Weekly Forex Currency Review 16-01-2009

The global economy is liable to deteriorate further in the short-term. There will be renewed fears over the financial sector and speculation that further government support will be required for the banks.  Risk appetite will, therefore, remain fragile in the short-term, but there should be scope for stabilisation given the continuing policy action.  With all major economies in difficulties, it will be difficult to secure decisive currency trends.

Key events for the forthcoming week

Dollar:

The US economy will continue to weaken sharply in the near term as unemployment continues to rise rapidly. The Federal Reserve will maintain a highly expansionary monetary policy to help underpin conditions. Attention will turn towards economic measures by the new Administration with a particular focus on the fiscal package.  There will be expectations of a recovery late this year which will provide some US currency support. There is also scope for some further near-term defensive dollar demand as the global economy continues to deteriorate.  The overall US currency fundamentals will still be very weak.

The dollar maintained a firmer tone against the main European currencies over the week and pushed to a one-month high against the Euro. The US currency gained some defensive support as risk appetite was lower, but weakened from its best levels.

Financial-market stresses were an important focus as fear became the dominant feature once again. There was further speculation, for example, that the Bank of America and Citigroup would require additional government support to survive. On Friday, the US Treasury announced that Bank of America would receive US$20bn in equity. The Senate also approved the second US$350bn TARP tranche.

The US economy continued to have an important influence on market sentiment. Retail sales data was even weaker than expected with a sharp 2.7% decline for December, the sixth successive decline, while underlying sales fell even more sharply by 3.1%. Given that the November data was also revised weaker, fears over the consumer spending outlook continued to increase.

The New York manufacturing PMI survey strengthened to -22.2 for January from a revised -27.9 the previous month and there was a similar pattern for the Philadelphia Fed index with an improvement to -24.3 from -36.1. The data suggested that the rate of decline in the manufacturing sector may be easing, but there will be unease over unemployment as the Philadelphia Fed employment index was at a record low.

Jobless claims rose to 524,000 in the latest week from 470,000 the previous week. In contrast, the number of continuing claims fell back after last week’s sharp increase.

The US trade deficit was sharply lower than expected with a decline to US$40.4bn for November from a revised US$56.7bn the previous month and this was the lowest figure since November 2003. Exports fell by over 5.0% over the month while there was a very steep 12% decline in imports.  Crude oil imports declined by US$15bn for the month, but underlying imports were also extremely weak.

The Fed’s Beige Book reported that economic conditions had weakened further in the last month. Credit quality also remained a concern while layoffs continued in most districts. Fed Chairman Bernanke continued to express major concerns over the economy with comments that further bank bail-outs may be required. The structural vulnerability was also illustrated by a US$83bn Federal budget deficit for December compared with a US$45bn surplus last year.

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The Euro-zone economy will continue to weaken in the short-termwith particular fears over the industrial sector while consumer trends should be more resilient. The ECB will remain under pressure to cut interest rates further to stem the downturn. The bank is likely to take a more measured stance, at least in the short-term, while it will also look to resist currency debasement. The Euro will still be hampered by the internal structural fears as stresses in the weaker Euro-zone economies increase which will limit Euro support.      
       
The Euro was generally on the defensive over the week with losses against most major currencies. Confidence in the economy was weaker with sentiment also damaged by financial fears after wider than expected losses at Deutsche Bank.

The Euro-zone industrial data remained very weak with production falling by 1.6% for the second successive month in November while GDP estimates were cut.

There were increased fears over the structural outlook with Greece’s debt credit rating downgraded by Standard & Poor’s while there were warnings that Spain and Ireland’s ratings could also be under threat. There were also reports that the Irish government was close to requesting IMF assistance, although these reports were denied, while bond yield spreads within Euro-zone countries widened.

The ECB cut interest rates by a further 0.50% to 2.00% at the latest meeting which was in line with consensus expectations and pushed rates to equal the record low.

In the press conference following the meeting, bank Chairman Trichet continued to warn over risks to the Euro-zone economy. He also suggested that the inflation risks were balanced with a further decline over the next few months followed by a renewed increase over the second half of the year.

Trichet also stated that March was likely to be the next important meeting when the bank would have fresh forecasts available. The comments suggested that the bank will look to hold rates steady at the February meeting to assess economic developments.

Yen:  

The economy will continue to weaken in the short-termand the severe industrial sector weakness will increase official alarm. The Bank of Japan will continue to look at fresh measures to underpin the economy. There will also be additional pressure on the authorities to block any renewed currency appreciation. The yen will gain short-term support from a renewed deterioration in risk appetite. Nevertheless, the gains should be limited given the prospect of increased internal opposition to a firmer currency and the grim economic outlook.
        
The yen had a generally firm tone over the week. It pushed to highs near 88.50 against the dollar while it strengthened to a one-month high against the Euro. A renewed downturn in risk appetite helped trigger renewed demand for the Japanese currency.

The Japanese data remained weak with a depressed reading for the PMI services sector while the strength of bank lending appeared to be a sign of weakness in cash flow and other credit sources rather than corporate confidence.
 
Core machinery orders declined by 16.2% in November which was double the decline expected. The Keidanren industrial organisation stated that there was the need for intervention to weaken the yen which renewed speculation that the Finance Ministry could order action on the exchange rate.

The US financial support provided some support to risk appetite on Friday which pushed the dollar back above the 90.0 level as equity markets rallied.

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The economy will continue to deteriorate in the short-termwith unemployment rising further while export trends are weak. There will be pressure for additional interest rate cuts from the Bank of England, although the central bank may look to be more cautious. 

There is an increased risk that further financial support will be required for the banking sector which would undermine confidence.

The UK currency will tend to weaken when risk appetite is at a very low level, but Sterling should still gain some relative protection from severe difficulties elsewhere in the global economy.
After strong gains the previous week, Sterling initially reverted to a generally weaker tone as confidence remained depressed. The UK currency dipped to re-test six-year lows below 1.45 against the dollar. It was more resilient against the Euro and consolidated stronger than the 0.90 level.

Sterling was hampered by a renewed spike in risk aversion while a renewed focus on banking-sector weaknesses offered no support. Some relief in conditions and a lack of confidence elsewhere pushed the UK currency to 1.49 against the dollar on Friday.

The retail sales evidence remained weak with the BRC report recording an annual like-for-like sales decline of 3.3% for December while there was a very weak BCC survey on business trends. Sterling still gained some protective support from the major difficulties seen in Euro-zone economies.

The November trade deficit for goods rose to a record GBP8.3bn from GBP7.6bn previously as non-EU exports declined. The data further undermined confidence in the economy with fears that the improved competitiveness will not have a major beneficial impact on trade given weak overseas demand.

Swiss franc:

The National Bank will maintain a very low interest rate policy in the short-termand there is likely to be opposition to currency gains, especially with the export sector under severe pressure. The near-term franc trends will remain correlated strongly with degrees of risk appetite with the Swiss currency gaining support when fear intensifies.  The franc will still struggle to secure strong support from current levels given the bank reservations over currency strength.

The dollar pushed to highs near 1.13 against the franc over the week. The franc had a robust tone against the Euro with gains to beyond 1.47, the strongest level since October. Fears over European credit rating downgrades triggered some defensive demand for the Swiss currency.

National Bank member Jordan reiterated fears over the economy in comments on Thursday. He also stated that the bank may intervene if the economy continued to deteriorate which suggested that the bank would resort to quantitative easing. He also warned that the franc strength was a cause for concern given the downturn in exports

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The Australian dollar was unable to hold above the 0.70 level against the US currency early in the week. It weakened to lows below 0.66 as risk appetite came under pressure and commodity prices weakened before finding some relief on Friday.

The domestic data offered no support for the currency, although the residential mortgage data was slightly stronger than expected. The headline employment decline was lower than expected with a 1,200 fall while there was a steeper decline in full-time jobs.

Overall, there is scope for fragile Australian dollar gains despite major fears over the global economy and implications for commodity prices.

Canadian dollar:

The Canadian dollar pushed to highs near 1.18 against the US currency, but failed to hold the gains and dipped sharply to lows beyond 1.25 before a correction.

The Canadian currency was unsettled by a stronger US currency tone as well as by downward pressure on energy prices as global economic growth fears increased.

The Canadian trade surplus dipped to CAD1.1bn for November which was the lowest level for 11 years as exports came under pressure with a notable decline in shipments to the US. Vehicle sales also fell sharply in November and the business outlook survey was weak which reinforced expectations of a further cut in interest rates.

Volatility is liable to remain an important feature with scope, but with scope for limited Canadian dollar gains given that the relative fundamentals are still solid.
 
Indian rupee:

Confidence in the rupee remained fragile over the week with further unease over the risk of capital outflows following the Satyam scandal. Overall risk appetite also weakened as regional equity markets were subjected to renewed selling pressure and this was a negative factor for the rupee as the stock market deteriorated.

It consolidated stronger than the 49.0 level against the US currency on Friday with some evidence of tough dollar resistance near this level. An improvement in risk appetite also provided some degree of relief for the local market.

Overall, there is scope for limited Indian rupee gains from current levels, although a strong recovery looks unlikely given the serious domestic and global growth fears. 

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The Hong Kong dollar found support weaker than the 7.76 level against the US currency with a slightly firmer tone, but struggled to make much headway.

The local currency was again unsettled by speculation over capital outflows associated with the selling in regional stock markets. HKMA Chief Yam stated that the recent capital inflows were welcome and the selling pressure eased on Friday as market sentiment improved and inter-bank rates edged higher.

The Hong Kong dollar could drift slightly weaker on fears over further capital outflows, although substantial losses from current levels should be avoided. 

Chinese yuan:

The Chinese yuan has again been confined to relatively narrow ranges over the past week with consolidation just stronger than 6.84 against the dollar.

There were further concerns over the economy with a reported 2.0% decline in exports in the year to December. There was also further speculation over net capital outflows and increased fears over a more substantial deterioration in confidence.

There was renewed speculation that the new US administration would push for a stronger yuan to help alleviate underlying trade imbalances.

Given central bank fears over the risk of substantial capital outflows, it is likely to maintain a strong preference for yuan stability in the short-term. Rhetoric from the US administration will be watched very closely over the next few weeks.

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