Weekly Forex Currency Review 18-12-2009

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This is the last Weekly Forex Bulletin for 2009.  Normal services will resume 4th January 2010.

The Week Ahead

The dollar has gained support from a small shift in yield expectations and a significant deterioration in confidence surrounding the Euro-zone. The US fundamentals are still broadly weak and it remains the case that there will be a lack of confidence surrounding all the major currencies. Year-end positioning will tend to limit the scope for renewed gains in high-yield instruments.

Key events for the forthcoming week

Dollar:

The US economic releases have continued to suggest some improvement in conditions with consumer spending firm. There are still very important areas of vulnerability with fears that the rebound will stall quickly once fiscal support lessens. The Fed has adopted a slightly more positive tone and will look to end quantitative easing, but short-term interest rates are likely to remain at very low levels. There will also still be fears over medium-term reserve diversification. There will be some potential dollar support from a lack of confidence in the other major currencies, especially if wider risk appetite deteriorates further.

The dollar secured strong net gains for the week as US sentiment was slightly firmer while confidence in Europe deteriorated significantly. The dollar strengthened to a three-month high close to 1.43 against the Euro before a limited correction.

The US capital flows data was weaker than expected with net long-term inflows of US$20.7bn for October after inflows of US$40.7bn previously while there were small total net outflows. The data overall had a slight negative underlying dollar impact.

Growth indicators were mixed. There was a stronger than expected reading for industrial production with a 0.8% monthly increase for November. In contrast, the NAHB index weakened to 16 for the month from a figure of 17 the previous month. Jobless claims rose to 480,000 in the latest week from a revised 473,000 the previous week which was slightly worse than expected.

There was a sharp decline in the New York manufacturing index to 2.6 for December from 23.5 which maintained some fears over the sector even though the series is volatile on a monthly basis. In contrast, the Philadelphia Fed index was stronger than expected with a rise to 20.4 from 16.7 the previous month. The index components were mixed with a deterioration in orders offset by a firmer employment reading.
 
There was a sharper increase in producer prices of 1.8% for November after a 0.3% the previous month while there was a 0.6% core increase. Consumer prices rose 0.4% for November while core prices were unchanged which provided some degree of optimism that inflation trends are still contained. The low point for inflation has, however, certainly been passed and the Fed will need to be on alert with the annual rate rising to 1.8% from -0.2% previously.

There were no surprises from the Federal Reserve on interest rates with the benchmark Fed funds rate left in the 0.0 – 0.25% range while there was also no change in the discount rate after some speculation over a possible move.

The Fed also maintained its references to interest rates remaining at low levels for an extended period. The statement was, however, slightly more optimistic on the economic outlook and also referred to capacity use being higher while the quantitative easing programme would be wound down from February 2010.

For now, markets will tend to give the US economy the benefit of the doubt following the slightly more optimistic comments from the Federal Reserve on Wednesday even though there will still be scepticism over the potential for an early increase in interest rates.

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There will be further concerns over Euro-zone structural weaknesses, especially with fears over further credit-rating downgrades. There will also be pressure on the ECB to delay any monetary tightening in order to help protect the weaker Euro-zone members. There is a small possibility of heavy selling pressure on the Euro, especially if there is evidence of more severe stresses within the banking sector.  For now, confidence in the ECB should remain relatively firm.

The Euro came under substantial selling pressure during the week with sharp losses against the dollar while it also lost significant ground on the major crosses as structural fears increased. There was initial stop-loss selling once the Euro weakened through the 1.45 level and a further round of selling once the 1.4450 area also broke.

There were warnings from the ECB that Greece needed to take steps to restore its sovereign credit rating by the end of 2010 when collateral requirements will return to pre-crisis levels.  Difficulties within the Austrian banking sector triggered a renewed loss of confidence in the Euro as the government injected funds and effectively nationalised the fourth-largest bank.

The Euro weakened further on Thursday with a Standard & Poor’s suggesting that a review of European covered bonds could lead to a downgrading of ratings on the bonds. There was also another Credit rating downgrade for Greece with Standard & Poor’s matching the downgrade by Fitch seen last week. These developments reinforced a mood of pessimism towards the Euro-zone economy and financial sector.

The latest speculative positioning data recorded a small net long Euro position against the dollar for the first time in 8 months which lessened the potential for a further speculative shift in the dollar’s favour.

The Euro-zone PMI was also generally favourable with the manufacturing reading edging higher to 51.6 for December from 51.2 previously.

Yen:  

There will be further unease over the government debt situation while there will also be continuing unease over the deflation threat. In this context, there will be continuing pressure for yen gains to be resisted in order to help underpin competitiveness and curb any further downward pressure on prices. The yen will gain support when risk appetite weakens while a lack of confidence in the Euro and dollar will also help underpin the Japanese currency. Verbal intervention will remain a threat to curb any significant yen advance.

The dollar made some headway against the yen during the week, but continued to hit selling pressure above the 90 level against the Japanese currency.

The headline Japanese Tankan business sentiment index recorded an improvement to -24 for the latest quarter from -33 previously which was slightly better than expected. Smaller companies were less confident over a rebound in the economy and there were notably weak readings for capital spending with expectations that the decline in investment would be over 40% for the current fiscal year. The capital spending expectations maintained pressure for yen gains to be resisted.

There was greater speculation that the yen would be used as a funding currency and risk appetite also improved at times, but the Japanese currency was still broadly resilient with a reluctance to sell the currency aggressively.

The Bank of Japan held interest rates at 0.1% and there were no new quantitative easing measures, but the bank warned that it would not tolerate deflation.

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There will be persistent fears over the UK government debt position and a great focus on European deficits will increase the potential for further speculation that the UK will lose its AAA credit rating. The inflation data will maintain some speculation that the Bank of England will be forced into an earlier than expected monetary tightening, although it is doubtful whether there will be substantial Sterling support given a lack of confidence in the fundamentals. Sterling’s best source of protection is still likely to be weakness in the other major currencies.

Sterling weakened against the dollar, but did show some underlying resilience. In this context, the UK currency did advance against the Euro as the UK currency continue to secure some support from a lack of confidence in the Euro-zone economy.

The latest consumer inflation data recorded an increase in the headline rate to 1.9% from 1.5% which was marginally above expectations. Although the impact was limited, there will be increased speculation over a significantly higher rate over the next few months and this will maintain pressure for an early policy tightening by the Bank of England. There will certainly be pressure for the quantitative easing programme to be suspended.

The unemployment data was again stronger than expected with a decline in the claimant count of 6,300 for November while the previous month's data was also revised stronger and this was the first decline in the claimant count for over two years. Although the ILO data was slightly weaker. the data will increase speculation that there will be a move away from quantitative easing in February.

The latest UK retail sales data was weaker than expected with a 0.3% monthly decline for November, the weakest figure since June, which contributed to some further downward pressure on Sterling. The latest CBI retail survey was still optimistic over December sales, but there were expectations of a significant slowdown early in 2010 which had a neutral impact.

Swiss franc:

Developments within Europe will continue to be watched closely and the Swiss currency is likely to gain some defensive support from fears over the Euro-zone economy and banking sector. The franc support is liable to be limited given unease over the extent of Swiss banking-sector liabilities. The National Bank will remain an important focus and the bank is still liable to block significant franc gains, especially against the Euro.

The dollar pushed significantly higher against the Euro during the week with a high above the 1.05 level. The Euro gradually declines against the franc and a break of the 1.50 support level triggered stop-loss Euro selling. There was no evidence of National Bank intervention, but markets remained on high alert.

There was a 3.4% increase in industrial output for the third quarter, matching the previous quarter while the government up-graded its economic assessment slightly.

The Swiss ZEW index edged lower to 54 for November from 56.4 which did not have a substantial impact

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The Australian dollar dipped to lows below 0.89 against the US currency during the week, undermined by a firmer US currency and a downgrading of yield expectations.

Domestically, the Reserve Bank minutes were slightly more dovish than expected as they stated that the bank had flexibility on the scope for further interest rate increases The currency was also undermined by dovish comments from Reserve Bank official Battellino who cast further doubts on the pace of interest rate increases. The third-quarter GDP data was also weaker than expected with a 0.2% increase which undermined currency support.

The currency found some support below the 0.8850 level during the day as the sharp decline over the previous 48 hours provided some degree of support.

The Australian dollar should be able to resist heavy short-term losses from current levels even with limited scope for any fresh momentum.

Canadian dollar:

The Canadian dollar was unable to sustain a move through the 1.05 level against the US dollar during the week and weakened to lows around 1.0750 before stabilising.

The currency was unsettled by a generally firm US dollar while weaker gold prices also contributed to the weaker tone. 

The Canadian dollar is vulnerable to some further depreciation, but losses should be measured unless there is a further substantial deterioration in risk appetite.

Indian rupee:

The rupee maintained a weaker tone during the week and depreciated to a three-week low close to 47 against the US dollar. The Indian currency was undermined by significant gains for the US dollar.

The local stock market failed to make any headway and has not registered any gains for December. There was increased speculation over potential profit taking by overseas institutions ahead of the year end which also dampened rupee support.

The fundamental outlook should still offer some reassurance, but the rupee will continue to be vulnerable to selling pressure if there is a deterioration in risk appetite.

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The Hong Kong dollar weakened significantly over the past few days as several negative factors combined to undermine the currency.

The US dollar was generally firmer in global markets while there was an outflow of short-term funds linked to recent Initial Public Offerings. There was also less confidence surrounding the local stock market, especially with some speculation that there would be a tighter Chinese policy on bank lending during 2010.

The Hong Kong dollar will tend to weaken if there is a serious deterioration in international risk appetite, but losses should still be very limited in the near term.

Chinese yuan:

The Chinese central bank maintained very tight control of the spot market resisting significant moves even with a firmer US currency in global markets. There was some movement in the NDF market with forward indicators of yuan appreciation weakening to a three-month low.

There was some speculation over a clampdown on bank lending growth during 2010 which created some speculation over less stable capital inflows during the year, although the latest direct investment flows data remained encouraging.

The central bank will want to maintain a stable policy in the short-term, especially with weaker liquidity during the new-year periods.