Weekly Forex Currency Review 12-09-2008

Overall strategy:

Markets will continue to focus on risk appetite and the extent of stresses within global financial markets and economies.  The dollar will continue to gain defensive support from a reduction in net capital inflows into emerging markets and an unwinding of carry trades. Nevertheless, the overall fundamental weaknesses suggest very limited scope for further gains.

Key events for the forthcoming week

Dollar:

There will be some optimism that the move to rescue mortgage finance companies will spark a decline in mortgage rates which will also encourage a recovery in the housing sector. Conditions will still be very tough and there will be upward pressure on the US budget deficit which will reinforce unease over the US fundamentals. There will also be further concerns over the banking sector with the Fed struggling to justify higher interest rates, especially if consumer spending stumbles. Despite protection from a reduced flow of capital overseas, the dollar will struggle to secure further firm buying support.

Developments within the US financial sector were a key influence on the currency markets. The US administration effectively nationalised mortgage finance companies Fannie Mae and Freddie Mac due to mounting losses and the risk that they would fail. There were also fears that the difficulties in raising fresh capital would continue to put upward pressure on interest rates which would further damage the housing market.

The dollar initially weakened following the rescue with lows beyond 1.44 against the Euro, but then regained ground strongly. The currency pushed to 12-month highs against the Euro and on a trade-weighted basis. The US currency continued to gain support on defensive grounds with a reduction in carry-trade positions and a net flow of funds away from international funds.

The US banking sector was a continuing and important focus with further fears over the future of investment bank Lehman Brothers. The share price fell sharply and Wall Street also weakened rapidly at times. Speculation that there would be an industry bid increased late in the week and this pulled the dollar from its best levels.

There were only limited growth-related US data releases following the monthly employment report at the end of last week. The payroll survey had recorded a further 84,000 decline in employment while unemployment rose sharply to 6.1% from 5.7%.

The labour-market data again recorded a higher than expected figure for jobless claims at 445,000 in the latest week from an upwardly-revised 451,000 the previous week which will reinforce fears over the labour market. Market speculation over a possible move to cut interest rates was again a feature.

The US trade deficit rose to US$62.2bn in July from a revised US$58.8bn the previous month. There was a strong increase in energy imports as volume and prices both rose rapidly over the month. The export performance was still encouraging, although shipments were made when the dollar was trading close to its weakest level.

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Confidence in the Euro-zone economy will remain weak in the short-term with expectations of a further deterioration in growth conditions. While these growth fears persist, the inflation emphasis from the ECB will provide only limited Euro support. Nevertheless, the underlying fundamentals are still relatively sound which should still provide some degree of support to the currency while there is likely to be some global central bank interest in the currency at lower levels.                
       
The Euro was subjected to further selling pressure with particular losses against the yen as the Japanese currency strengthened to a 13-month high. The Euro was undermined by an unwinding of long positions and carry-trade reduction before some correction on Friday with a recovery back above 1.40 against the dollar.

The ECB continued to warn over the threat of inflation with a particular focus on second-round inflation effects as the central bank looked to stem upward pressure on wage settlements. Bank officials were also very cautious over growth prospects.

The Euro-zone sentix investor confidence index continued to weaken for September with a decline to -20.2 from -15.3 the previous month. The latest French industrial production data was stronger than expected which provided some relief.

The European Commission cut its 2008 GDP growth forecasts and also suggested that the 2009 forecasts would be lowered. There were also reports that the IMF had cut its Euro-zone forecasts and had warned over the recession risk in Germany.

Yen:  

Confidence in the economy will remain weak in the short-term.  There will be some relief that the domestic banking sector appears to be avoiding heavy losses. The yen will also gain support from an underlying reduction in risk appetite with the potential for a further reduction in carry trades. There is also the potential for a repatriation of capital with the first half of the fiscal year at the end of September. There is, however, likely to be interest in yen selling on any rallies from current levels with domestic investors still looking for higher yields.
                   
The yen retained strength during the week with net a net advance against the dollar even though the US currency was strong. There were also firm Japanese currency gains on the crosses with temporary gains through 150 against the Euro.

The Japanese currency continued to gain support on defensive grounds with a continuing switch away from carry trades as risk aversion increased. The yen retreated from its peak levels on Friday as global stock markets looked to stabilise.

Domestically, there was a 3.9% decline in core machinery orders for July, although this was a slightly lower decline than expected and the impact will be limited with regional and global trends remaining the dominant focus.

The Japanese money supply and bank lending data continued to suggest that the domestic sector was avoiding major difficulties from the global credit tightening.

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Recession fears will remain a key short-term focus, especially with the housing sector still in serious difficulties.  There will be strong pressure on the Bank of England to cut interest rates as soon as possible in order to help support economic conditions. Any cut in rates may not prove too damaging as there would be some expectations of an economic recovery.  Sterling is likely to remain very fragile in the short-term, but should be able to avoid further heavy losses given fears over the US and Euro-zone economic conditions.

Sterling secured a brief advance against the dollar, but was then subjected to renewed selling pressure and weakened to fresh 30-month lows below 1.75 before a limited recovery. The UK currency secured a net advance against the Euro.

The housing-market evidence remained weak with a further 1.8% decline in house prices according to the latest Halifax Survey which pushed the annual decline to over 10%. The RICS also reported a further decline in prices, although the main focus was on the lack of activity in the market as transactions remained at extremely low levels. The NIESR reported a 0.2% decline in GDP over the three months to August.

Industrial production also fell for the fifth successive month which maintained  a lack of confidence in the economy. The UK visible trade account recorded a GBP7.7bn deficit in July from a revised GBP8.0bn previously as the oil account deteriorated.

In testimony to the Treasury Select Committee, Bank of England Governor King stated that the prospects for growth had deteriorated while inflation has risen with inflation pressures exacerbated by Sterling weakness.

There was a variety of opinions and the remarks from Bank of England officials with Blanchflower repeating his recent warnings that unemployment was liable to rise sharply. King, overall suggested that the bank would not rush towards a cut in rates.

Swiss franc:

There will be further expectations of a slowdown in the Swiss economy as the domestic and export sectors remain under pressure. The National Bank meeting in September will be important for near-term market sentiment and the franc will gain support if the bank looks to take a tough policy stance.  The franc will also gain some support on defensive grounds if there is a further slide in stock markets, although the main focus will tend to be on the Japanese yen. Overall, the Swiss franc will struggle to make strong headway.      

The Swiss franc weakened to 9-month lows beyond against the dollar during the week while it secured a net advance against the Euro.

The franc gained defensive support, especially as global stock markets were subjected to significant selling pressure as banking fears continued, although it under-performed relative to the Japanese yen and retreated from its best levels against the Euro.

There were no significant domestic economic developments over the week. National Bank officials continued to suggest that the Swiss economy would slow, although they rejected the notion of a credit crunch. There was caution ahead of the quarterly meeting due next week while there was also caution over the Swiss banking sector.

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The Australian dollar was subjected to further selling pressure during the week and dipped to 13-month lows against the US dollar at near 0.79 before a corrective recovery back to above the 0.80 level on Friday.

Levels of risk aversion continued to have an important impact with a notable increase in fears undermining the currency despite some brief respite after the US mortgage-finance company rescue. The Australian dollar was also unsettled by a decline in commodity prices over the week with copper for example retreating to 8- month lows.

The labour-market data was stronger than expected with a 14,600 employment gain for August while unemployment fell to 4.1% from 4.4%. The data stemmed expectations over an aggressive policy to lower interest rates by the Reserve Bank. The currency was, however, undermined by a larger than expected 0.50% cut in New Zealand interest rates as regional sentiment remained very fragile.

The near-term Australian dollar moves will remain strongly correlated with levels of risk aversion and the net risks suggest a corrective recovery is realistic.

Canadian dollar:

The Canadian dollar was subjected to net losses over the week with a retreat to lows beyond 1.08. The currency was unsettled by a drop in commodity prices as oil retreated to near the US$100 per barrel level while metals prices also fell.

Following the employment increase reported at the end of last week, the domestic growth data was generally firm with a rise in housing starts. The Canadian dollar struggled to secure any significant benefit from the data releases.

The trade account remained in comfortable surplus for July at CAD4.9bn, although it was at its lowest level since February as export shipments declined.

The Canadian dollar will be hampered by a decline in commodity prices, although it should be able to resist heavy losses from current levels.

Indian rupee:

The rupee was under pressure during much of the week with the currency retreating to near two-year lows against the US dollar at 45.60. The currency suffered from general dollar strength while overall confidence in the rupee was also weaker.

Stock markets remained on the defensive which undermined the currency on a further outflow of overseas funds while confidence in the regional economy also deteriorated. There were reports of limited central bank intervention to help stem currency losses and there was some stabilisation on Friday as regional stock markets rallied.

Confidence in the economy and region is liable to remain very fragile as growth fears persist. In this environment, the rupee will tend to remain on the defensive.

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The Hong Kong dollar strengthened over the week as a whole and tested levels beyond 7.80 against the US currency before settling close to this level.

The local currency was boosted by corporate demand and retained a firm tone even though the US dollar was generally strong. The Hang Seng index remained on the defensive with a dip to 18-month lows which was a negative influence on the currency and there was selling pressure on gains to beyond 7.80.

Overall, the Hong Kong dollar will struggle to extend gains much beyond the 7.80 level against the US dollar given increased unease over the regional economic trends.

Chinese yuan:

The yuan edged lower against the US dollar over the week, although this primarily reflected a strong US currency. It gained ground against the Euro and consolidated near 6.8450 against the dollar on Friday as officials resisted significant losses.

The trade surplus was at a record high of 28.7bn for August which eased immediate fears over export trends, although there was still unease over the risk of a sharp regional slowdown and the potential impact on China.

Consumer inflation eased to 4.9% in August which increased speculation that the central bank could move to a less restrictive policy, but optimism was dampened by a 10.1% increase in producer prices which was the highest rate for over 10 years. 

Unease over regional economic trends will continue to limit the extent of speculative capital inflows into the region and this should limit the scope for yuan gains with the central bank again looking to curb losses from current levels.

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