown, but there was some relief that the series has held relatively firm

Bank of England MPC member Miles stated that the time was not yet right for higher interest rates, maintaining the slightly more dovish tone seen over the past few days. Posen highlighted the risks of inflation and a renewed downturn in the economy while Sentence maintained his preference for higher rates

Expectations surrounding interest rates are liable to fluctuate considerably during the next few weeks and this is also liable to maintain Sterling volatility.

Swiss franc:

The franc will continue to gain defensive support from a general lack of confidence in the Euro and Euro-zone economy. The National Bank policies will remain under very close scrutiny in the short -erm and there have been further suggestions that the bank will not intervene in the short-term, especially as fears over deflation have eased very substantially. The bank is still likely to be uneasy over the implications of rapid franc gains, especially if the dollar comes under renewed selling pressure and renewed intervention remain an important threat. Franc volatility is likely to remain a key feature.

The Swiss franc maintained a very strong tone on the crosses and strengthened to fresh record highs beyond 1.32 against the Euro before a partial correction. The franc also strengthened to a 10-week high against the dollar as the US currency retreated to lows below the 1.06 level.

The KOF business confidence index edged higher to 2.25 in the latest month from 2.16 the previous month which maintained underlying confidence surrounding the Swiss economy. The robust reading will also lessen pressure on the National Bank to intervene and restrain the franc. The latest PMI reading also remained firm at 65.7 for June which maintained confidence in the manufacturing sector.

The National Bank continued to downplay the deflation risks and also suggested that it would raise interest rates if there was any sign of inflationary pressure.  Member Danthine, for example, repeated comments that the deflation threat had disappeared.

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The Australian dollar was subjected to high volatility over the week and there were substantial net loses as domestic and international confidence faltered.

There was further selling pressure following weaker than expected Chinese PMI data. Domestically, there was also a decline in building approvals which undermined sentiment while the retail sales data was subdued and there was still an Australian dollar low around 0.8315 against the US currency.

A mining-sector tax deal provided some relief and the Australian dollar was able to rally back towards the 0.85 area.

The Australian dollar moves will continue to be influenced strongly by trends in risk appetite and degrees of optimism over the world economy. Volatility is liable to remain higher and the currency is liable to remain generally on the defensive.

Canadian dollar:

The Canadian dollar was subjected to heavy selling pressure in the middle of the week with lows near 1.07 against the US dollar as commodity prices fell and risk appetite deteriorated with equity markets under heavy selling pressure.

There was still some underlying support from confidence in the domestic fundamentals which helped limit selling pressure, but the Canadian currency under-performed European currencies as commodity prices remained weaker.

Volatility levels are liable to remain higher in the short-term and although the Canadian dollar should be resilient, it will be difficult to make much headway.

Indian rupee:

The rupee was generally on the defensive over the week and retreated to a three-week low near 46.75 against the US dollar. The Indian currency failed to gain support from a further Chinese yuan advance, but did find some reprieve late in the week as the US dollar faltered.

Stock markets remained under pressure during the week which undermined the rupee and the currency retreated 3.3% for the second quarter as a whole.

There was a weaker than expected reading for the latest Indian PMI index which reinforced doubts over durability of a regional rebound.

Despite losses when international risk appetite deteriorates, the rupee should be able to prove broadly resilient given longer-term confidence in the fundamentals.

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The Hong Kong dollar was unable to gain any renewed support during the week and declined steadily. The local currency weakened to lows near 7.7940 late in the week as risk appetite continued to deteriorate with sharp losses in regional bourses.

The local bourse and Hong Kong dollar were unable to gain any sustained relief as doubts over growth trends remained a key focus.

The Hong Kong dollar trends will be influenced by developments in risk appetite and the Chinese yuan and an improvement in risk appetite will be needed to secure more than limited gains.

Chinese yuan:

The Chinese yuan continued to appreciate during the week and pushed to highs around 6.78 against the US dollar, the strongest figure since the 2005 revaluation.

The domestic economic data was weaker than expected with the PMI indices weakening to near-2010 lows, but yuan sentiment remained strong on expectations that the central bank would tolerate further gains over the next few weeks.

There was some easing of international tensions as G20 officials were focussed more on renewed stresses within financial markets.

There will be greater daily fluctuations for the Chinese yuan, but the central bank is still likely to resist substantial near-term appreciation, especially as domestic and global growth doubts will create caution within the Chinese authorities.

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