Weekly Forex Currency Review 15-10-2010

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Official currency policies will continue to be a very important focus in the short-term, especially with increased media attention surrounding the area of currency valuations and international tensions. There will be persistent speculation that individual countries will look to pursue devaluation policies in order to boost competitiveness and aim to support growth through rising exports. Any increase in market tensions would also risk a further surge in currency-market volatility.             

 Key events for the forthcoming week

 Dollar: 

The generally lacklustre economic data will continued to undermine confidence in the economy. There will also be further expectations that the Federal Reserve will sanction a second round of quantitative easing and there will be expectations that the US will push for a weaker currency in order to boost demand for exports. Sentiment has deteriorated so far that there could be a sharp rebound in the currency on only a small shift in sentiment. There are also still important US vulnerabilities which will provide some degree of dollar protection, but a strong recovery looks unlikely.  

The dollar held a steady tone over the first half of the week, but was then subjected to renewed selling pressure and weakened to a nine-month low on a trade-weighted index. Monetary policy expectations remained a key focus during the week.

Minutes from the Federal Reserve September meeting stated that additional policy action may be required if the economic outlook worsened. There were also comments over the need to avoid any deflation pressures and that inflation expectations could be pushed higher to help boost consumer spending. These comments reinforced speculation that the Fed would move towards additional quantitative easing despite cautious remarks from some Fed officials.

Following a disappointing US payroll report at the end of last week, the US economic data was slightly weaker than expected with jobless claims rising to 462,000 in the latest week from a revised 449,000 previously. The August trade deficit was also higher than expected with a rise to US$46.3bn from US$42.6bn the previous month while producer prices rose 0.4% for September.

The data overall maintained expectations that the Federal Reserve will push towards further quantitative easing. There were also expectations that the US Administration would push for a weaker US dollar to help boost competitiveness.

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The Euro-zone data has tended to be of secondary important over the past week with attention focussed on the dollar. The forthcoming business surveys will be watched very closely and any evidence of deterioration would undermine sentiment. There will also be further unease over the structural vulnerabilities, especially if internal yield spreads start to widen again. In addition, there are likely to be protests against the Euro’s value and the impact will be substantial if the ECB verbally intervenes. The Euro will still tend to gain by default from expectations of monetary easing elsewhere.

The Euro was subjected to profit taking at times, especially as the currency was technically over-stretched on a short-term view, but there was fresh demand for the currency at lower levels and it pushed above the 1.40 level against the US dollar for the first time since February.

The Euro was also boosted by comments from Bundesbank head Weber who stated that the bond-buying programme should be ended immediately which increased market expectations that there would be ECB resistance to quantitative easing measures. There were further expectations that the Euro would gain by default given the expectations of further quantitative easing by the US Federal Reserve.

There were no major comments from senior Euro-zone officials about the Euro’s value, but markets remained on high alert over verbal intervention after the comments from Juncker last week that the Euro was too strong at 1.40 against the dollar.

Yen:

 There will be further expectations of Asian currency appreciation which will also tend to provide background yen support. Given the low US yields, the dollar will also find it difficult to gain any significant yield support. There will be scepticism whether the Bank of Japan can intervene successfully, but it would be dangerous to assume that they will be ineffective. The dollar could secure a rapid reversal, but will find it difficult to sustain any strong advance given the net capital flows.

 The dollar was unable to make any headway during the week as there was no fundamental support for the US currency and it retreated to fresh 15-year lows below 81.20 against the Japanese currency.  The Bank of Japan was under increased pressure to intervene to deter yen momentum buying and keep US selling under control.

The yen strengthened sharply in Asian trading on Thursday as there were wider gains for Asian currencies. The latest market moves were triggered mainly by a monetary tightening by the Singapore Monetary Authority as they stated that the currency would be allowed to gradually strengthen within a wider trading band. The move strengthened market speculation that there would be underlying appreciation for Asian currencies and also triggered renewed speculative dollar selling.

Prime Minister Kan stated that the authorities would take decisive action if necessary which maintained speculation that there could be fresh intervention.

The latest Japanese machinery orders data was stronger than expected with a 10.1% monthly increase which will boost optimism towards the economy to some extent, although the overall impact is likely to be limited, especially as bank lending continued to register an annual decline with the 10^th consecutive year-on-year fall.

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There will be expectations of weaker UK growth with sentiment affected in particular by the prospect of aggressive fiscal tightening and unease over the housing sector. There will be pressure for interest rates to remain very low to help support growth and there will be further speculation that the Bank of England will adopt further quantitative easing. In this environment, the UK currency will certainly be vulnerable in absolute terms. There will, however, be further protection in relative terms from a serous lack of confidence in the other main economic areas.  

Sterling proved resilient against the dollar as the US currency was undermined by wider selling pressure. There was a move above resistance in the 1.60 area, although it found it difficult to gain further momentum and tested five-month lows beyond 0.88 against the Euro.

The UK currency held steady on despite another weak RICS housing survey with the house-price index dipping to -36% for September from -32% previously. The BCC also warned over a third-quarter slowdown in the economy even though playing down the prospect of a double-dip recession. There was a sharp decline in the latest Nationwide consumer confidence survey.

The inflation data also did not have a major impact with the headline consumer rate in line with expectations at an unchanged rate of 3.1% for September. The latest labour-market data was mixed as there was a larger than expected increase in the claimant count, but there was also a decline in the unemployment rate to 7.7% from 7.8%.

The trade deficit narrowed to GBP8.2bn for August from GBP8.7bn the previous month and the underlying export performance will continue to cause underlying concerns with trade not able to provide a positive contribution to the economy.

The latest leading indicators have registered a clear loss of momentum and there were expectations of a slowdown in the economy over the next few months as fiscal tightening takes effect.

There was a further focus on potential monetary easing during the week. MPC member Miles stated that quantitative easing may have to be used again over the next few months which reinforced speculation that the bank could move to additional policy easing. In contrast, Sentance maintained his preference for higher interest rates.

Swiss franc:

The Swiss franc will continue to gain defensive support from expectations that other major central banks will pursue further quantitative easing and also directly or indirectly promote a weaker currency to help boost trade conditions. There will be expectations that the National Bank will defend currency stability in the medium term. From a shorter-term perspective, there will still be the possibility of National Bank action to slow any advance, especially if deflationary pressure starts to build. The franc should be able to resist heavy selling pressure.

 The franc resisted selling pressure against the Euro during the week while it advanced to a record high beyond 0.95 against the dollar as defensive demand for the Swiss currency persisted.

Expectations of further quantitative easing by the Federal Reserve and increased speculation that other countries will push for weaker currencies continued to provide underlying support to the Swiss currency.

There were some rumours of National Bank intervention as the Swiss currency weakened, but it appeared to be an order-driven move rather than central bank action

Markets will, however, also remain on high alert over the possibility of National Bank opposition to rapid franc gains even though there will be expectations that the bank will strongly defend longer-term currency value.

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The Australian dollar continued to challenge resistance levels during the week and pushed to fresh 27-year highs very close to parity against the US dollar before correcting slightly weaker.

The currency drew support from gains in commodity prices and generally firm risk appetite while there were expectations of firm Asian demand. There was also evidence of strong speculative inflows which helped push the currency higher as markets focussed on the weak US currency.

Markets will continue to have the parity level against the US dollar in focus, but the currency will certainly be vulnerable to profit taking and a sharp correction.

Canadian dollar:

 The Canadian dollar gained further support against the US currency and strengthened to challenge levels beyond parity during the week before correcting slightly weaker.

The currency drew important support from generally firm risk appetite and a rise in commodity prices as other currencies were unsettled by expectations of further quantitative easing and a push for weaker currencies.

There was a slightly stronger than expected trade report which had a small positive impact on the currency with only temporary losses following a weaker than expected employment report at the end of last week.

The fundamentals suggest that the Canadian dollar should maintain a firm tone, but it will be difficult to sustain advances from current levels.

Indian rupee:

The rupee maintained a firm tone during the week and advanced to a 25-month high near 44.00 against the US dollar. The rupee was again supported by a weaker US currency trend as it dipped to a 9-month low, but it did under-perform on the crosses.

The central bank intervened in the market to weaken the rupee for the first time this year and there was also firm dollar demand from oil importers.

The latest industrial production data was weaker than expected with a 5.6% annual increase and this increased unease over a loss of competitiveness.

The rupee should be able maintain a firm tone given optimism longer-term capital inflows, but unease over export competitiveness is likely to increase.  

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The Hong Kong dollar hit strong resistance beyond 7.7550 against the US dollar during the week and weakened to test support just beyond 7.76 during the week.

There was caution over pushing the Hong Kong currency stronger towards the intervention limit, especially given the possibility of HKMA intervention.

The Hong Kong dollar should maintain a firm tone in the short-term, especially with persistent speculation over further Federal Reserve quantitative easing.

Chinese yuan:

 The yuan maintained a strong tone during the week and advanced to fresh post-revaluation highs close to 6.65 against the US currency. There was also a further shift in the NDF market with expectations of increased yuan gains on a 12-month view.

There was evidence of increased capital flows into Chinese markets with the authorities buying over US$44bn during September to curb further appreciation for the yuan.

There was strong political pressure for further yaun gains with a notable increase in media speculation over a currency war between the US and China.

There will be strong expectations of further yuan appreciation in the medium term. The yuan should maintain a generally robust tone given the underlying flows with officials still likely to counter rapid yuan gains.

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