Weekly Forex Currency Review 11-07-2008

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Confidence in the US economy will remain fragile in the short-term which will leave the currency at risk. The extent of dollar vulnerability will also be determined by the extent of stresses elsewhere in the global economy together with the attitude of G8 members towards US currency weakness. The dollar will struggle to make strong headway without evidence of improvement in the economy.                    

Key events for the forthcoming week

Dollar:

Overall confidence in the economy will remain fragile with fears that on-going weakness in the housing and mortgage sectors will cause a renewed downturn, especially if the labour market continues to deteriorate. Given the economic and financial risks, the Fed will find it difficult to justify and significant monetary tightening in the short-term. Unease over the global economy will provide important dollar protection, especially as confidence in the European economy is liable to weaken further.  There is also likely to be G8 pressure for a stronger dollar and the currency should be able to avoid heavy selling pressure.     

The dollar strengthened during the first half of the week, but was unable to make strong headway and then retreated as confidence in the US financial sector remained very fragile with lows around 1.58 against the Euro.

The US currency was also unsettled to some extent by Middle East tensions as Iran carried out military tests including missile launches and oil prices recovered ground.

There was little in the way of economic data to drive the markets during the week. Pending home sales fell 4.7% in May, reinforcing unease over the housing sector, although the impact was limited following a 7.1% increase the previous month. There was a further increase in reported mortgage foreclosures.

Initial jobless claims fell sharply to 346,000 in the latest week from 404,000 previously, but the data is liable to have been distorted by seasonal grounds and there was a significant increase in continuing claims.

Fed Chairman Bernanke stated that the Fed could extend the terms of its lending facility through the discount widow and extend the facility beyond the end of 2008 which provided some initial relief to the banking sector.

There were still fears over the mortgage sector with rumours that mortgage finance companies Fannie Mae and Freddie Mac were facing additional stresses and pressure to boost capital. Bernanke called on the institutions to boost capital while regional Fed President Lacker warned that they could be insolvent. There was speculation that the administration would have to take control of the companies.

G8 members made little reference to currency issues during the 3-day meeting with no specific references for the dollar to strengthen, although there were some calls for the Chinese yuan to appreciate against the Euro.

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The ECB will continue to take a firm tone on inflation. The bank has, however, continued to state that it now has no bias on policy direction which will continue to dampen speculation over any further increase in interest rates over the next few months. Overall concerns surrounding the Euro-zone economy are also likely to increase which will tend to undermine the Euro, especially given the risk of substantial capital outflows.  In this context, the fundamentals will limit scope for further Euro gains.        
       
The Euro remained vulnerable to profit taking following the revision to Euro-zone interest rate expectations following last week's ECB meeting. The currency still secured strong support on significant retreats and secured a net advance for the week.

The Euro-zone Sentix index fell sharply to -9.3 in June from 5.2 the previous month which was the lowest level for over two years and reinforced unease over the economy. The industrial production data was weaker than expected  with sharp monthly declines in the latest releases for Germany, France and Italy.

The ECB maintained firm stance on inflation in comments over the week while there were further remarks that the bank had no short-term bias on interest rates.

The ECB warned that there has been some decline in international interest for the Euro on valuation grounds.

Yen:  

Sentiment towards the economy will remain generally weak in the short-term. The most recent data has, however, offered some optimism over capital spending and the bank lending data suggests that Japanese is not as vulnerable to any credit crunch which will support the yen. The Japanese currency will also still gain some support on fears over the global economy, especially if credit stresses continue to increase. There will still be pressure for capital outflows from Japan on yield grounds and yen rallies will attract strong selling pressure.  
                    
The yen resisted further losses against the US dollar, but was still unable to secure sustained gains against high-yield currencies and weakened back towards all-time lows against the Euro late in the week as sentiment remained weak.

The Japanese machinery orders data was stronger than expected with an increase of 10.4% for the latest month to give a 5.1% annual increase. The bank lending data also recorded the strongest increase for over two years.

Wholesale prices inflation rose to a fresh 17-year high for June at 5.6%, although the impact was limited as there was no evidence that the Bank of Japan was considering an increase in interest rates.

There was further evidence of capital flows from Japan on yield grounds with domestic investors looking to increase their holdings of overseas bonds.

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The latest economic data has continued to suggest a deterioration in conditions with particular fears surrounding the housing sector. There will also be expectations of a downturn in consumer spending as confidence remains very weak and job losses increase. The Bank of England will continue to face a series of very difficult policy decisions, especially as there will be strong pressure for an increase in rates to be resisted. The currency will gain some support on yield and valuation grounds.  Nevertheless, Sterling is liable to remain on the defensive over the next few weeks as economic fears increase.
 
Sterling weakened during the week as confidence towards the economy continued to deteriorate. The UK currency weakened back to near 0.80 against the Euro, but held relatively firm against the dollar as the US currency was subdued.

The housing data remained depressed with the Halifax Bank reporting a further 2.0% decline in house prices for June to give a 6.1% annual decline in prices. There was no relief from the industrial sector as industrial production fell a reported 0.8% in May to give a 1.6% annual decline.

There were further job-loss announcements in the housing sector while retail sales reports were also generally gloomy and there was a further slide in consumer confidence. The British Chambers of Commerce in its latest survey warned that the economy was at high risk of falling into recession.

The Bank of England left interest rates unchanged at 5.0% the latest MPC meeting. There was no statement with the decision and the vote split was also not announced.

Swiss franc:

There will be concerns over the Swiss financial sector given the banking-sector vulnerability and there will also be fears that any stresses within the financial sector will have a wider negative impact on the economy. The franc will gain support from global growth fears with defensive inflows while there will also be some speculation over capital inflows from global central banks on reserve diversification grounds.  Nevertheless, the Swiss currency has struggled to make much headway and rallies are liable to quickly attract selling pressure.  
 
The Swiss franc recorded small net losses against the Euro over the week while there was no clear trend against the dollar with choppy trading and consolidation around 1.03 late in the week.

The seasonally-adjusted unemployment rate was unchanged at 2.5% in the latest month which did not have a significant impact on the markets.

The franc gained some support when credit fears increased and equity markets were subjected to selling pressure, although the impact was limited.

There was further unease over the Swiss banking sector during the week which limited support for the Swiss currency

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The Australian dollar weakened to lows below 0.95 against the US dollar during the week, but rebounded to the 0.96 level following the latest labour-market data.

The domestic data releases overall were mixed over the week. The Westpac consumer confidence index weakened to a 16-year low in the latest monthly survey as high energy prices damaged sentiment. In addition, there was a sharp 7.9% decline in housing finance in the latest survey.

In contrast, the employment data was stronger than expected with a monthly increase of close to 30,000 while there was a decline in unemployment to 4.2% from 4.3%. Deterioration in those indicators which look further forward was still a negative influence on the Australian currency.

Overall sentiment should remain firm in the short-term, but the Australian dollar will struggle to make much headway from current levels given unease over future trends.

Canadian dollar:

The Canadian dollar found support close to 1.0230 against the US currency and strengthened back towards 1.01 during the second half of the week.

The latest housing starts data recorded a decline to an annual rate of 218,000 in May from 228,000 the previous month. There was still optimism that the Canadian sector was holding up better than in other major economies.

The latest Bank of Canada business outlook was also generally optimistic over the near-term outlook despite continuing evidence of a slowdown.

The Canadian dollar will struggle to secure strong gains from current levels even if there is a limited short-term advance from current levels.

Indian rupee:

After a retreat to a 13-month low of 43.50 against the dollar the previous week, the rupee managed to secure a limited recovery during the week and strengthened to 42.90 on Friday with substantial corporate US dollar selling seen during the day.

The rupee gained some support from a temporary decline in oil prices, but sentiment remained fragile and oil prices strengthened again late in the week.

The local stock market has fallen by over 30% during 2008 which is continuing to undermine confidence with fears over further capital outflows. The rupee gained some support from hopes for a increased government stability.

Overall, confidence in the economy and rupee is likely to remain fragile in the short-tem with the threat of further capital outflows which will limit any gains.

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The Hong Kong dollar was unable to sustain gains through the 7.80 level against the US currency during the week and weakened to around 7.8030, although moves were limited. There was some increase in carry-trade activity as yield spreads edged wider.

There was also some evidence of US dollar demand from corporates and Chinese institutions over the week which provided some degree of support.

Overall confidence in the local stock market was still generally weak which undermined the local currency.

Reduced expectations over higher US interest rates should offer important protection to the Hong Kong dollar even if gains are limited.

Chinese yuan:

The yuan secured further post-revaluation highs against the US dollar with a move to highs beyond 6.84 against the US dollar, although moves were relatively constrained.

There was caution given speculation that the authorities may discourage aggressive appreciation, although the central bank continued to push the reference rate stronger

The June trade surplus fell to US$21.4bn from US$26.9bn the previous year with annual export growth slowing to 17.6%. The lower surplus increased peculation that the authorities would look to slow yuan gains, especially as there were increased domestic calls for currency appreciation to slow. There were also expectations that inflationary pressure would subside over the next few months.

The IMF head Stauss-Kahn again stated that the Chinese currency was substantially under-valued. At the G8 meetings, there were also calls for the yuan to strengthen against the Euro.

There is scope for further yuan gains in the near term, but appreciation is liable to slow with some risk of a reversal late in 2008. 

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