Weekly Forex Currency Review 03-09-2010

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Underlying confidence in the global economy is liable to remain weaker in the short-term which will continue to curb selling pressure on the dollar even if the currency is unable to gain strong support.  G7 policy actions will be watched very closely given further speculation that the Bank of Japan will intervene to weaken the yen. Volatility levels are liable to be elevated in the short-term as funds look to take key investment decisions for the remainder of 2010.               

Key events for the forthcoming week

Dollar:

Confidence in the US economy will remain generally fragile, but the latest releases will lessen fears to some extent over a renewed slide into recession. Overall yield support for the dollar will remain weak and underlying fears over the fundamentals will continue. Global considerations will remain important and the US currency will continue to gain some degree of defensive support when global risk appetite deteriorates. Given the underlying vulnerabilities, the dollar will find it difficult to gain strong support unless there is renewed evidence of a global credit crunch.

The dollar was unable to gain much support on fundamental ground during the week and, although there was firm buying of US Treasuries at times, defensive support generally faded as risk appetite looked to stabilise. The US ADP employment report was weaker than expected with a reported decline in private-sector jobs of 10,000 for August after a revised 37,000 increase for July. The data will reinforce expectations of a lacklustre payroll report on Friday. There was a stronger than expected The US jobless claims data recorded a small decline to 472,000 in the latest week from a revised 478,000 previously which helped ease fears.

The ISM manufacturing report also strengthened to 56.3 from 55.5 the previous month even though the regional components had suggested a deterioration in conditions was likely. The manufacturing report proved decisive for market sentiment and there was an important improvement in risk appetite. As US Treasury prices fell sharply and defensive dollar demand faded, the Euro rallied to above the 1.28 level for the first time in two weeks.

Elsewhere, consumer confidence rose to 53.5 for August from a revised 51.0 the previous month with the index still at depressed levels historically as labour-market fears persisted. The Chicago PMI index fell to 56.7 from 62.3 the previous month.

The Fed minutes from August’s meeting recorded that some members were uneasy over the changes to the asset-purchases scheme and there is certainly the risk of greater divisions within the Fed over the next few months

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There is evidence that sentiment towards the Euro-zone has stabilised and there will be relief that demand for bonds has been relatively firm. There will still be unease over the structural vulnerabilities and persistent recession conditions in the weaker countries will maintain important underlying political and economic strains. In this environment, only a limited deterioration in sentiment could trigger heavy selling pressure on the Euro.

The currency will also be much more vulnerable if there is an underlying deterioration in global risk conditions.
The Euro was vulnerable at times during the week, but did manage to resist heavy selling pressure as underlying fears were contained. There was also a lack of focus with many European participants on holiday.

There were no surprises from the ECB with interest rates left on hold at 1.0% following the latest council meeting. The central bank also announced extra liquidity auctions in line with previous signals and emphasised that these were not policy signals. President Trichet was slightly more optimistic over the growth outlook and also warned that inflation could be higher and the slightly more optimistic tone provided some underlying Euro support.

The Euro also gained support from successful bond auctions in Spain and France, together with an improvement in risk appetite. In this environment, the Euro was able to find support below 1.2650 against the dollar, rallying to a high near 1.2850, and had a slightly firmer tone on the crosses.

Yen:   

The yen will continue to gain important protection from a lack of confidence in the global economy and especially from a fundamental lack of confidence in the other major economies. The Japanese economy also remains in difficulties which will limit demand for the yen, especially given the very important underlying vulnerabilities. Official yen policies will remain a key focus and there is likely to be intervention if the yen advances strongly from current levels. It will be much more difficult for the authorities to adopt a cohesive longer-term strategy, especially if G7 support for intervention is not forthcoming.

The yen spiked weaker early on Monday following an announcement of an extraordinary Bank of Japan policy meeting with a dollar high near 85.80.
 
The central bank held interest rates at 0.10% following the emergency meeting. The bank did provide additional liquidity within its money-market operations, but the yen still gained ground following the announcement with disappointment that no radical action was announced.

Finance Minister Noda did comment on Tuesday that he was ready to take bold action if necessary, but markets, at this stage, wanted to see action rather than rhetoric and the yen maintained a generally firm tone with the dollar retreating back to near 84.

The Japanese data was mixed with a higher than expected industrial production increase offset by a weaker PMI reading and confidence in growth prospects remained weak. The spending data was better than expected for the second quarter which provided some yen support, although the impact was limited.

The latest Chinese PMI data, together with stronger than expected Australian data had a positive impact on risk conditions which lessened upward pressure on the yen.

Potential Prime Minister candidate Ozawa stated that intervention to stem yen gains was a possibility, but markets will be watching the actions of current senior officials much more closely to assess near-term policy actions.

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The latest reports on consumer spending levels have been generally favourable, but underlying unease over the economy is likely to increase after weak survey evidence. There will be expectations of further weakness in the housing sector which will also pose an important threat to consumer spending. The outlook will be much worse if there is evidence of a renewed deterioration in credit conditions. Sterling will continue to gain some degree of protection from a lack of confidence in the US and Euro-zone, particularly if the economy can sustain growth while the budget deficit is cut. Nevertheless, the net risks suggest that Sterling will be vulnerable.
 
Sterling was generally fragile during the week with losses against the dollar and Euro as markets questioned the medium-term outlook for Sterling. There were lows near 1.53 against the dollar and 0.8350 against the Euro.
The UK manufacturing PMI index weakened to 54.3 for August from a revised 56.9 the previous month and this was a nine-month low for the index.

There were particular concerns over the manufacturing data, especially as the industrial sector had been providing important support over the past few months.

The PMI construction report was weaker than expected with a decline to 52.1 for August from 54.1. The housing data has remained weak and Sterling will be particularly vulnerable if there is any evidence of a renewed credit crunch. The services-sector report also weakened in the latest month.

The UK currency gained some degree of support from an improvement in risk appetite while a generally weaker dollar also helped provide protection.

Swiss franc:

The franc will continue to gain support when confidence in the global economy deteriorates and trends in risk appetite will remain very important for currency trends. Underlying fears over a renewed deterioration in the global economy are likely to sustain a firm franc tone in the near term. Volatility is likely to remain an important near-term feature given that there will be pressure for the National Bank to curb the rate of appreciation even if sustained intervention is ruled out as a policy option. Longer-term expectations that the currency is overvalued will tend to limit the scope for buying support.

The Swiss franc advanced strongly at times with defensive demand for the currency enhanced by speculative buying as markets looked to maintain momentum for a stronger Swiss currency. The dollar weakened to 2010 lows near 1.01 while the Euro fell to fresh record lows.

The franc was unable to sustain its best levels, especially against the Euro. There was an underlying easing of risk aversion and the Euro-zone bond auctions also curtailed defensive franc support to some extent.

There is evidence of aggressive speculative plays in the franc and this is liable to trigger further substantial volatility in the near term.

Domestically, there was a solid reading for the UBS consumption index which boosted confidence in the economy and lessened immediate fears over a return of deflationary pressures which would also lessen the case for currency intervention.

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The Australian dollar proved resilient during the week and advanced to a high just above 0.91 against the US dollar.

The forward - looking data remained disappointing as the PMI services-sector index remained below the pivotal 50 level. The manufacturing index also fell to 51.7 from 54.4, but GDP data was stronger than expected with a 1.2% second-quarter advance.

There was still no announcement of  a new government as both main parties looked to secure the backing of key independents

Given the underlying global and domestic risk profile, the Australian dollar is liable to have a generally negative bias in the short-term even if losses are measured.

Canadian dollar:

The Canadian dollar continued to find support weaker than 1.0650 against the US currency during the week.  Trends in risk appetite and commodity prices tended to remain the dominant influence with the Canadian currency losing ground when there was a spike lower in oil prices.

The domestic data did not have a significant impact with the latest GDP release in line with market expectations.

The Canadian dollar will tend to remain on the defensive due to doubts over the domestic and international growth outlook. The net risks suggest that selling pressure should be contained unless there is a huge spike in risk aversion.

Indian rupee:

The rupee continued to find support near 47 against the US dollar, but also found it difficult to make much headway as underlying risk aversion remained higher.

The GDP data slightly exceeded expectations which boosted confidence, butt here was some unease that the July trade deficit rose to the highest level for 2 years which could indicate that competitiveness will be a medium-term issue.

The local stock market also found it difficult to make much headway, but there was confidence in longer-term capital flows.

The rupee will find it difficult to make much headway given global risk conditions, but should be able to prove broadly resilient given longer-term capital inflows. 

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The Hong Kong dollar was unsettled at times by rising risk aversion and falling equity markets and had a weaker tone overall consolidating just weaker than 7.79 against the US dollar. The impact and market moves were contained and risk conditions looked to stabilise over the second half of the week.

There was a further easing of US Libor rates which lessened the potential for any liquidity squeeze and upward pressure on the US currency. Speculative flows remained limited during the Chinese summer period.

The Hong Kong dollar should be able to resist substantial losses even if risk appetite deteriorates, especially with the US Fed maintaining a highly-expansionary policy.

Chinese yuan:

The yuan continued to drift slightly weaker against the US dollar , although the central bank maintained generally tight control of the currency. There was speculation that any yuan move weaker than the pre-float level beyond 6.825 against the dollar would be resisted.

The economic data provided some degree of relief with the PMI manufacturing-sector indices both above the pivotal 50 level for August even though there was some concern over the orders component.

The central bank is likely to maintain generally tight control over currency moves in the short-term, especially as uncertainty over the Chinese and global economic outlook will remain a notable feature.

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