Weekly Forex Currency Review 20-03-2009

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Central bank policies will remain a very important focus in the short-term, especially after the Federal Reserve move to start buying US Treasury bonds.  In countries where non-conventional policies are resisted, then the short-term implication is likely to be for a firmer currency. In this context, ECB policies will be critical for direction over the next few weeks.    

Key events for the forthcoming week

Dollar:

The Federal Reserve move to sanction direct credit easing through purchases of bonds will be an important negative influence on the US currency. Fears over a further rapid increase in dollar supply will combine with fears over currency debasement to undermine confidence.  The dollar may gain some support from hopes that aggressive policy action will help underpin the economy and it will also gain defensive support at times if risk appetite deteriorates again. Aggressive policies elsewhere will also provide some protection.  Nevertheless, the dollar will find it difficult to make more than a limited short-term recovery.

After drifting weaker, the US currency then weakened very sharply after the Fed meeting with the largest recorded daily decline against the Euro and the US currency was on track for the sharpest overall weekly decline for 20 years.

The US manufacturing data was generally depressed as production declined by a further 1.4% while the New York Empire index also weakened further to a record low of -38.2 in March from -34.7 previously. The Philadelphia Fed index improved slightly to -35.0 for March from -41.3 the previous month, although the employment and prices components weakened to fresh record lows.

Elsewhere, initial jobless claims fell to 646,000 in the latest week from 658,000 previously which was slightly lower than expected while the number of continuing claims rose to a fresh record high at close to 5.5mn.

The housing data was stronger than expected with starts rising sharply to an annual rate of 0.58mn for February from a revised 0.48mn the previous month as apartment starts were notably firm. There was also a rise in building permits to 0.55mn.

As expected, the Federal Reserve left the Fed funds target interest rate at 0.00 – 0.25%. The Fed stated that the economy was continuing to contract and that inflation could remain at very low levels for a prolonged period given the economic weakness.

The main focus was also on the statement given the importance of quantitative easing. The Fed was much more aggressive than expected as it announced that it would step-up the pace of credit expansion. The Fed announced that it would buy up to US$300bn in long-term Treasury bonds over the next six months. In addition, it will also increase its purchase of mortgage bonds by US$750bn to a potential US$1.25trn.

The decision to expand direct credit supply substantially undermined confidence in the US currency directly due to fears over medium-term debasement while it also increased risk appetite which tended to lessen defensive support for the dollar.

The fourth-quarter current account deficit fell to US$133bn from a revised US$181bn previously which will lessen the US financing requirement. The latest capital account data recorded net long-term outflows of US$43bn for January following inflows of US$34.7bn previously. The overall account recorded net outflows of US$148.9bn.

Official Chinese holdings rose over the month and much of the outflows appears to reflect hedge-fund activities, but there was unease over the capital account situation given reports that China was concerned over the risk of capital losses.

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The Euro-zone economy will remain under pressure in the short-term with a further downturn in the industrial sector and a sharp GDP decline.  Monetary policy developments will remain very important in the short-term and the Euro will gain important support if the ECB takes a firm line. Resistance to non-standard policy measures while other central banks pursue quantitative easing would tend to strengthen the Euro, possibly sharply. There will be the threat of increased internal policy tensions and pressure for Euro gains to be capped.    

The Euro initially resisted pressure for more than a limited correction and then advanced powerfully against the dollar with a peak above 1.37 against the US dollar. The currency was also generally firm on the crosses as other currencies weakened.

The German ZEW index edged higher to -3.5 in March from -5.8 and this was the highest reading for 18 months. The institute reported that conditions remained extremely bad, but there were the first signs of hope while the bottom of the  recession was likely to be reached during the Summer of 2009.

The Euro-zone core inflation rate was slightly higher than expected at 1.7% compared with expectations of 1.6% which curbed expectations of an aggressive ECB response.

The comments from ECB officials suggested that they would consider lowering interest rates slightly further, but there was further resistance to non-conventional policy measures. Pressure on the ECB increased following the Fed’s credit easing.

Yen:  

The Japanese economy will continue to contract as overall confidence remains extremely weak with particular fears over the industrial sector. The US move to direct credit easing will certainly limit the scope for a dollar advance against yen. The Japanese currency is unlikely to make much headway on the crosses, especially with increased pressure for currency gains to be capped.

The yen again found support close to 99 against the US currency during the week and strengthened sharply to highs beyond 94. The gains primarily reflected dollar vulnerability and the yen was unable to make any headway on the main crosses.

The Japanese industrial data remained extremely weak with the monthly Tankan index weakening to a record low of -78 in March from -74 the previous month. The non-manufacturing sector improved marginally while the Bank of Japan forecast that the economic deterioration would slow as inventories started to come under control.

Following its council meeting, the Bank of Japan left interest rates on hold at 0.10%. The bank indicated that it would move to buy up to US$1trn of subordinated debt issued by banks to help ease credit difficulties. The central bank also increased its programme of government bond buying with additional purchases of JPY21.6trn over the next 12 months. There was no evidence of central bank currency intervention.

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Overall confidence in the UK economy will remain extremely fragile in the short-term, especially after the very weak unemployment data. Confidence will also tend to be undermined by the deteriorating budget position. International trend and policy responses will also remain very important and the UK currency will gain some important protection from the fact that other central banks are pursuing aggressive monetary policies. This should curb selling pressure on Sterling unless there is further severe deterioration in the financial sector.

Sterling came under pressure following the weak employment data, but domestic developments were overshadowed by Federal Reserve action and Sterling pushed to a four-week high against the dollar close to 1.46.  In contrast, the UK currency dipped to seven-week lows against the Euro beyond 0.94 as volatility spiked higher.

The unemployment claimant count rose by 138,400 for February after a revised 93,500 increase for January. This was the biggest monthly increase for at least 30 years with the unemployment total at a 10-year high while annual earnings growth also weakened sharply to 1.8% from 3.1%.

The latest public-sector finance data recorded a record-high net borrowing of GBP75.7bn in the first 11 months of the fiscal year from GBP21.9bn the previous year. The IMF also warned that the UK economy would fare worse than the US and Euro-zone economies with the risk of a further small GDP contraction for 2010 following a decline of near 4.0% for 2009.

According to the March minutes, the Bank of England voted 9-0 for the 0.50% cut in interest rates to 0.50% while there was also unanimous MPC approval for the decision to adopt quantitative easing.

Swiss franc:

The National Bank policy to weaken the franc will remain an extremely important negative factor for the Swiss currency, especially with evidence that the central bank is continuing to intervene to weaken the franc. There will also be further unease over the growth outlook as exports continue to decline rapidly. The franc will still gain some defensive support if risk appetite deteriorates and especially if the ECB also shifts to a quantitative approach.  

The franc remained generally weak against the Euro with National Bank intervention continuing to block rally attempts with little overall change. The franc still managed to secure a robust advance against the dollar to highs beyond 1.12.

Industrial production fell 5.9% in the year to the fourth quarter while orders fell 8.8%. In its latest report, the Economics Ministry (SECO) forecast that the economy would contract 2.2% in 2009, with most private forecasts suggesting a steeper contraction.

The trade surplus dipped to CHF0.73bn in February from CHF1.99bn the previous month while exports fell 16% over the year. The Swiss ZEW index also registered only a slight monthly improvement, although the survey was taken before the latest National Bank announcement on credit easing and intervention

Attention continued to focus strongly on the National Bank and its determination to stop franc appreciation. Chairman Roth stated that intervention was designed to minimise the deflation risk rather than boost competitiveness in global markets. Fellow member Jordan took a downbeat tone and stated that it was necessary to relax monetary policy too much rather than not enough given the economic deterioration.

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The Australian currency struggled to make much headway early in the week, but then accelerated sharply through resistance levels and pushed to highs above the 0.69 level as the US currency crumbled, commodity prices advanced and stock markets rallied.

The Australian Reserve Bank comments failed to provide clear direction with uncertainty whether there would be a further interest rate cut at the April meeting. The domestic data was generally subdued with a sharp decline in housing starts for the fourth quarter, although global risk conditions remained dominant.

There is scope for further near-term Australian dollar gains, although there is also the risk of a sharp reversal in the second quarter given the underlying economic stresses.

Canadian dollar:

After fluctuating in narrow ranges, the Canadian dollar strengthened sharply to highs near 1.22 against the US currency. The currency gained some support from rising commodity prices and improved risk appetite, although the US currency trend was the principal trigger for a breakout. The currency failed to hold its best levels.

The domestic growth data remained weak with a sharp decline in manufacturing sales for February. In contrast, the inflation data was stronger than expected with a 0.7% in prices for February while core prices also rose by a larger than expected 0.5%.

The Canadian dollar should be able to avoid a renewed heavy downturn against the US currency, although it will be difficult to make strong headway from current levels
 
Indian rupee:

The rupee gained strong support over the week as the international backdrop remained more favourable. The US currency weakened sharply which supported the local currency while risk appetite was also generally firmer as the Indian stock markets rose 10% from early-March lows with net overseas capital inflows.

This combination triggered the biggest rupee daily advance for 4 months with a move to 50.10 against the dollar on Friday. Annual wholesale inflation fell to 0.44%  in the latest weekly data which maintained expectations of a further cut in interest rates.

The rupee will continue to gain short-term support from a weaker US currency and improved risk appetite. Confidence is still liable to prove brittle and the rupee will be vulnerable to a significant reversal given the global downturn. 

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The Hong Kong dollar continued to have a firmer tone over the week and pushed to 10-week highs around 7.7505 against the US dollar before a slight correction.

Risk appetite continued to improve over the week which lessened fears over capital outflows. The sharply weaker US dollar tone also helped underpin the Hong Kong dollar as liquidity pressures eased and pushed US Libor rates lower.

The Hong Kong dollar moves will remain correlated strongly with risk appetite, although the weak US currency tone should provide some important protection.  

Chinese yuan:

The Chinese currency remained trapped in relatively narrow ranges over the week although there was greater uncertainty over moves and there was greater activity in the NDF market. The yuan pushed to a four-month high in the market as the US currency came under heavy pressure while NDF rates also indicated appreciation over the next month for the first time since September.

There were significant rumours over the week with some unease that the Chinese authorities would pare their holdings of US Treasuries. There was, however, also some speculation that the central bank had been intervening to support the yuan.

There is an increasing risk of underlying stability in the Chinese currency market due to shifts in underlying capital flows and uncertainty over economic rends as well as dollar direction. The central bank will continue to promote near-term stability.