Weekly Forex Currency Review 16-07-2010

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There has been a further shift in interest-rate expectations following the Federal Reserve minutes with markets pushing any tightening further back while there has been further speculation that additional measures could be required. In this environment, the dollar will remain dependent on defensive support to make significant headway against the European currencies. Unease over the global economy is likely to remain a key focus over the next few weeks.                  

Key events for the forthcoming week

Dollar:

The US data has been mixed over the past week, but underlying expectations of a slowdown during the second half of 2010 will persist, especially with weaker manufacturing survey evidence. The Federal Reserve has also adopted a generally more cautious outlook. Yield support for the dollar will, therefore, be weaker and there will also be increased unease over the budget outlook. An underlying lack of confidence in the fundamentals will continue to limit support for the dollar. International growth considerations will also be important and there is certainly the threat that confidence will deteriorate further which would trigger renewed defensive demand for the US currency.

The dollar was unable to make any headway during the week and subsided to significant losses against the major currencies as confidence in the US outlook deteriorated. The dollar dipped to a two-month low against the Euro and Sterling.

The US retail sales report was slightly weaker than expected with a headline 0.5% decline for June after a revised 1.1% decline the previous month while underlying sales dipped by 0.1%.
The New York manufacturing index declined to 5.1 for July from 19.6 the previous month and the Philadelphia Fed index also dipped to 5.1 from 10.0. With a deterioration in business confidence there were further fears that the US economy would slow significantly over the second half of 2010.

There was a 0.5% decline in producer prices for June which reinforced market expectations that the Federal Reserve could take additional steps to support the economy later in 2010.

The FOMC minutes from June’s meeting also registered a slightly more negative tone with comments that the economic outlook remained relatively modest while the risks were tilted to the downside. These comments will reinforce speculation that the Fed could be forced into additional measures to support the economy later this year.

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Confidence surrounding the Euro-zone has stabilised to some extent and there has been some tentative evidence of renewed longer-term capital inflows with credit-rating downgrades having less of an impact. The recent bond auctions will also provide some degree of Euro support. Underlying confidence is still likely to be very fragile given the structural vulnerabilities. There will be particular fears if growth indicators start to deteriorate again. Overall, the Euro is likely to find it very difficult to make further significant headway given the corrective recovery already seen.

The Euro was initially undermined on structural grounds as ratings agency Moody’s cut Portugal’s credit rating by two notches to A1 from Aa2 which encouraged a renewed widening of European bond spreads. The latest German ZEW data was also weaker than expected with a decline in the business confidence index to 21.2 for July from 48.7 the previously. The data maintained fears over a renewed downturn in the Euro-zone economy, although ZEW officials were optimistic that a double-dip recession would be avoided.

The Euro was able to resist selling pressure as underlying sentiment towards the currency remained slightly stronger while there was some tentative evidence of renewed longer-term inflows into the currency. Fitch commented that Spain’s credit-rating outlook was stable and this also helped underpin Euro sentiment. There was further relief surrounding the European bond auctions with successful Spanish and Greek sales reinforcing the mood of greater optimism towards the Euro-zone and the Euro.

Yen:   

The Japanese fundamentals will remain under close scrutiny and there will continue to be serious reservations over the long-term government-debt outlook. The government’s Upper-House defeat will also make it more difficult to push through reform measures and the ratings agencies will remain on alert. The yen will also lose ground when international risk appetite improves, but there are still likely to be important doubts, especially given vulnerability within the global economy which will tend to limit interest in carry trades. Markets will be on alert over verbal intervention from the authorities.

The yen was unable to sustain gains against the Euro during the week, but was resilient against the dollar and re-tested US currency support levels close to 87.

Markets remained sensitive to Japan’s government debt profile and there were increased doubts whether there would be decisive measures to cut the deficit and this put the yen under some selling pressure in Asian trading on Monday. Standard & Poor’s also warned that it was uneasy over Japan’s credit rating which unsettled sentiment. Confidence in Japan was also undermined by the government’s defeat in the Upper-House elections which triggered further doubts over reform prospects.

The Japanese currency maintained a firmer tone on fears over a sharp slowdown in the Chinese economy following an official report warning over second-half prospects and confidence was only partially restored following the release of the second-quarter data which recorded Chinese growth of 10.3% from 11.9% in the first quarter.

Domestically, the Bank of Japan held interest rates at 0.10% following the latest MPC policy meeting and it also upgraded its economic assessment with a slightly more optimistic tone in the statement, although changes in tone were limited

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There will be uncertainty over UK growth trends with mixed signals likely to continue, but there are likely to be increased fears over growth trends, especially with continuing unease over the impact of government spending reductions.  Overall, the Bank of England is not likely to be in a position to increase interest rates aggressively which will curb Sterling support. The UK currency will tend to remain more vulnerable when risk appetite deteriorates. There will still be a significant degree of protection from a lack of confidence in the US and Euro-zone fundamentals while confidence in the UK structural position has improved.  

Sterling weakened against the Euro during the week before finding support beyond 0.84. The UK currency found support below 1.50 against the dollar and advanced to 10-week highs above 1.54 as the US currency came under pressure.  

First-quarter GDP was un-revised at 0.3% according to the final release. Within the data, there was a downward revision to private-sector growth and exports which increased fears that the economy will stall over the next few months.

Headline consumer inflation fell to 3.2% for June from 3.4% the previous month which was close to expectations. In contrast, the core rate was higher than expected at 3.1% from 2.9% previously. The inflation data is likely ensured further uncertainties and divisions over monetary policy within the Bank of England.

The latest unemployment count data was slightly stronger than expected with a further decline of 21,000 in claims for June. In contrast to recent months, the ILO report was also stronger than expected with an unemployment drop to 7.8% from a revised 8.0%.

MPC member Sentence repeated his preference for an early increase in interest rates with comments that rates at the emergency level of 0.50% were no longer required. He was, however, also anxious to comment that rates would need to remain at low levels to underpin the economy. Posen warned that there was a risk of a slip back into recession and there were still expectations that the bank would not be in a position to increase interest rates significantly.

Standard& Poor’s stated that the UK AAA credit rating was safe for now, but the outlook remained negative. In particular, the agency was concerned that forecasts were too optimistic while weaker than expected growth would cause further stresses within the budget.

Sentiment towards the UK currency was boosted by comments from US pension fund PIMCO that it now considered UK bonds more attractive. These comments helped maintain expectations of capital inflows and reduce fears surrounding sovereign debt.

Swiss franc:

The franc will lose some defensive support if there is an improvement in sentiment surrounding the Euro-zone and reduced fears over credit ratings. Underlying confidence within the Euro area is still likely to be very fragile which will limit any selling pressure on the franc. Currency volatility is likely to remain a key feature over the next few weeks, especially as renewed franc gains against the dollar will tend to increase unease over the deflation threat.

The dollar was unable to gain any sustained traction against the franc during the week and retreated to a 5-month low of 1.04 in US trading, primarily reflecting wider selling pressure on the dollar.

There was solid demand for the Euro against the franc with a move to the 1.3470 area. A further solid debt auction within the Euro area helped curb defensive demand for the Swiss currency

There was some speculation that National Bank Chairman Hildebrand could be replaced after the central bank registered heavy paper losses on its currency intervention and this had a mixed impact on the franc with some speculation that the bank would face strong opposition to further Euro buying.

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There was renewed caution over Asian equity markets which dampened demand for the Australian dollar and there was a slide to lows near 0.8680.

There was also a further decline in international freight rates which triggered some fresh doubts over the global economy. The currency was still able to regain ground as the US currency came under pressure and it challenged resistance levels above 0.8850 before hitting fresh selling pressure.

Volatility will remain a threat as the Australian dollar moves will continue to be influenced strongly by trends in risk appetite. Overall, given the international risk profile, the Australian dollar will find it difficult to make much headway.

Canadian dollar:

The Canadian currency made a succession of challenges on US dollar support close to 1.03, but was unable to make a break and weakened back to the 1.0420 area.

The currency was hampered by a decline in confidence towards the global economy during the week as US growth indicators were generally disappointing

The Canadian currency still drew some support from the very strong employment figures released late last week with expectations that interest rates would be increased again next week.

Volatility levels are liable to remain higher in the short-term and the Canadian is likely to find it difficult to make much headway given the global risk profile.

Indian rupee:

The rupee found it difficult to maintain a decisive trend during the week and generally consolidated just stronger than the 47.70 level against the dollar.

The Indian currency was supported by a generally weaker US dollar during the week. Risk conditions were also relatively favourable, although there was some reversal in stock-market conditions late in the week. The rupee was also unsettled by evidence of a slowdown in the Chinese economy.

Despite losses when international risk appetite deteriorates, the rupee should be able to prove broadly resilient given longer-term optimism towards fundamentals.  

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The Hong Kong dollar strengthened sharply to a high near 7.7650 against the US dollar, but was unable to sustain the advance and drifted weaker towards the 7.7750.

There was a generally weaker US currency which provided support for the Hong Kong dollar while US interest rates were also weaker. The currency was restrained by fears over a slowdown in the Chinese economy.

The Hong Kong dollar trends will be influenced by developments in risk appetite and the Chinese yuan. Given the softness in US rates, the Hong Kong dollar should be able to resist substantial losses.   

Chinese yuan:

The Chinese yuan was unable to make further headway against the US dollar during the week and edged slightly weaker. There were reduced expectations of yuan gains in the forward markets.

The Chinese growth-orientated data was slightly weaker than expected with a slowdown in GDP growth to 10.3% for the second quarter. There was also a weaker reading for consumer inflation which dampened expectations of further monetary tightening.

There will continue to be greater daily fluctuations for the Chinese yuan. Given increased doubts over the domestic and international growth profile, there will be resistance to substantial yuan gains unless the dollar depreciates very sharply.

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