Weekly Forex Currency Review 09-01-2009

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The global economy is liable to deteriorate further in the short-term. Markets will also be looking to judge how effective the very aggressive monetary and fiscal policies will be over the next few months. The dollar could gain some support if the US appears set to recover first of the major economies. The Fed balance sheet expansion still suggests that the US currency is at risk of substantial medium-term selling pressure and overall confidence in the US will be very fragile.

Key events for the forthcoming week

Dollar:

Confidence in the economy will remain very weak in the short-term with fears over a further very sharp contraction in the first quarter, especially with extremely weak employment data. The Federal Reserve will keep short-term interest rates close to zero and will look to maintain the quantitative easing. The incoming Administration will announce a further massive fiscal stimulus and there will be some hopes that aggressive policy action will trigger a recovery in the economy. There will, however, be very serious fears over the medium-term dollar implications which will also tend to limit near-term currency support.

The dollar secured sharp gains at the beginning of the week, but it struggled to sustain the momentum and, despite gains against the Euro, was slightly weaker for the week as a whole on a trade-weighted basis.

The US ADP employment report was extremely weak with a reported decline in private-sector jobs of 693,000 for December after a revised 476,000 decline the previous month. The ADP has revised its methodology in an attempt to match the BLS monthly payroll report more closely and this is likely to have pushed the job loss estimate higher with the November figure revised sharply higher.

Initial jobless claims were again lower than expected in the latest reporting week, but there was a surge in continuing clams which suggested the employment market was still very weak and employment fears were a key focus over the week.

The US ISM services-sector index was slightly stronger than expected with a rise to 40.6 in December from 37.3, although there were some fears that it reflected seasonal factors. Elsewhere, pending home sales fell 4.0% in November after a revised 4.2% decline the previous month which reinforced fears over the housing sector.

The FOMC minutes from December’s policy meeting were notably downbeat. Members saw substantial downside risks to the economy with GDP set to contract for 2009 while some favoured quantitative reserve requirements and saw a risk of uncomfortably low inflation. The minutes will reinforce expectations of a highly expansionary Fed policy over the next few months.

The Congressional Budget Office (CBO) stated that the budget deficit for the current fiscal year was likely to exceed US$1trn which will reinforce the huge financing issues which will be faced by the US over the next year at least.

There will also be increased fears of a series of annual deficits above US$1trn which will tend to undermine the longer-term confidence in the US currency, especially after the very weak employment data. President-elect Obama pledged a fiscal stimulus package of at least US$800bn including tax cuts to help stabilise the economy.

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The Euro-zone economy will continue to weaken in the short-term with particular fears over the industrial sector. There will be pressure for a further aggressive ECB policy response, but the overall evidence suggests that the bank will take a more cautious approach and focus on medium-term risks. This stance will tend to provide some initial Euro support, but the currency will be very vulnerable to selling pressure if there is a further increase in internal tensions.     
       
After strong gains during December, notably against Sterling, the Euro was subjected to significant selling pressure on the crosses over the week and this also dragged the Euro down against the dollar with lows near 1.33 before a recovery.

The flash Euro-zone consumer inflation estimate weakened to 1.6% for December from 2.1% and compared with a forecast decline to 1.8%. The sharper than expected reduction in inflation reinforced expectations of further ECB interest rate cuts and a significant reduction at the January meeting.

German unemployment rose in December, the first increase for three years, while there was  sharp decline in industrial orders for the second successive month with a 6.0% drop to give an annual decline of over 15%

There have been more dovish comments from ECB members with Papedemos, for example, that deflation must be avoided while bank Chairman Trichet stated that there had been significant deterioration in the real economy. Nevertheless, the ECB appeared reluctant to sanction an aggressive near-term interest rate cut following the substantial cuts seen over the past three months.

Yen:  

The economy will continue to weaken in the short-term and the severe industrial sector weakness is liable to trigger a very sharp GDP contraction. The Bank of Japan will consider fresh moves to underpin the economy as well as maintaining extremely low interest rates.  There will also be additional pressure on the authorities to block any renewed yen appreciation. Risk appetite will certainly strengthen at times, but it will be difficult to secure a sustained improvement given the global fears and this should limit yen losses.         

The Japanese currency weakened sharply at the beginning of 2009 with the dollar pushing to highs above 94.50 while the yen lost ground on the crosses.

Risk tolerances strengthened during the holiday period and in the first few days of 2009, but the mood of confidence then came under renewed pressure with a sharp Nikkei decline after seven consecutive declines as global economy fears increased.

Bank of Japan Governor Shirakawa also noted that the bank would look for measures to curb yen strength while there were reports that the central bank would announce a further downgrading of its economic assessment.

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The economy will continue to deteriorate in the short-term and there will be a particular focus on rising unemployment. There will be pressure for additional policy measures to help support the economy. The Bank of England is likely to be more cautious over cutting interest rates sharply again in the short-term. The very serious US and Euro-zone weaknesses will also provide some underlying Sterling protection.  The UK currency may look to stabilise for now, although a move to quantitative easing would pose very serious medium-term Sterling risks.

After coming under very heavy pressure late in 2008, Sterling secured significant respite. From lows near 0.98 against the Euro, the UK currency pushed back to 0.90 while it rallied to above the 1.50 against the dollar. Once the push to parity against the Euro stalled, there was the potential for a sharp reduction in short Sterling positions.

There were reports of merger-related capital inflows associated with the EDF purchase of British Energy, potentially in the region of GBP12bn, which helped support Sterling directly and triggered a further reduction of short positions.

The Nationwide reported a further 2.5% drop in house prices for December with a 15.9% annual decline. The services-sector PMI index was marginally higher at 40.2 in December from 40.1 previously which came as a slight relief even though it still signalled a very weak economy. Industrial output fell by a sharp 2.3% for November.

The Bank of England cut interest rates by a further 0.50% to 1.50% at the latest policy meeting which put rates at a record low. The bank statement was downbeat with warnings that credit availability had tightened further while the rate of economic contraction had intensified during the fourth quarter.

The bank, however, also stated that rate cuts, tax cuts and Sterling weakness would provide a considerable stimulus. This raised speculation over a slower pace of rate cuts and the possibility that there could be a pause to assess developments.

Swiss franc:

The National Bank will maintain a very low interest rate policy in the short-term, especially as there has been a further decline in inflation. Confidence in the economy will also remain weak in the short-term. Franc trends will continue to be influenced strongly by degrees of risk aversion and the Swiss currency will lose ground is there is a sustained improvement in confidence. The National Bank is also likely to resist substantial franc appreciation from current levels. 

The franc weakened very sharply in the first full trading sessions of 2009 with lows beyond 1.1250 against the dollar before recovering. Defensive franc demand faded, although it regained some ground later in the week as equity-market gains stalled.

The Swiss PMI index rose to 36.9 in December from 35.2 the previous month which was stronger than expected and offered some hopes that a further deterioration in the economy can be avoided, although the figure is still very depressed in historic terms.

The seasonally-adjusted Swiss unemployment rate rose to 2.8% in December from 2.7% previously, reinforcing the weaker trend. Consumer prices also fell 0.5% in December with the year-on-year increase falling to 0.7% and this maintained expectations that the National Bank will maintain a very loose monetary policy.

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The Australian dollar pushed to the highest level against the US dollar since early October with a peak above 0.72. The currency drew initial support from an improvement in risk appetite and rising commodity prices, but global growth fears returned to unsettle the currency later in the week.

The domestic services-sector PMI index edged higher for December, but it was still trapped below 50 for the ninth consecutive month. There was also a sharp decline in building approvals in the latest week which increased unease over domestic trends as the construction PMI index dipped to a record low.

There is scope for an underlying Australian dollar appreciation despite major fears over the global economy and implications for commodity prices.

Canadian dollar:

The Canadian dollar has been subjected to a high degree of volatility over the week against all the major currencies. Despite weakness at times, the Canadian dollar pushed to two-month highs beyond 1.18 against the US currency while it also advanced firmly against the Euro.

The currency gained initial support from higher oil prices and improved risk appetite while it proved resilient when commodity prices retreated again. The domestic influences were limited with the PMI index remaining below the 50.0 level for December, although this is traditionally a weak month on seasonal grounds.

Volatility is liable to remain an important feature with scope for only limited Canadian dollar gains given fears over the industrial sector.
 
Indian rupee:

The rupee managed to retain a firmer tone early in 2009 with support from capital inflows. The central bank announced a further 1.0% cut in interest rates to 5.5%  while the government announced fresh incentives for investment inflows which underpinned sentiment. Low oil prices were also favourable for the currency.

The currency, however, weakened sharply later in the week following the revelation of serious fraud at Satyam with a decline to a one-month low beyond 39 against the US dollar on fears that underlying capital inflows would be damaged.

Overall, there is scope for a tentative Indian rupee recovery from current levels, especially as financial-market fears have eased, although strong gains look unlikely. 

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The Hong Kong dollar has remained weaker over the past few days and dipped sharply to lows beyond 7.76 against the US currency on Friday. The sustained intervention by the HKMA finally had some impact in weakening the currency.

There was also evidence of capital outflows on selling of local shares while corporate US currency demand was firm. HKMA chief Yam stated that the recent Hong Kong appreciation was due to the unwinding of carry trades rather than speculative inflows.

The Hong Kong dollar is liable to drift weaker on possible capital outflows, although substantial losses from current levels should be avoided. 

Chinese yuan:

The Chinese yuan has traded in generally narrow ranges against the US currency over the week. The central bank has maintained a very tight control of the market. There were further concerns over the economy as industrial output slowed sharply in response to the global downturn.

There has been unease over the risk of capital outflows and SAFE stated that it would strengthen its risk management of currency flows as it looked to curb any capital leakage. The central bank stated that it still had ample scope to respond to economic weakness with further monetary easing.

The overall evidence suggests that the central bank will resist currency depreciation and aim for continuing stability for now as the underlying fundamentals deteriorate.

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