Weekly Forex Currency Review 10-10-2008

Weekly market analysis: October 10th 2008:

Conditions within the global economy and financial sectors will remain of critical importance. Confidence has been very badly damaged and defensive strategies will tend to dominate in the short-term. These trends will tend to trigger further support for the Japanese currency, although the extent of recent gains looks excessive against high-yield currencies.

Key events for the forthcoming week

Dollar:

There will be expectations that the economy will deteriorate further as the credit tightening takes effect with consumer spending under severe pressure. Markets will also continue to speculate over further rate cuts by the Federal Reserve. The US currency will gain some backing if the authorities can restore confidence in the banking system and global economic fears will also tend to offer support. The currency has gained important technical support from the lack of liquidity and, if the global central banks can ease money-market stresses, then demand for the currency would tend to weaken with volatility set to remain at elevated levels.

There was further extreme tensions in the US and global financial markets as fears over the deteriorating economic trends and the banking sector continued to escalate.

At the end of last week, the House of Representatives approved the Troubled Asset Rescue Plan following its rejection the previous week. Despite the approval, Wall Street remained under heavy selling pressure and dipped to five-year lows with the Dow Jones index weakening sharply to below the 9,000 level on Thursday.

There was a sharp deterioration in emerging-market sentiment with the Brazilian and Mexican currencies, for example, falling very sharply. There were also huge stresses surrounding the Icelandic economy and the dollar continued to gain defensive support as funds were forced to unwind positions in emerging markets and commodities.

The global central banks continued to battle against extremely tight credit markets over the week. Despite further liquidity injections and the financial-rescue plan, market stresses remained intense with spreads still at extremely elevated levels. Fears over the global economy, allied with structural dollar demand on a liquidity shortage, continued to benefit the US currency and it retained a firm tone. The dollar pushed to a 14-month high against on a trade-weighted basis.

The Federal Reserve also cut interest rates in a co-ordinated move with a cut to 1.50% from 2.00%. The central bank also stated that it would move to buy Commercial Paper in the markets while there was some speculation that the Treasury would take direct stakes in the banking sector, but sentiment remained extremely fragile.

Federal Reserve Chairman Bernanke was generally downbeat in his assessment of the US economy and at the end of last week there was a reported decline of 159,000 in September employment, the steepest decline of 2008 and the ninth successive decline.

There was little in the way of major economic data over the week with initial jobless claims falling to 478,000 in the latest week from 498,000 the previous week. There was a decline in monthly consumer credit for the first time in over 10 years which maintained fears over the outlook for consumer spending.

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Confidence in the Euro-zone economy is liable to weaken further in the short-term with expectations that the ECB will continue to cut interest rates. There will also be fears over the banking sector and doubts whether the authorities can achieve a cohesive response. The economy should still hold up in relative terms given that the area as a whole is less vulnerable to a housing downturn despite serious difficulties in individual countries. The Euro will be vulnerable initially, but should be able to avoid heavy selling pressure from current levels..

The Euro remained generally weaker as markets continued to downgrade economic prospects for the region. There were notable losses against the yen and franc with a steadier performance elsewhere and it found support below 1.3550 against the dollar.

Early in the week, there was confusion over the German stance over bank deposit protection and fears that the European authorities would not be able to make a concerted approach unsettled confidence in European markets. There were no major developments from the ECOFIN meeting of European officials.

As part of the co-ordinated central bank moves, the ECB cut interest rates by 0.50% to 3.75% from 4.25%. The central bank cited additional risks to the growth outlook and a reduction in inflation pressures for the move to cut rates.

The German factory orders and industrial output data was stronger than expected but failed to have a significant impact with markets concentrating on future trends. The Sentix confidence index continued to record a deterioration.

Yen:

The domestic data will increase fears over the Japanese economic trends and there is also likely to be greater resistance by the Finance Ministry to currency gains if the economy is deteriorating. Near-term yen moves are still likely to be dominated by the degrees of risk aversion and fears over the global economy. There will be further important defensive support, but there is scope for fear to ease slightly which would lessen immediate yen demand and there will be some bargain hunting for high-yield currencies.

The Japanese currency strengthened rapidly as market fears intensified and there was evidence of a massive unwinding of carry trades. The yen tested levels below 100 against the dollar and also strengthened to highs beyond 135 against the Euro.

There were gains against the Australian dollar before a partial correction later in the week. A fresh surge in fear pushed the yen to 98.60 against the dollar on Friday.

Domestically, there was a sharp decline of over 14.2% in machinery orders for August which reinforced fears over the domestic economy. The Nikkei index recorded the largest weekly decline in history with a daily fall of 10% on Friday.

The Bank of Japan left interest rates at 0.50% in the week at the regular monetary meeting. The bank also declined to join in the co-ordinated interest rate moves, although it did indicate that a cut in the emergency Lombard rate had been discussed.

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The economy will continue to deteriorate in the short-term and the difficulties within the banking sector will increase fears over an even more serious downturn. The Bank of England will face strong pressure to relax monetary policy much more quickly to avert a severe recession. A series of interest rate reductions should trigger only limited selling pressure on the currency, especially as rates have fallen elsewhere. Evidence of stabilisation in the banking sector would also offer protection, but near-term sentiment will remain very weak.

The UK currency initially held firm against the Euro, but then weakened sharply later in the week with a retreat to around 0.7960. The UK currency remained firmly on the defensive against the dollar and dipped to lows below 1.70 the weakest for five years.
The banking sector remained a key focus and the government announced a major rescue plan as fears over the sector increased. There was GBP50bn support package for the banks with the government taking a stake in the banks while there were wider guarantees with the total potential support for the bank at GBP500bn.
The UK data remained generally weak with a decline in industrial production for the sixth consecutive month while there was a further recorded decline in house prices.
The Bank of England moved the schedule interest-rate setting meeting 24 hours earlier and joined in with the co-ordinated interest rate cuts with a reduction of 0.50% in the repo rate to 4.50% from 5.00%. The bank cited increasing fears over growth and a reduction in inflation pressures, although it still expected inflation to increase over the next 2-3 months. Markets moved to price in an accelerated pace of rate cuts.

Swiss franc:

The Swiss economy will continue to weaken in the short-term and there will be further concerns over the banking sector, especially given that the financial sector is very important for the economy as a whole. Any easing of global fears would also tend to weaken the currency. There should still be very important near-term defensive support which will limit the scope for selling pressure unless there is evidence of serious deterioration in the Swiss banking sector.

The franc continued to advance against the Euro with a peak beyond the 1.52 level as fear dominated the markets. The dollar peaked close to 1.15 against the Swiss currency before retreating to 1.1150 in very nervous trading conditions.

The Swiss currency secured important defensive support on the combination of heavy selling pressure in equity markets and major fears over the global banking sector.

The Swiss National Bank joined in the move to cut interest rates. The target band for the repo rate was cut to 2.00 - 3.00% with the target level reduced to 2.50% from 2.75%, although the rate was holding near the 3.0% ceiling ahead of the rate decision.

The government and National Bank downgraded its growth forecasts for 2009 and overall confidence in the economy was weaker.

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The Australian currency was subjected to sustained and intense selling pressure over the first half of the week. The currency dipped to four-year lows against the US dollar with lows close to the 0.65 level. There was a fresh surge in risk aversion which undermined the currency while there was a sustained downturn in industrial commodity prices as global growth and market fears intensified.

The Reserve Bank of Australia announced a bigger than expected interest rate cut with benchmark rates cut by a full percentage point to 6.0%.

There was a small rise in employment for September while the unemployment rate increased to 4.3% from 4.1% which maintained expectations of a sharp slowdown.

Australian dollar volatility is likely to remain extremely high in the short-term with some scope for a limited net recovery after very heavy losses.

Canadian dollar:

The Canadian dollar weakened sharply over the week in very volatile trading conditions. Trading remained very volatile and the currency weakened to lows near 1.16 against the US dollar from levels near 1.03 early in October.

The Canadian currency was undermined by a fresh surge in risk aversion while commodity prices were lower with crude oil dipping to below US$90 per barrel.

The economic data was stronger than expected with a strong rebound in the PMI index while building permits were also robust, but releases had little market impact.

The Bank of Canada cut interest rate by 0.50% to 3.00%, matching the moves made by the other global central banks in an orchestrated move to boost market sentiment.

The Canadian dollar will remain vulnerable on global growth fears, but it should be able to resist heavy losses from current levels.

Indian rupee:

The rupee remained under pressure during the week as turmoil remained intense in global markets. The currency dipped sharply to record lows beyond 49 against the dollar on Friday. There was some stabilisation later in the day as there was aggressive US currency selling by the central bank.

There was further evidence of capital outflows over the week with net sales for the year reaching close to US$20bn and there were greater concerns over the foreign debt burden which had increased to over US$220bn at the end of September. Wider confidence in the economy also remained weak which undermined the currency.

There is scope for a fragile rupee correction if there is some improvement in risk appetite, especially as oil prices have fallen sharply. Overall sentiment is likely to remain at depressed levels which will limit the scope for recoveries.

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The Hong Kong dollar had a slightly firmer tone for the week as trading conditions remained very volatile with consolidation around 7.7650 against the US currency.

The HKMA cut the benchmark interest rate by 0.50% to 2.00% following the co-ordinated global interest rate cuts. There were still very tight conditions in the money markets and local interest rates remained high.

Confidence in the regional economy remained fragile, especially with fears over a sharp slowdown in the Chinese economy.

Given the money-market stresses, trading conditions are liable to remain erratic in the short-term with a slightly weaker Hong Kong dollar tone realistic.

Chinese yuan:

The Chinese yuan was slightly stronger over the week with the central bank continuing to resist substantial moves and it settled close to 6.8350 against the dollar.

There was a further significant shift in monetary policy with the Central bank cutting benchmark interest rates by 0.27% as part of the co-ordinated global move while reserve requirements were also cut by 0.50%.

The NDF markets continued to signal yuan depreciation, although expectations of the yuan decline narrowed during the week.

Given the shift in monetary policy, there is only limited scope for Chinese yuan appreciation with the central bank still likely to concentrate on near-term stability.

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