Weekly Forex Currency Review 10-09-2010

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Underlying confidence in the global economy has proved resilient with some hopes that emerging-market strength will help offset persistent weakness in the G7 area, but underlying sentiment is still liable to deteriorate over the next few weeks given the underlying stresses. G7 policy actions will continue to be watched very closely given further speculation that the Bank of Japan will intervene to weaken the yen.               

Key events for the forthcoming week

Dollar:

Confidence in the US economy will remain generally fragile with particular doubts surrounding consumer spending as the labour market remains subdued. Overall yield support for the dollar will remain weak amid speculation that the Federal Reserve could sanction further quantitative easing. Global considerations will remain important and the US currency will continue to gain some degree of defensive support when risk appetite deteriorates. Given the underlying vulnerabilities and weak fundamentals, the dollar will find it difficult to gain strong support unless there is renewed evidence of a global credit crunch.

The dollar was able to make some progress against the Euro at times, but generally failed to impress during the week as support remained generally limited.

There has been no sign of renewed stress in Libor markets and there was no demand for dollars in the latest European bank auctions which will curbed dollar support.

As far as the US data is concerned, there was a further contraction in consumer credit, maintaining the trend seen over the past 2 years. The Federal Reserve released its Beige book and the report suggested that there were widespread signs that growth within the economy had eased over the past few weeks.

The latest jobless claims data was better than expected with a decline to 451,000 in the latest reporting week from a revised 478,000 previously. A further retreat away from the important 500,000 level will increase hopes that labour-market conditions have stabilised following a soft patch during the Summer, especially with the monthly data slightly stronger than expected.

The trade data was also significantly better than expected with a drop in the monthly deficit to US$42.8bn from a revised 49.8bn the previous month. The June and July deficits should probably be seen in combination, but the drop in July imports helped trigger an upgrading of third-quarter GDP growth forecasts.

Although confidence in the US economy improved slightly following the data, the principal effect was an improvement in international risk appetite with an advance in stock markets and gains for commodity currencies.

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There will still be unease over the structural vulnerabilities within the Euro-zone 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 or evidence of more serious stresses within the banking sector 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, but it may be able to hold its position in the near term.

The Euro was generally weaker on the crosses as there were renewed fears surrounding the financial sector, but there was support below 1.27 against the dollar.

There were further concerns over the Euro-zone banking sector which continued to unsettle the currency with doubts over the credibility of recent stress tests. There was also a continued widening of yield spreads within the area as yields in countries such as Portugal and Spain rose.

The increase in bond yields will make it even more difficult for the weaker countries to finance budget deficits and will increase the cost of fiscal tightening. In this environment, the risks of a vicious cycle remains an extremely important source of longer-term vulnerability for the Euro. A weaker than expected German industrial orders report increased speculation that the recent rebound in growth could stall.

Demand in the latest Euro-zone bond auctions was subdued and yields rose compared with the previous sales which indicated that there were important underlying stresses. There was, however, relief that demand was slightly stronger than expected and this did provide some relief for the Euro. ECB member Weber was also less pessimistic over the liquidity situation in his most recent comments which helped underpin the currency and it was confined to relatively narrow ranges against the dollar.

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 with capital flows to the US and Europe weak. 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 as the evidence suggests that other G7 members will be very reluctant to back an intervention policy.

The dollar remained weak during the week, hitting fresh 15-year lows below 83.50 against the Japanese currency on Wednesday while the Euro also tested support below 106 against the Japanese currency. Risk appetite stabilised later in the week and this curbed yen buying support to some extent.

Finance Minister Noda stated that he was ready to act and that decisive steps would be taken including intervention. Noda also stated that it would be difficult to gain international support for intervention and markets continue to suspect that the yen will need to strengthen much further before the necessary political will can be found.

The Japanese current account surplus was higher than expected which increased confidence that the economy could withstand a strong yen and the latest machinery orders data was also stronger than expected which provided underlying yen support.

Bank of Japan officials continued to suggest the possibility of intervention to restrain the yen and markets will inevitably remain on high alert for action, but officials struggled to deliver a cohesive response.

The central bank left interest rates on hold at 0.10% following the regular council meeting. There were no further policy announcements which was unsurprising given that an emergency meeting had been held the previous week.

The evidence suggests that there was still strong Chinese demand for Japanese securities. There was also be a persistent lack of confidence in the US and Euro-zone economies which provided default yen protection.

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Underlying unease over growth trends is likely to increase after weak survey evidence in all economic areas. 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 bank-credit availability. Sterling will continue to gain some degree of protection from a lack of confidence in the US and Euro-zone, especially given renewed fears over the Euro-zone bond markets and financial sector. Nevertheless, the net risks suggest that Sterling will be vulnerable to some underlying selling pressure.  

Sterling came under selling pressure early in the week before stabilising. There were reports of substantial Sterling selling by a major UK clearing bank, possibly related to a government European Union payment and this helped push the currency lower in thin trading conditions. Sterling weakened to a six-week low beyond 0.8380 against the Euro, but then recovered strongly.

The latest trade data was weaker than expected with the shortfall widening to a record GBP8.7bn for July from a revised GBP7.5bn the previous month.  Although the rise in imports will increase speculation over firmer consumer spending, there will also be unease that a competitive currency has not helped narrow the trade gap.

As expected, the Bank of England held interest rates steady at 0.50% following the latest monetary policy meeting. There was also no change to the quantitative easing amount of GBP200bn. There had been some speculation that the bank could consider a fresh round of quantitative easing at the meeting. And the decision to hold rates steady provided some degree of relief.

Sterling gained support within Europe from renewed fears over the European banking sector and sovereign-debt default risks while the latest Halifax housing report was also stronger than expected.

Swiss franc:
 
Underlying fears over a renewed deterioration in the global economy are likely to sustain a firm franc tone in the near term and the currency will also gain very important support from a lack of confidence in the Euro-zone financial sector. 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 together with some doubts over the Swiss financial sector may also limit the scope for buying support.

The Swiss franc continued to gain important defensive support during the week with a strong advance against the Euro as Euro-zone banking fears increased. The Euro retreated to fresh all-time lows below 1.2850 against the franc and was unable to gain much respite while the dollar tested support below 1.01.

Renewed fears over the Euro-zone banking sector provided important support for the Swiss currency.

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The Australian dollar proved resilient during the week and advanced to a high just above 0.9270 against the US dollar. There was some relief that a new government was formed after prolonged negotiations with Labour retaining power.

The construction PMI index trapped well below the 50 level for August, maintaining the run of disappointing survey evidence. In contrast, the labour-market data was stronger than expected with a further employment increase of over 30,000 for August while unemployment fell to 5.1% from 5.3%.

Given the underlying global and domestic risk profile, the Australian dollar will find it difficult to make further significant progress.

Canadian dollar:

The Canadian dollar found support towards 1.06 against the US currency and advanced to a high near 1.03 during the second half of the week.

The Bank of Canada increased interest rates by a further 0.25% to 4.50% at the latest policy meeting which was in line with expectations. The statement did express caution over further increases, but was slightly tougher than expected which underpinned the currency. There was also a strong reading for the latest PMI index.

Risk appetite remained fragile, but equity markets were generally firmer and commodity prices also rallied which helped support the Canadian currency

The net risks suggest that selling pressure on the Canadian dollar should be contained with underlying confidence in the fundamentals providing support.

Indian rupee:

The rupee nudged stronger against the US dollar during the week and approached four-week highs near 46.50, although ranges were relatively narrow. The US currency was unable to make headway in a global environment, but importer demand helped support the dollar.

There was a continued sense of optimism surrounding the local stock market and prospect for capital inflows which helped underpin the currency even though inflows were measured.

The rupee will find it difficult to make strong gains 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, but there was no evidence of significant selling pressure and it advanced to highs beyond 7.77 against the US dollar.

Risk conditions looked to stabilise over the second half of the week which provided Hong Kong support while underlying regional optimism stayed intact.

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 had a significantly firmer week against the US dollar and strengthened to high near 6.78 against the US currency. Dollar support was stifled by general vulnerability in the Asian region while the central bank was slightly more tolerant of yuan gains.

There was further international pressure for the pace of yuan appreciation to accelerate, especially with US congressional elections in November and there also some domestic calls for a stronger currency, especially with speculation that there was another strong trade report for August.

The central bank will remain reluctant to allow more than limited yuan gains, but may be more tolerant of a measured advance, especially if the US currency is generally more fragile within global markets.

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