Weekly Forex Currency Review 13-08-2010

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Underlying confidence in the global economy is liable to remain weaker in the short-term which will provide some defensive support for the US dollar. Sentiment could still reverse rapidly and overall confidence in the US fundamentals will remain weak as the trade and budget deficits remain an important negative factor. There is likely to be increased speculation over a fresh phase of competitive currency devaluations which is liable to increase market volatility.                 

Key events for the forthcoming week

Dollar:

There will be further expectations of a slowdown in the US economy as growth estimates will also be downgraded. The Federal Reserve move to maintain a highly-expansionary monetary policy through a further modest expansion in quantitative easing will tend to undermine the dollar. Overall confidence in the fundamentals will also remain weak with substantial trade and budget deficits. The global economic conditions will also be very important for dollar sentiment and the US currency should gain important protection from fears that none of the major economies will be able to provide economic leadership.

The dollar remained under pressure in the first half of the week with the trade-weighted index at a three-month low on a lack of confidence in the US economy. Attention switched towards the global risk profile over the second half and the US currency staged a strong 36-hour recovery.

As expected, the Federal Reserve left interest on hold in the 0.00-0.25% range. The FOMC statement was more cautious over the economic outlook with comments that the pace of recovery is likely to be more modest in the near term than had been expected while inflation was likely to be subdued for some time.

The Fed stated that principal payments received from mortgage-backed securities would be re-invested in longer-term US Treasuries. This was effectively a modest expansion of the quantitative easing programme as the Fed moved to prevent any reduction of liquidity or increase in yields.

The US trade deficit for June was sharply worse than expected with a 21-month high of US$49.9bn from a revised US$42.0bn the previous month as exports were generally subdued and imports rose strongly.

The main impact of the data was to increase fears over a sharp downward revision to the second-quarter GDP growth data with estimates that a cut in the trade contribution could push growth as low as 1.0%. There was also a loss of confidence surrounding the US fundamentals, especially with fears surrounding the budget deficit also increasing with a US$165bn deficit for July.

The US jobless claims data was again weaker than expected with an increase to 484,000 in the latest reporting week from a revised 482,000 previously. Claims close to the 500,000 level are certainly an indicator of a generally fragile labour market.

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The latest Euro-zone economic data has suggested that the recent spurt in growth could be in the process of peaking which will create underlying caution. Following weak Greek data, there will be further speculation that the weaker economies will remain trapped in recessionary conditions. There will also be renewed fears over the underlying structural vulnerabilities which will tend to unsettle the Euro.  The Euro performance will also remain correlated closely with degrees of confidence in the global economy and the net risks will make it difficult for the currency to gain strong support.

The Euro was unable to sustain initial gains during the week and was subjected to renewed selling pressure after mid week before securing a technical correction and consolidating around 1.29 against the dollar. The Euro-zone data releases were also generally favourable with a stronger than expected reading for the Sentix business confidence index and German trade surplus. The German GDP data was much stronger than expected with a provisional 2.2% expansion for the second quarter.

There was a renewed widening in Euro-zone bond spreads which tended to revive fears over the sovereign-debt risk, especially with rumours that the ECB was buying Irish bonds following higher than expected loan losses at the Bank of Ireland.

Confidence in the Euro area was also damaged by a weaker than expected Greek GDP data as there was a further 1.5% quarterly contraction in the economy. Persistent recession in the weaker economies maintained fears that the current policies and Euro structure will prove to be unsustainable.

Yen:   

The yen will continue to gain important protection from the decline in US yields and expectations of subdued global growth. Defensive demand for the yen will also tend to increase if confidence in the global economy deteriorates, especially if European financial-sector fears increase again with weak capital outflows.  The domestic policy stance will be very important and there will certainly be very important unease over the implications of yen strength. There is certainly likely to be further verbal intervention and official yen selling is a possibility which is liable to trigger increased currency volatility.

The yen tested multi-year highs stronger than 85 against the dollar and also strengthened sharply against European pairs as global economic fears increased.

There was a deterioration in risk appetite during Wednesday with slightly weaker than expected Chinese data and unease over the financial sector fuelling fears over a global slowdown, especially with the Federal Reserve also downgrading expectations.

The Bank of Japan held interest rates at 0.1% following the latest policy meeting with a unanimous vote in favour and the bank also decided not to introduce any further measures to boost liquidity. The bank will wait for further evidence on the impact of yen strength before taking any further action.

The Japanese economic data was generally weaker than expected with a 1.6% increase in machinery orders after a 9.1% decline the previous month while there were continuing fears over deflationary pressure.

The dollar found further support below 85 against the yen on rumours of rate checking by the central bank. There were reports that Prime Minister Kan had described the sudden exchange rate moves as rough and there were meetings between Bank of Japan and Finance Ministry officials.  

The yen came under more sustained pressure after the Bank of Japan governor’s statement on currencies reinforcing speculation that there could be intervention to weaken the currency.

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Confidence in the economy is liable to deteriorate gradually further in the short-term. There will be unease over consumer spending trends and increasing fears over unemployment as fiscal tightening takes effect.  There will be significant divisions within the Bank of England, but the most likely outcome is that the bank will be very reluctant to increase interest rates significantly which will curtail Sterling support. Sterling trends will also be much more vulnerable to selling pressure if global risk appetite remains weaker.  

Sterling was undermined by increased doubts over the domestic economic performance.  A sharp deterioration in risk conditions and failure to break resistance also tended to undermine the UK currency. Sterling weakened to lows near 1.5550 against the dollar before finding support while the UK was resilient against the Euro.
There was a larger than expected decline in UK consumer confidence. The latest housing data was weaker than expected with the RICS survey recording a figure of -8 from the +8 the previous month which was the first monthly decline for 12 months.  

The employment data was mixed, but a lower than expected decline in the claimant count ensured a generally negative reaction. In contrast, the trade account data was better than expected with a decline in the goods-account deficit to GBP7.4bn from a revised GBP8.0bn the previous month with a recovery in exports.

In its quarterly inflation report, the Bank of England downgraded its growth forecasts to some extent and also stated that the growth risks were biased to the downside. As far as inflation is concerned, the bank expects the rate to be above the 2.0% target until the end of 2011, primarily due to the impact of higher taxes before falling to significantly below the 2.0% target level in 2-years’ time.

There was a strong emphasis on the high degree of uncertainty over the outlook and the bank stated that policy could be adjusted in either direction. There will be divisions within the bank, but the net risks suggest that rate increases would be resisted and this will tend to undermine Sterling.

Swiss franc:

The franc will gain renewed support when confidence in the global economy deteriorates and trends in risk appetite will remain very important for the franc. Underlying doubts over international trends are likely to sustain a firm franc tone in the near term, especially if Euro-zone structural fears return. There should also be a general mood of confidence towards the Swiss economy which will underpin the currency. Volatility is likely to remain an important near-term feature with the franc broadly reslient.

Franc volatility remained an important feature over the week, notably against the Euro. The franc weakened to lows beyond 1.39 against the Euro before recovering strongly to a high beyond 1.35 as global risk appetite deteriorated. Despite several spikes firmer, the dollar was unable to sustain gains to above 1.06.

Renewed doubts over the global economy provided important support for the franc, especially as some structural fears surrounding the Euro-zone returned. There was a slight deterioration in consumer confidence according to the latest SECO survey which may increase speculation that the economic cycle is peaking, although the impact was limited.

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The Australian dollar was unable to extend gains during the week and dipped sharply over the second half with a test of support levels below 0.90 against the US dollar. The currency came under pressure as risk appetite deteriorated with renewed reservations over carry trades.

The domestic NAB business confidence survey weakened for the fifth successive month. The higher than expected unemployment rate of 5.3% from 5.1% previously had some impact in undermining the Australian currency on Thursday, but the solid increase in employment helped lessen the negative impact.

Given the underlying global and domestic risk profile, the Australian dollar will find it difficult to make headway even if near-term losses from current levels are limited.

Canadian dollar:

The Canadian dollar was unable to sustain gains during the first half of the week and then depreciated steadily as international risk conditions were less favourable. There were lows close to 1.05 against the dollar before some stabilisation.

A decline in oil prices to two-week lows had a negative impact on the Canadian dollar. There was also some evidence of unease over the domestic financial sector, although the impact was limited.

The Canadian dollar should prove to be resilient in the short-term. It will still be difficult to secure much of advance given doubts over the global growth outlook.

Indian rupee:

The rupee was unable to maintain its position during the week as international considerations were generally hostile and it retreated to 3-week lows beyond 47 against the dollar.

Risk conditions were less favourable as markets fretted over the global economic outlook while a firm recovery in the US dollar also put the rupee under pressure. There was firm dollar demand by importers during the week, but there was still some evidence of resilience.

The rupee will find it difficult to make much headway in the near term, but should be able to prove broadly resilient given longer-term optimism towards fundamentals. 

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The Hong Kong dollar was unable to strengthen through the 7.76 level against the US dollar during the week and weakened to the 7.77 area later in the week.

International risk conditions were important and unease over the global economy had a negative impact on the currency. There were also some further reservations over the Chinese financial and property sectors.

The Hong Kong currency should be able to resist substantial losses over the next few weeks given that the US Federal Reserve will maintain a highly-expansionary policy.

Chinese yuan:

The yuan was unable to make any headway during the week and weakened sharply over the second half with the central bank reference rate dipping very sharply to beyond the 6.80 level against the US currency. The central bank reacted strongly to push the yuan weaker as the US dollar rallied and this suggested that the authorities were more sensitive to a firm US currency.

There were fears over a slowdown in the economy with a particular focus on the property sector and unease over the potential banking-sector exposure to bad loans.

The central bank is likely to maintain a tight control over currency moves in the short-term with continuing resistance to more than a limited yuan advance against the US currency unless the dollar weakens very sharply.

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