Weekly Forex Currency Review 20-08-2010

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Underlying confidence in the global economy is liable to remain weaker in the short-term which will continue to provide some significant defensive support for the US dollar and will also continue to underpin the yen. If sovereign debt fears intensify again, there could be strong dollar support, but the US currency will continue to have to battle with weak domestic fundamentals.  Volatility levels are liable to increase in the short-term, especially with lower than normal liquidity over the next two weeks.               

Key events for the forthcoming week

Dollar:

The latest data releases will maintain fears over a significant slowdown in the economy, especially with all sectors looking vulnerable. The Federal Reserve will maintain an expansionary policy and there will be speculation over additional policy measures. From a medium-term perspective, confidence in the US fundamentals will also remain very fragile with fears that the AAA credit rating will eventually be lost. The global economic conditions will also be very important for dollar sentiment and the US currency should gain important short-term protection due to fears over a renewed deterioration in conditions.

The dollar was unable to gain support on domestic grounds during the week, but there was defensive support for the currency at times and it proved resilient against the Euro with consolidation in the 1.28 region. The US housing data was slightly weaker than expected with starts at an annualised rate of 0.55mn for July from a revised 0.54mn previously while permits declined to the lowest rate for 14 months which maintained underlying fears surrounding the housing sector. The headline industrial production increase was a higher than expected 1.0% for July.

The other US economic data was significantly weaker than expected as jobless claims rose to 500,000 in the latest week from a revised 488,000 previously. This was the highest reading since February and will reinforce unease over US labour-market trends. In addition, the Philadelphia Fed manufacturing index fell to -7.7 for August from 5.1 in July.

Although prone to considerable volatility, there will were fears that the manufacturing sector could come under further stress. Given that an industrial recovery has been an important leader in the overall recovery, there will be further doubts over the economy as a whole. There was a notable deterioration in risk appetite following the US data as equity markets were subjected to renewed selling pressure. There was also defensive dollar demand and the US currency reversed initial losses.

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There will be general optimism over near-term German economic trends. There will also be expectations that the underlying divergence in performance between the stronger and weaker economies could intensify with the weaker members remaining in recession. There will, therefore, still be fears over Euro-zone structural vulnerability which will tend to lessen Euro support. The currency performance will also remain correlated closely with degrees of confidence in the global economy and the net risks suggest that strong Euro support is unlikely.

The Euro proved resilient for much of the time with a round of successful bond auctions helping to provide support for the currency. A stabilisation in risk appetite also provided some support at times, but selling on rallies remained a notable feature as there were still underlying economic fears.

The headline German ZEW survey was weaker than expected with a decline to 14.0 for August from 21.2 previously, although there was a robust gain in the current conditions index which tempered the impact. There was an upgrading of near-term German growth forecasts by the Bundesbank and there was also further near-term optimism over the German economy following the much stronger than expected GDP data last week.

Yen:   

The yen will continue to gain important protection from low US yields and expectations of a US slowdown. Defensive demand for the yen will also tend to increase if confidence in the global economy deteriorates, especially if European financial-sector fears increase again with weak capital outflows.  The domestic policy stance will continue to be extremely important and there will certainly be a high degree of unease over the implications of yen strength. There will be further verbal intervention and official yen selling is also a possibility, but any initial yen losses may reverse quickly. Overall, volatility levels are liable to increase over the next few weeks.

The yen continued to gain underlying support from reduced confidence in the global economy with notable caution over carry trades and the US dollar continued to test support levels near the 85 level. The Japanese currency was generally firm on the crosses as rally attempts by European currencies quickly faded.

With the yen at very sensitive levels, comments from senior Japanese officials remained under close scrutiny. Finance Minister Noda stated that the he was watching market developments closely. The Bank of Japan indicated that it was still assessing the impact of yen strength before deciding on any further action.

Although firm Asian currencies in general was a theme and  will help protect Japanese competitiveness, there was heightened speculation that a decision would be made to intervene and this discouraged yen buying.

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The latest economic data has provided some degree of relief on cyclical and structural grounds. There are still likely to be expectations of a slowdown in the economy, especially with consumer spending liable to weaken.

There will be further divisions within the Bank of England, but the most likely outcome is that the bank will maintain a highly-expansionary policy and the domestic outlook is unlikely to provide strong support.  Sterling will also be much more vulnerable to selling pressure if global risk appetite deteriorates.  

Sterling was unable to make a serious challenge on resistance levels near 1.57 against the dollar and retreated to lows below 1.55 with reports of US selling undermining the UK currency. Sterling found support at lower levels and the Euro was unable to move above the 0.83 level even though rallies were limited.

The headline UK consumer inflation rate was in line with market expectations with a decline to 3.1% for July from 3.2% previously while there was a larger than expected decline the core rate to 2.6%. Bank of England governor King warned in his letter to the government that inflation was likely to remain high in the short-term

Sterling was subjected to selling pressure in early Europe on Wednesday with speculation over a dovish set of Bank of England minutes. In particular, there were rumours that some members might have voted for an easing of policy and Sterling came under pressure.

In the event, there was a 8-1 vote for holding interest rates unchanged at 0.50%. Sentance again dissented from the verdict and called for a 0.25% increase in interest rates. The minutes stated that members had considered the options of tightening and loosening policy, but inflation concerns were an important factor.

The data releases later in the week were better than expected with retail sales rising by 1.1% for July while there was a firmer reading for the CBI industrial orders survey.

In addition, the latest government borrowing requirement recorded a deficit of GBP3.2bn for July from GBP13.9bn the previous month. The monthly deficit was also lower than the previous year’s figure which increased optimism towards the structural outlook, at least in the near term.

Swiss franc:

The franc will gain renewed support when confidence in the global economy deteriorates and trends in risk appetite will remain very important for the franc. Underlying doubts over international trends are likely to sustain a firm franc tone in the near term, especially if Euro-zone structural fears return. There should also be a general mood of confidence towards the Swiss economy which will underpin the currency. Volatility is likely to remain an important near-term feature given that the National Bank will certainly be uneasy over the speed of recent gains.

The franc resisted losses during the week and secured renewed gains over the second half as there was renewed safe-haven demand. The dollar weakened to lows near 1.0250 while the Euro retreated sharply to a trough below 1.32.

Sovereign debt fears will continue to be an important market focus and the Swiss currency will continue to gain defensive support on fears that a series of major economies will be at risk of losing their AAA credit ratings in the medium term.

Domestically, there was a record trade surplus for July which helped lessen immediate fears surrounding export competitiveness. There was also a recovery in the ZEW business confidence index to 9.1 for August from 2.2 the previous month.

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The Australian dollar secured robust buying support at times, but was unable to sustain gains during the week and there was again significant weakness over the second half of the week with a test of support below 0.89 against the US currency.

The Australian dollar came under pressure as risk appetite deteriorated with renewed reservations over carry trades and doubts over the global economy.

Confidence in the domestic economy was also generally fragile after a run of weaker than expected data while the General election campaign did not have a major market impact.

Given the underlying global and domestic risk profile, the Australian dollar is liable to have a generally negative bias in the short-term.

Canadian dollar:

The Canadian dollar rallied to the 1.0260 area against the US dollar before hitting resistance and there was some renewed selling pressure later in the week as international risk appetite faded with lows beyond 1.04. A retreat in oil prices also had a negative impact.

A weaker than expected wholesale sales report also had an important impact in undermining the currency with fears that North American demand would be weaker .

The Canadian dollar should prove to be resilient in the short-term. It will still be difficult to secure much of advance given doubts over the global growth outlook.

Indian rupee:

The rupee was able to resist selling pressure for much of the week and consolidated in the 46.55 area against the US dollar. There was a market holiday on Thursday which curbed trading activity to some extent.

Although the currency did come under some selling pressure when there was a deterioration in risk appetite and a retreat in equity prices, there was an important degree of resilience which suggested only limited capital outflows.

The rupee will find it difficult to make much headway given global risk conditions, but should be able to prove broadly resilient given longer-term capital inflows. 

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The Hong Kong dollar was unable to make any significant headway during the week and settled slightly weaker around 7.7730 against the US currency.

Risk conditions remained important and a generally defensive tone towards the global economy stifled demand for the Hong Kong dollar. There was a further decline in US Libor rates which lessened the threat of heavy Hong Kong dollar selling.

The Hong Kong currency should be able to resist substantial losses even if risk appetite deteriorates further, especially as US Libor rates have remained low.

Chinese yuan:

There were no further significant yuan losses during the week and the currency edged slightly firmer to the 6.79 area against the US dollar.

There was evidence that the central bank took note of strong criticism seen the previous week and it did allow the currency to make some ground. Nevertheless, there was no evidence that the bank would allow strong appreciation.

There has been further evidence of official caution over the economy which will increase internal pressure for currency appreciation to be resisted. There was further speculation that the authorities will look to target a trade-weighted yuan index.

The central bank is likely to maintain generally tight control over currency moves in the short-term, especially if doubts over the Chinese and global economic outlook increase.

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