Weekly Forex Currency Review 19-06-2009

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The US currency will continue to be unsettled by speculation over medium-term reserve diversification into alternative currencies and institutional bonds. The global central banks have a strong incentive to maintain relative currency stability in the short-term  to help underpin a global recovery. In this context, there are likely to be further public comments in support of the dollar which should help limit losses even if underlying sentiment remains fragile.          

Key events for the forthcoming week

Dollar: 

Underlying confidence in the dollar will remain fragile with further unease over the threat of medium-term diversification. While risk appetite remains firmer, there will also be further expectations that defensive demand for the US currency will be lower. The impact will be offset by a narrowing of the current account deficit which will lessen the dependency on capital inflows while yield support is also still higher. The dollar can, therefore, still prove resilient in the short-term , although it will be difficult for the currency to make much headway.

The dollar struggled to make any great headway during the week, but it did again show some resilience in the face of underlying weak sentiment and consolidated just stronger than 1.40 against the Euro.

The latest US capital flows report recorded net long-term inflows of US$11.2bn for April from US$55.4bn the previous month. There was a decline in US Treasury holdings by many central banks during the month and this will maintain underlying unease over the risk of reserve diversification away from the US currency. 

The current account deficit narrowed to US$101.5bn for the first quarter of 2009 compared with a revised US$154.9bn the previous quarter. The deficit is narrowing at a substantial pace, but both figures were significantly higher than expected. A narrower structural deficit will still provide some degree of dollar protection.

The US currency gained some support from assertions by global finance officials that the dollar will remain the dominant international currency with Russian Finance Minister Kudrin the latest official to voice dollar support.

The US housing data was slightly stronger than expected with starts rising to an annual rate of 0.53mn for May from a revised 0.45mn the previous month. There was a strong rise in multi-family starts which helped push the total higher while building permits also edged higher.

The industrial data was weaker than expected with a 1.1% production decline for May while there was a decline in the capacity use rate to 68.3% from 69.1% previously.

The US Philadelphia Fed index rose to -.2.2 for June from -22.6 the previous month which was sharply stronger than expected and the highest reading for nine months. The data caused significant relief, especially as the New York manufacturing index released earlier in the week, had registered a monthly deterioration

Elsewhere, initial jobless claims edged slightly higher to 608,000 in the latest reporting week, from 605,000 previously while there was a decline in continuing claims which will boost confidence that the labour market is starting to stabilise.

US consumer prices rose by 0.1% in May compared with expectations of a 0.3% monthly increase while the underlying rate was in line with expectations with a 0.1% rise. The weaker than expected headline increase and the largest annual decline since 1950 of 1.3% provided some support to risk appetite and curbed dollar demand. There were also reduced expectations that the Fed would consider an increase in interest rates which also tended to undermine the US currency.

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There are still important Euro-zone vulnerabilities and structural uncertainties which will limit the potential for Euro gains, especially if there are renewed fears over currency devaluations in the Baltic States.  There will also be further concerns over the threat of additional debt write-downs by the regional banks. 

The Euro will tend to gain some support if underlying global risk appetite remains higher, especially if there is further evidence of a sustainable global economic recovery.  It will be difficult to secure strong gains from current levels.

The Euro again registered a relatively mixed performance during the week. There were further net losses against Sterling and the yen while it struggled for direction against the dollar.

There was a further rise in the German ZEW business confidence index to 44.8 in June from 31.1 the previous month which was the highest figure for three years. Companies were still pessimistic over current conditions which tended to offset the mood of optimism to some extent.

There were further concerns over the banking sector with reports that Euro-zone banks may need to announce debt write-downs of at least a further US$200bn. The situation in the Baltic States stabilised for now despite underlying fears.

Yen:  

There will be further capital outflows from Japan in search of higher yields. These flows will tend to increase when confidence in the global economy improves and yen moves will, therefore, remain correlated strongly with degrees of risk appetite. The yen much more vulnerable to selling pressure when international confidence rises. There is still likely to be an underlying mood of caution which should stem yen losses while renewed banking-sector stresses would provide support. The yen and dollar may continue to move in tandem especially with officials content to see lower market volatility.

The yen strengthened to test dollar support levels near 95 and also secured a firm tone against the Euro as capital outflows failed to trigger substantial selling pressure on the currency. The Japanese currency then edged lower to 96.80 on Friday

Following the latest council meting, the Bank of Japan left interest rates on hold at 0.10%. The bank also upgraded its view of the economy which was in line with market expectations. There was an improvement in the latest Tankan monthly survey and expectations of stronger Chinese growth which helped underpin confidence.

The latest capital account data also continued to record net outflows from Japan in to higher yield markets while the latest fund launches have attracted strong investor support. In this environment, there was still evidence of yen selling on rallies.

There was some speculation that Japanese institutions would tend to reduce the buying of overseas bonds which could provide important yen support

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Optimism over a recovery in the economy should continue to provide some degree of currency support.  The most recent evidence has been more mixed and confidence could still falter quickly, especially given the very substantial debt burden. The budget situation also remains very serious and will tend to cap any further Sterling support. The degrees of risk appetite will remain very important for the currency and Sterling should prove much more resilient while risk appetite remains firm. In contrast, a return of global fear could trigger sharp downward pressure on the currency.   

Sterling was subjected to frequent bouts of profit taking during the week. From peaks above 1.65 against the dollar and beyond 0.8450 against the Euro, it ended off its peaks even though the underlying tone was still robust.

The unemployment claimant count rose by 39,300 in the latest monthly survey after a revised 49,600 increase the previous month which was a significantly slower increase than expected even though the unemployment total was at a 12-year high.

The inflation rate was higher than expected with the annual CPI rate only declining to 2.2% in May from 2.3%, maintaining the trend of higher than expected numbers. The higher than expected rate increased pressure for the Bank of England to resist a further expansion of quantitative easing and consider an early end to the programme to help contain inflation and inflation expectations.

The Bank of England minutes recorded a 9-0 vote for unchanged interest rates and quantitative easing measures with members still uneasy over the economic outlook. Although still very cautious, Bank Governor King was slightly more optimistic in his comments on Wednesday.

Other data was weaker than expected with a 0.6% reported decline in retail sales for May to give a 1.6% annual decline which was substantially weaker than expected. The latest monthly government borrowing data registered a record monthly deficit of GBP19.9bn. The latest bank lending data was also weak as lending remained under pressure while the CBI industrial survey remained near record lows.

Swiss franc:

The National Bank has continued to show its determination to resist franc gains. Although the bank will be reluctant to get drawn into targeting specific levels, there is a strong probability that they will intervene to prevent substantial franc gains from current levels, especially against the Euro.  The franc will still gain some support if there is a renewed spike in international risk aversion and the currency has proved to be broadly resilient over the past few weeks.  

The franc resisted downward pressure for much of the week, but did lose ground following the central bank quarterly meeting.

At the latest policy meeting the National Bank left interest rates on hold at 0.25% which was in line with expectations. The bank confirmed that it would resist a franc strengthening while the corporate bond purchases would continue.

The bank expressed satisfaction with the policy effectiveness so far and the threat of further action will continue to limit the scope for franc gains.

Following the council meting there were rumours of fresh intervention to weaken the currency with reports that the BIS was buying Euros against the Swiss franc and the Euro strengthened to highs above 1.5120 from near 1.50 with the dollar near 1.0850

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The Australian dollar has been trapped between pressure for a correction after recent gains and firm underlying demand for the currency on expectations for a global economic recovery. The currency has continued to hit resistance above the 0.8050 level while corrections have been limited to the 0.7850 region.

The currency continued to draw underlying support from optimism over commodity prices and expectations of capital inflows. The domestic data did not have a major impact with a larger than expected decline in housing starts.

It will remain difficult for the currency to sustain gains much beyond current levels even though the Australian dollar should retain a generally firm tone.

Canadian dollar:

The Canadian dollar maintained a generally weaker tone over the week, but found firm support close to the 1.1450 level against the US dollar. The currency was unsettled by commodity-price volatility, although underlying optimism was still firm.

The consumer prices data was stronger than expected with a headline increase of 0.7% and a core increase of 0.4% for May, but the impact was limited as the Bank of Canada was still expecting interest rates to be left on hold over the next 12 month.

A substantial amount of global improvement has been priced in and this will make it difficult for the Canadian dollar to regain momentum even if losses are limited.  

Indian rupee:

The rupee again had a weaker tone over the week with losses to a one-month low in the 48.20 region against the US dollar before a small recovery to 48.10 on Friday.

Although global risk appetite was still firm, there was downward pressure on Indian share prices which had a negative impact on the rupee. There were also some fears that the government would make tax incentives less attractive given the pressure to strengthen the underlying fiscal position and this curbed capital inflows.  

The rupee will continue to secure some protection from underlying optimism over capital inflows and hopes for a global economy. It will continue to be difficult to make strong headway unless there is a rapid decline in the US currency.  

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The Hong Kong dollar maintained a strong tone over the current week and remained close to the 7.75 stronger limit for the currency band. There was no sign of aggressive intervention by the HKMA to protect the currency band

The local currency continued to gain underlying support from optimism over capital inflows and confidence over a recovery in the regional economy.

The Hong Kong dollar is likely to maintain a firm tone in the short-term , especially with little underlying support for the US currency.    

Chinese yuan:

The yuan had a very slightly firmer tone, but moves remained very limited as the central bank continued to block currency moves. In this environment speculative activity remained very limited with the spot rate near 6.833 against the dollar.  

The World Bank upgraded its forecast for Chinese GDP growth to 7.2% from 6.5% which maintained optimism over domestic growth trends

Chinese officials were still generally very cautious over the outlook, warning that conditions were still very fragile. The reservations over growth trends have been instrumental in the authorities continuing to target exchange rate stability.

The central bank will maintain its policy of yuan containment in the short-term  and will continue to target relative stability. There will still be expectations of medium-term currency gains, especially given underlying US dollar vulnerability.