Weekly Forex Currency Review 04-06-2010

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Sovereign debt fears will remain a very important short-term focus with particular fears surrounding the weaker Euro-zone members. There will also be doubts over the global economy and this could be particularly dangerous for risk appetite if there are renewed stresses within the banking sector. In this environment, the Euro will remain vulnerable to selling pressure even though the rate of decline is likely to slow.           

Key events for the forthcoming week

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Underlying confidence in the Euro-zone economy and Euro will remain very fragile with fears of medium-term debt defaults by weaker member countries. There will also be some further speculation that countries such as Greece will be forced to leave the Euro area.  The negative Euro impact will be even greater if tensions intensify in countries such as Spain and Portugal. The Euro is not under-valued at current levels and G7 members will primarily be concerned over the need to maintain orderly markets. Given the high number of speculative positions, there will be some scope for a short-term corrective Euro recovery.

The Euro was subjected to heavy selling pressure during the European session on Tuesday with fears over the debt situation and increased speculation that there would be a renewed downturn in the European economy and a double-dip recession.

Underlying confidence in the ECB had also deteriorated and this was another contributory factor for Euro weakness. The currency weakened sharply to test 2010 lows near 1.2150 and there was a temporary retreat to below this level for fresh four-year lows. As risk appetite improved, there was a recovery in the Euro and a squeeze on short positions pushed the currency to a high around 1.2350.

On the economic front, there was also a decline in Euro-retail sales which maintained market fears over a renewed downturn in the region’s economy. The unemployment rate rose to a 10-year high of 10.1%.

Spanish Savings banks were put on a negative ratings watch by Standard & Poor’s which reinforced unease over the European financial sector. There were further stresses within the European bond markets with the spread on Spanish bond markets rising to a record high since the Euro’s launch in 1999. 

Government officials denying that the French AAA credit rating could come under threat. There were also denials that global central banks were looking to diversify away from the Euro. There were still expectations that the ECB would increase liquidity as money-market stresses continued and confidence remained weaker. There was further selling pressure on significant Euro gains.

Yen:  

The domestic political situation will continue to be watched closely and there will be negative implications for the yen, although the impact is likely to be limited. Underlying confidence in the Japanese fundamentals will also remain generally fragile. Trends in risk appetite will remain important and the Japanese currency will gain some support if there is a sustained deterioration in confidence surrounding the global economy. In particular, increased strains within the European banking sector would trigger important yen support with the potential for capital repatriation. The yen will still find it difficult to sustain gains.

The Japanese currency gained support at times when global risk appetite deteriorated, but was unable to break dollar support below 90.50 and then came under pressure.

Confidence in the global economy undermined by weaker than expected Chinese PMI reports while there was further unease over the European economic and financial outlook which pushed the Euro to 9-year lows below 110 against the yen.

The domestic political situation continued to have some negative impact on the yen with the resignation of Prime Minster Hatoyama sparking a further round of uncertainty and doubts over medium-term economic policies. Finance Minister Kan was nominated to become the new Prime Minister which reinforced speculation that the administration would favour a weaker Japanese currency.

In this environment, the dollar strengthened to a high above 92.80 against the yen while the Euro found support below 110.

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There will be a high degree of doubts over medium-term UK growth trends and there will also be uncertainty over the monetary-policy outlook. There will be pressure for the Bank of England to maintain very low interest rates which could compromise inflation control. Confidence will also remain very fragile given the debt profile and vulnerability will increase when there is a deterioration in global risk appetite, especially if there are renewed stresses within the UK banking sector. Overall, Sterling is liable to weaken against the dollar, while Euro-zone vulnerability will offer protection against the Euro. 

Sterling maintained a firm tone against the Euro during the week as underlying confidence in the Euro-zone remained weak and it strengthened to an 18-month high near 0.83. Sterling found support near 1.4450 against the dollar while there was resistance above the 1.4750 level.

The UK PMI index for the manufacturing sector held steady at 58.0 for May, contrary to expectations of a measured decline in the index and this helped underpin sentiment to some extent, especially with the construction PMI also robust.

There were strong rumours during Tuesday that the Prudential deal to buy AIG’s Asian operations would collapse and this pushed Sterling higher on expectations of reduced capital outflows. Subsequently, there was confirmation that the deal would be abandoned which continued to provide some net support.

The PMI index for services was little changed at 55.4 for May, but the new business component was at a nine-month low. Following the weakness in consumer credit reported on Wednesday, there was further unease over the risks of a renewed downturn during the second half of 2010.

Bank of England Governor King was confident that inflation would remain contained and he was also still very cautious over the economic outlook

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 will face pressures to stem franc gains to protect competitiveness, but there will also be pressure on the bank to curb intervention levels. The Swiss currency could be vulnerable to some selling pressure if there are renewed fears over the domestic banking sector, especially after a critical report from the government over regulation within the financial sector.

The dollar strengthened to a fresh 13-month high above 1.17 against the Swiss franc during the week before weakening back to below the 1.15 area. The Euro remained under pressure against the Swiss currency due to fears over the Euro-zone economy and weakened to lows near 1.4050. There was no clear evidence of National Bank intervention, but a strong suspicion that the bank was selling the Swiss currency.

Domestically, there was a 1.3% increase in retail sales in the year to April from a revised 4%. The impact was limited, especially as markets have been focussed on the industrial outlook and the potential impact of franc gains against the Euro.

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The Australian dollar secured a firmer tone, but there was selling pressure above the 0.85 level against the US dollar as underlying confidence remained fragile.

The Reserve Bank left interest rates on hold at 4.50% at the latest policy meeting which was in line with market expectations. There was a firmer than expected retail sales report, but there was a sharp decline in building approvals. The GDP data was slightly weaker than expected at 0.5% for the first quarter, but the previous figure was revised higher.

The PMI index for the services sector weakened to 47.5 for May from 52.3 previously and this was the fourth month in 2010 with a figure below the 50.0 benchmark level. The data overall tended to cast important doubts over the domestic economy and the prospect for higher interest rates.

The Australian dollar moves will be influenced strongly by trends in risk appetite. Volatility is liable to remain higher and the currency will find it difficult to make much headway given domestic and international doubts.

Canadian dollar:

The Canadian dollar found support close to the 1.06 area against the US dollar and strengthened to highs beyond 1.04. Trends in risk appetite remained important with the currency gaining support when stock markets and commodity prices rallied,

The Bank of Canada increased interest rates to 0.50% from 0.25% which was in line with market expectations. The bank was more cautious over the economic outlook and there were reduced expectations of further aggressive interest rate increases.

Volatility levels are liable to remain higher in the short-term and the Canadian dollar will find it difficult to advance much further given the global risks.

Indian rupee:

Global market activity continued to dominate rupee moves as volatility remained at very high levels. During the week, the rupee suffered its sharpest one-day decline for 18 months as the Euro weakened and there was fresh downward pressure on global stock markets with renewed fears over sovereign credit ratings.

There was evidence of buying support on dips with investors still broadly optimistic over the longer-term outlook and it consolidated near 47 against the dollar.

Despite losses when international risk appetite deteriorates, the rupee should be able to avoid heavy losses given underlying confidence in the fundamental outlook. 

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There was a decline in Hong Kong dollar volatility during the week with the local currency resisting a renewed decline through the 7.80 level against the US dollar.

Global equity markets attempted to stabilise during the week after a bout of losses and dollar Libor rates also stabilised, but confidence was still fragile.  

Volatility levels are liable to remain higher in the short-term and the Hong Kong dollar will find it difficult to secure strong near-term gains.

Chinese yuan:

The spot yuan rate drifted close to 6.83 against the US currency while the yuan also retreated slightly from recent highs against the Euro.

The latest Chinese PMI data was weaker than expected with a significant monthly decline and this maintained unease over underlying growth trends.

There was great reluctance to discuss exchange rate policies by key Chinese officials and policy uncertainty was a key feature, but there was further international pressure for a stronger yuan. The Chinese authorities denied that they would look to diversify away from Euro-zone bonds.

Fears over further near-term global market volatility, doubts over the economic outlook and recent gains against the Euro will discourage the Chinese authorities from sanctioning greater yuan flexibility in the near term.