Weekly Forex Currency Review 08-05-2009

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The net evidence suggest that markets will continue to take a more positive approach to risk in the short-term, especially as the broad run of data releases across the main economies has continued to suggest that conditions are stabilising.  Nevertheless, it will be difficult to push the mood of optimism much further in the near term given the vulnerabilities in the consumer and credit sectors.      

Key events for the forthcoming week

Dollar:

The latest data has continued to support expectations that the economy is stabilising with business confidence improving while there has also been a tentative improvement in labour-market conditions.  Immediate fears surrounding the banking sector have also eased with no shocks from the bank tests. In the near term, defensive dollar demand is liable to ease, but the potentially negative impact on the US currency could be offset by the impact of higher bond yields. It may remain difficult to secure a decisive direction in the short-term with the dollar struggling to make much headway.  

The dollar maintained a generally weaker tone during the week as defensive demand for the currency eased. There was a further narrowing of credit spreads during the week which boosted confidence and international risk appetite was also robust. The dollar was particularly vulnerable against the commodity currencies.

Following a firmer manufacturing report last week, the US ISM index for the non-manufacturing index strengthened to 43.7 in April from 40.8 previously.  This was a six-month high for the index and again above market expectations.  The orders component strengthened with a limited recovery in the employment sub-index.

The US ADP employment report was also stronger than expected with job losses of 491,000 for April following a revised 708,000 decline previously. Although still severe in historic terms, it maintained optimism that the economy is stabilising.

Pending home sales rising 2.1% for March compared with expectations of no change. There was also a reported increase in construction spending for the month compared with expectations of a further monthly decline.

Jobless claims were slightly stronger than expected with a decline to 601,000 in the latest week from 635,000 the previous week. Continuing claims were also slightly lower than expected, although they were still at a fresh record high. The employment data during the week increased optimism that the economy is starting to stabilise and there were hopes that the Friday payroll data would be stronger than expected.

Fed Chairman Bernanke repeated his recent cautiously optimistic comments with remarks that the economy is on track for recovery. He still warned that weakness would persist for some time while interest rates would remain at very low levels for an extended period.

Bernanke was also cautious over the banking sector and the stress-test results remained an important focus. The test results suggested that the main banks would need to raise additional capital of over US$70bn, but the market impact was limited as results had been leaked in advance.

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The ECB decision to lower interest rates and provide additional non-standard market support will have a mixed Euro impact. The reluctance to sanction a move to full quantitative easing could underpin medium-term inflation credentials, but confidence in the policy will be weak if the economy fails to improve. For now, sentiment should remain firmer with the Euro also gaining support from the underlying improvement in risk appetite.  The ECB will have reservations over allowing substantial Euro gains.
          
The Euro was mixed over the week as a whole and struggled to find a decisive direction as it reversed inter-week on the major crosses.

In contrast to recent sessions, much of the Euro-zone data was actually weaker than expected with German retail sales falling by 1.0% for March for a 1.5% annual decline. In addition, the Sentix business confidence index only improved marginally to -34.3 in May from -35.3 the previous month. The German industrial orders data was stronger than expected with a monthly 3.3% increase which helped underpin sentiment, although there was still a 26.9% annual decline.

At the latest council meeting, the ECB cut interest rates to 1.00% from 1.25%. This was in line with market expectations and represented a record low for the ECB benchmark rate. The Euro initially rallied following the announcement as there was no immediate announcement over quantitative easing.

At the press conference, the ECB announced that in principal it would buy Euro-denominated covered bonds with purchases of EUR60bn. It will also continue with its enhanced credit-support approach for the remainder of the year. The ECB stated that these were measures to enhance market liquidity and were not quantitative easing.

The ECB measures drew a mixed response as there was some optimism that the bank was taking decisive action to support the economy, while the limited measures also helped maintain medium-term confidence in the currency. The Euro recovered from initial losses against all the major currencies.

Yen:  

The yen will continue to lose support if there is a sustained improvement in risk appetite, especially as there will tend to be increased capital outflows into higher-yield and higher-risk assets. The yen has still been able to resist aggressive selling and any further evidence of improvement in the regional economy would help underpin confidence in the Japanese economy.  There is also a risk that global risk appetite will stumble again which would discourage carry trades. Nevertheless, the yen is unlikely to secure firm buying support. 

The yen was unable to make any progress over week, primarily due to the significant improvement in global risk appetite. Trading was subdued in Asian hours with a series of Japanese holidays as part of the Golden Week holidays. The dollar continued to probe resistance levels above the 99.0 level against the yen

The second Chinese PMI report recorded a move to just above the 50 level which reinforced optimism that the regional and global economies were improving and this was important in boosting risk appetite despite underlying doubts over export trends.

The latest data on fund flows recorded an increase in outflows from Japan and net outflows tended to continue when global risk appetite remained firmer which also tended to undermine the yen.

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The evidence continues to suggest that the economy is stabilising with the improvement in non-manufacturing indices particularly important. Credit conditions have improved, but there are still very important vulnerabilities, especially in the context of consumer spending and rising unemployment. The Bank of England decision to increase the amount of quantitative easing will also represent an important medium-term risk factor for the UK currency.  Sterling should be resilient unless risk appetite deteriorates sharply.

Sterling maintained a firm tone over the week as whole as the improvement in domestic conditions worked in combination with the improvement in risk appetite.

The rise in PMI index to 48.7 in April from 45.5 in March maintained a more positive short-term tone over the economy. The construction PMI index also rose to 38.1 in April from 30.9 previously which was the sharpest increase for close to 12 months.

As expected, the Bank of England left interest rates on hold at 0.50% following the latest monetary meeting. The bank also announced that it would expand the quantitative bond-buying programme with an additional GBP50bn of buying once the GBP75bn of buying has been completed under the existing programme.

The move towards additional quantitative easing will represent an important medium-term risk for the currency with fears over the underlying threat of higher inflation. In response, the UK currency weakened back to near 1.50 against the dollar from a high near 1.52 and also dipped sharply to 0.89 against the Euro from highs around 0.8760.

Swiss franc:

The Swiss economy is likely to secure only a limited recovery in the short-term as underlying stresses continue.  The National Bank will continue to intervene to prevent franc gains and fears over the implications of currency strength will increase if there is also a trend towards general dollar weakness. In this environment, the franc is unlikely to make much headway even if there is a renewed deterioration in global risk appetite.

The Swiss currency was trapped in relatively narrow ranges against the Euro over the week with small net losses to around 1.5130. The franc had a firmer bias against the dollar with a test of US currency support levels below 1.13.

There was a weak reading for the latest consumer confidence survey. The Swiss PMI index recovered to 34.7 in April from 32.6 the previous month which maintained expectations that conditions were stabilising. Nevertheless, it also tended to suggest that the improvement was lagging behind other major economies.

The latest inflation data recorded an increase in consumer prices of 0.9% for April compared with expectations of a 0.6% monthly rise. There was still a 0.3% annual decline in prices, but the data should lessen deflation fears.

National Bank Chairman Roth stated that the bank would resolutely fight franc appreciation while fellow member Jordan confirmed that there would be fresh action to curb any unwelcome currency advance.

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The Australian currency maintained a firmer tone and pushed to seven-month highs above the 0.76 against the US dollar before a limited correction weaker.

The Reserve Bank decision to hold interest rates at 3.0% boosted confidence as it reinforced the trend towards increased capital inflows on improved risk appetite.

The domestic data was stronger than expected with retail sales rising by 2.2% for March following the additional fiscal stimulus. The trade account was also stronger than expected with a AUD2.5bn surplus for March.

The Australian dollar should maintain a firmer tone in the short-term although it will be increasingly vulnerable to a sharp correction weaker following recent gains.

Canadian dollar:

The Canadian dollar continued to gain ground over the week and strengthened to 7-month highs near 1.16 against the US currency before a partial retreat.

The domestic data was generally stronger than expected with a sharp rise in building permits which helped improve currency sentiment.

The principal reason behind the stronger currency was still the improvement in international risk appetite and a rally in commodity prices.

The Canadian dollar should maintain a firmer tone in the short-term, although it will be increasingly vulnerable to a significant correction weaker.

Indian rupee:

The rupee was able to secure a more robust tone over the week and strengthened to 10-week highs near 49.20 against the US currency during the week. Gains were stifled to some extent by caution ahead of the general election results due on May 16th.

The currency continued to gain support from equity inflows as international risk appetite remained stronger. There were net capital inflows of US$1.5bn for April which helped underpin sentiment.

The rupee trends will continue to be influenced strongly with degrees of global risk appetite. Overall, there is likely to be scope for only limited net rupee gains from current levels given that improved conditions have been priced in.  

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The HKMA was again forced to intervene in the market to keep the Hong Kong dollar within the permitted trading band as it remained close to the 7.75 stronger limit. The persistent intervention pushed domestic bank balances to a record high.

The domestic retail sales data was weak with a 7.7% annual decline over the year, but degrees of risk appetite continued to dominate. As risk appetite remained robust, there were further net capital outflows.

Given the improvement in risk appetite, the Hong Kong dollar should be able to maintain a firm tone in the short-term with further intervention likely to be required.  

Chinese yuan:

The yuan maintained a firmer tone over the week, although there was only limited gains towards 6.822 against the US currency. There were mixed signals from the central bank with some suggestions that the authorities were considering letting the yuan advance more substantially, but it also maintained relatively tight control of the market and resisted more than limited gains.

The economic data remained generally supportive with the PMI index increasing to above the 50.0 level. There was still caution ahead of a further batch of economic data next week, especially with fears that the latest export data would remain depressed.

A slightly firmer yuan tone remains realistic in the near term. The yuan will also continue to be in a stronger position to advance if the authorities are more confident over the domestic and international growth outlook.