Weekly Forex Currency Review 05-11-2010

Following the central bank interest rate decisions this week, there will be continuing expectations that the US will be happy to see a weaker US dollar as it strives to boost the US economy. This policy stance is liable to trigger fresh tensions between G20 members as other countries look to resist importing deflationary pressures from the US.  Such friction is liable to trigger renewed currency volatility.              

Key events for the forthcoming week

Dollar:

The Federal Reserve move to expand the quantitative easing programme will reinforce a lack of yield support for the US currency and will also maintain expectations that the dollar’s value will be very much of secondary importance for the central bank. In this environment, the US dollar will be vulnerable to selling pressure, especially with increased speculation that the currency will be used to fund carry trades. Funds may have difficulties in finding attractive alternatives to the dollar which may provide some protection. There will also be major doubts surrounding the Euro-zone economy which will also provide some degree of support, but firm buying looks unlikely.  

The dollar found relief at times, but was generally under pressure as monetary policy action dominated the markets and it weakened to 10-month lows on a trade-weighted basis with sharp losses against European currencies.
The data on US consumer spending was generally weaker than expected with spending rising 0.2% for September as personal income contracted.  Jobless claims rose to 457,000 in the latest week from 437,000 previously, although the underlying measures were more resilient.

In contrast, the ISM index for the manufacturing sector was significantly stronger than expected with a rise to 56.9 for October from 54.4 the previous month. There was a strong rebound for the orders component, fuelled in part by buoyant export demand, while the employment index was also firm.

The ADP report estimated a 43,000 increase in private-sector employment for October after a revised 2,000 decline the previous month while the ISM index for the services sector rose to 54.3 from 53.2 previously. The economic data as a whole was over-shadowed by the Federal Reserve meeting.

In its statement, the FOMC remained concerned over the weak pace of growth with business investment slowing over the past few months. The Fed announced that it would buy an additional US$600bn in long-dated US Treasury bonds in the period until the end of June 2011 with planed purchases of US$100bn per month. Hoenig dissented against the majority as he has consistently over the past 12 months.

The Fed’s determination to press ahead with further quantitative easing had a negative impact on the dollar and it weakened to 2010 lows beyond 1.4250 against the Euro.

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The Euro-zone growth data has remained relatively firm as a whole, but there is still a high degree of divergence as the weaker economies are unable to escape from recessionary conditions. There have been persistent stresses within the bond markets and any further widening of yield spreads would make it even more difficult to curb budget deficits. In this environment, the ECB will find it difficult to move towards any policy tightening and there will also be the risk that investor confidence will deteriorate sharply which would trigger renewed selling pressure on the Euro.

The Euro secured strong gains against the dollar during the week, but the performance elsewhere was more mixed.

The Euro-zone developments tended to be overshadowed to some extent by the Fed developments, but were still potentially important for market confidence and the currency markets. There was a further widening of yield spreads with Irish bonds falling sharply. Markets have been unsettled by a renewed German push demanding that bondholders would take some of the burden of any future bailouts.

There were no surprises from the ECB as it left interest rates on hold at 1.0%. President Trichet also took a generally hard-line tone with comments that non-standard measures were by nature temporary, reinforcing market speculation that the ECB is looking to make an exit from special measures.

There was still unease over the Euro-zone structural vulnerabilities, especially with yield spreads continuing to widen while Irish budget-policy tensions also increased. There is still the risk that internal stresses will prevent the ECB from tightening policy and confidence in the Euro could deteriorate rapidly.

Yen:   

Given persistent fears over deflation, the Bank of Japan will maintain an expansionary monetary policy in an effort to support domestic demand and there will also be opposition to further yen gains. Capital outflows from Japan are still likely to be subdued, especially with the Fed’s quantitative easing expansion and any regional currency gains would also tend to support the yen as competitiveness would be less of an issue. The yen looks unlikely to weaken very far even with the possibility of further intervention to block record highs.

After a price spike in Asian trading on Monday which pushed the US currency to a high near 81.50, the dollar lost all its gains and re-tested support levels near 80.20 with reduced speculation that there had been any intervention by the Bank of Japan.

Bank of Japan minutes from the October meeting recorded that members were concerned over the risk of a downturn in longer-term inflation trends which will maintain pressure for a very loose monetary policy.

Finance Minister Noda stated that the Ministry was ready to take decisive action if necessary but, again, there was no evidence of actual intervention in the market.

The Bank of Japan left interest rates on hold at 0.00 - 0.10% following the latest council meeting. The bank did expand its asset-buying operations, but there was some disappointment in the overall stance.

The dollar did find support below 80.50, but found it difficult to make much headway.

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Expectations of further Bank of England quantitative easing will remain lower in the short-term following the batch of generally favourable economic data which will provide Sterling support. There will still be a high degree of unease over the economy with particular fears surrounding the housing sector as fiscal tightening takes effect. Sterling is unlikely to be a strong currency in absolute terms, but will continue to gain important protection from a lack of confidence in the dollar and Euro-zone doubts. In this context, losses should be measured even if sentiment deteriorates.

Sterling proved resilient against the Euro during the week and also pushed to 10-month highs near 1.63 against the dollar as the US currency remained firmly on the defensive.

The UK PMI index for manufacturing was stronger than expected with a gain to 54.9 from 53.4, the first monthly advance since May. The other data was mixed as the construction PMI index was weaker than expected with a decline to an eight-month low of 51.6 from 53.8 while the services-sector report showed an improvement.  

The report still suggested that the services sector is finding it difficult to gain any momentum as it is hampered by weak spending and investment levels.

As expected, the Bank of England left interest rates on hold at 0.50% following the latest MPC meeting and also held the asset-purchases target at GBP200bn. Expectations of any easing had faded considerably following the recent stronger than expected data, but Sterling still gained some initial support from the decision.

There was a contrast between the UK stance and Fed decision to expand quantitative easing which boosted Sterling. The UK currency also gained protection from fears over the Euro-zone structural vulnerabilities.

Swiss franc:

There will be some concerns that the Swiss economy is slowing more sharply than expected which will dampen sentiment. International trends are still liable to dominate in the short-term with the franc continuing to gain defensive support. Fears over structural vulnerability in the Euro-zone and an indirect policy of currency debasement will continue to provide important franc protection and limit the potential for selling pressure.

The dollar was unable to break back above parity against the franc and was then subjected to renewed selling pressure with a dip to below 0.96.

The Swiss PMI index was slightly weaker than expected with a 59.2 reading for October from 59.7 the previous month which will maintain speculation over an economic slowdown, although the data is still strong in historic terms and retail sales rose over the year.

The franc lost support on yield grounds and there were further suspicions that the National Bank was quietly engineering a weaker currency

Council member Danthine stated that the bank would be ready to act to counter currency strength if there was a return of deflation risks in the economy, but the comments did not have much of a negative impact on the franc.

The Swiss currency gained renewed support later in the week from stresses within the Euro-zone bond markets with the Euro and dollar losing ground.

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The Australian dollar consolidated in the early part of the week and then appreciated strongly to record highs against the US dollar with a peak near 1.02

The Reserve Bank surprised markets with a further 0.25% increase in interest rates to 4.75% which boosted the Australian dollar’s yield appeal and triggered renewed buying for the currency. There was further support from the Federal Reserve quantitative easing, especially as commodity prices also advanced.

The domestic data was mixed as there was  a slightly firmer net trend in the latest PMI surveys, but there was also a sharp decline in building approvals. The domestic data was mixed with a rise in the services-sector PMI index to above the 50.0 threshold offset by a sharp decline in building permits of 6.6%.

The Australian dollar will look to gain further support from a lack of US confidence and high commodity prices, but will be increasingly prone to sharp corrections.

Canadian dollar:

The Canadian dollar resisted any sustained selling pressure during the week and advanced to highs near parity against the US unit. The currency drew important support from the general weakness in the US currency while firm risk appetite and a flow of funds into commodity-related instruments also boosted the Canadian dollar.

The government rejection of a BHP bid for Canadian Potash did weaken the currency sharply, but the impact was more than offset by international trends.

The fundamentals suggest that the Canadian dollar should remain firm in the near term, although it will remain difficult to sustain advances beyond parity.

Indian rupee:

The rupee secured a renewed advance against the dollar during the week and appreciated to a two-week high around 44.20. The currency was boosted primarily by a generally weak US currency.

Domestically, the Reserve Bank of India increased interest rates for the sixth time this year, but also signalled that there would be no further increases in the short-term.

Underlying capital account trends were firm, but the currency was still hampered by substantial outflows from refunds associated with the recent IPO offerings.

The rupee should remain broadly firm given, although it will be difficult to advance far in the very short-term given adverse capital-account trends. 

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The Hong Kong dollar secured a firmer tone over the week and it broke through resistance in the 7.7550 area which triggered a further advance to near the band limit of 7.75 which would require HKMA intervention.

There was further speculation over capital inflows into Hong Kong on expectations of a medium-term revaluation and the US currency remained under pressure generally.

The Hong Kong dollar should maintain a robust tone in the short-term, especially with further speculation over a medium-term breaking of the peg.

Chinese yuan:

The yuan found support on dips towards the 6.70 level against the US dollar and resumed appreciation during the week with an advance to the 6.66 area.

The US dollar remained under pressure generally and this was an important factor in allowing yuan gains, although the central bank also acted to slow the advance.

The domestic data was generally encouraging with gains for the October PMI indices and this will tend to make the authorities more comfortable with a stronger currency.
There was further international political pressure for a stronger yuan, although the tone was more moderate.

There will be strong expectations of further yuan appreciation in the medium term due to underlying capital inflows and international pressure. The central bank looks content to allow gradual appreciation.

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