Weekly Forex Currency Review 21-04-2011

Underlying confidence in the dollar is likely to remain very weak in the short-term with further expectations of medium-term reserve diversification away from the US currency as global central bank holdings remain at historically extremely high levels. On valuation terms, the dollar is significantly under-valued against European currencies and there should also be protection from the serious Euro-zone structural vulnerabilities and G7 may look to stabilise markets.

 Key events for the forthcoming week

 Market analysis

Dollar: 

Dollar confidence will remain weak in the short-term amid expectations of further central bank diversification away from the US currency and momentum selling will also be an important factor.  The Federal Reserve will resist a near-term tightening in policy, but it is unlikely to extend quantitative easing which will offer some currency protection. The dollar is also under-valued at current levels and there will be important defensive support at times, especially as there are very important vulnerabilities in other key currencies. Overall, despite initial vulnerability, the dollar should be able to resist further heavy selling pressure.

The dollar gained strongly early in the week as risk appetite deteriorated, but it was unable to sustain the gains and then came under heavy pressure late in the week. The Euro challenged fresh 15-month highs above 1.46 while the dollar’s trade-weighted index was at a three-year low and very close to record lows.

Asian central banks continued to intervene to restrain their currencies against the dollar and there was further speculation that these reserves were being diversified away from the US currency which undermined the dollar.

Standard & Poor’s decision to put the US AAA credit rating on negative watch also had an important market impact. The ratings agency was concerned over the US budget trends and substantial increase in debt-servicing costs. Although an actual downgrading was still considered very unlikely on a two-year view and Moody’s was more optimistic. The Administration pledged to take decisive action to curb the budget deficit, but underlying sentiment remained weak

There was a stronger than expected reading for US existing-home sales for March with an increase in sales to 5.10mn from a revised 4.92mn the previous month and a rise in housing starts, but the market impact was limited as markets remained focussed on underlying yield considerations. There was a renewed surge in demand for high-yield instruments and the dollar was undermined by expectations that the Federal Reserve will maintain a policy of very low interest rates.

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The ECB remains determined to curb inflation and it is certainly looking at the possibility of increasing interest rates again within the next 2-3 months. Structural considerations will also remain very important and there will be further speculation that a Greek debt restructuring will be required very quickly. There will also be continuing fears surrounding the contagion threat. Any debt rescheduling would also increase pressures within the Euro-zone. In this context, there are still very important Euro vulnerabilities which will maintain the threat of a sharp Euro reversal.

The Euro was damaged by fresh structural concerns early in the week, but it recovered quickly and found fresh buying support as dollar confidence evaporated.

The Euro-zone PMI data was solid according to the latest flash readings, although there was some slowdown in the services sector. There were further expectations that the ECB would look to increase interest rates late in the second quarter which reinforced yield support for the Euro.

Confidence in Greek debt was damaged following media reports that the government had sought a debt restructuring at the previous Ecofin meeting. This was denied by the government, but there were also comments from German officials that Greece was unlikely to be able to last beyond the Summer without some form of restructuring and yield spreads continued to widen.

There was further upward pressure on Greek debt yields during the week with rumours that there would be a restructuring during the coming weekend. There was, however, some relief surrounding the latest Spanish debt auction which helped underpin the Euro. There were further expectations that the ECB would look to increase interest rates again late in the second quarter which maintained yield support.

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From a medium-term perspective, there will be a continuing lack of confidence in the Japanese fundamentals as the government debt burden continues to increase. Fiscal and monetary policy will remain highly expansionary and there will be further speculation that the Bank of Japan will eventually have to monetize government debt.  The yen will gain support when risk appetite deteriorates and exporter selling will also increase when the dollar rallies even though the trade surplus has declined. G7 will look to prevent any destabilising moves in the Japanese currency.

The dollar was unable to make any impression against the yen for much of the time and rallies back to the 83.60 area were quickly met with renewed selling pressure. The yen was broadly resilient even when there was a strengthening in risk appetite.

The seasonally-adjusted Japanese surplus declined to JPY0.10trn for March from JPY0.48trn the previous month as exports were undermined by the earthquake impact. The impact on market sentiment should be limited, but there will be some impact in lessening dollar supply from exporters which will provide some underlying support to the US currency.

The Chinese exchange rate policies will remain an important focus, especially with some speculation that there will be a one-off yuan revaluation this weekend. Any move to let the Chinese currency strengthen would tend to support the yen, at least in the very short-term and the dollar dipped to below 82 in Asian trading.

Sterling:

Confidence in the growth outlook will remain weak in the short-term with continuing fears that downward pressure on consumer spending will undermine the economy as a whole.  The expression of growth doubts by the Bank of England will reinforce expectations that the central bank will be very reluctant to increase interest rates which would maintain Sterling vulnerability on yield grounds. Sterling will gain some degree of support on safe-haven grounds, especially given the Euro-zone debt fears and a lack of dollar confidence. This safe-haven support would come under serious threat if confidence in the banking sector deteriorates again.

Sterling retreated to lows below 1.62 against the dollar, but quickly regained support and moved to a fresh 16-month high above 1.6450 as the US currency came under pressure. Sterling was unable to sustain recoveries through 0.88 against the Euro.

The Euro-zone developments will be watched in the short-term and Sterling has the potential for some support as a perceived safe-haven from the Euro stresses. The UK banking sector will, however, also be watched very closely and the currency will be much more vulnerable to selling pressure if fears over bad debts increase again.

In headline terms, the April Bank of England decision in April was unchanged from the March meeting according to the MPC minutes with 3 members voting for an increase in interest rates and Sentence again called for a 0.50% hike in rates while 6 members voted to rates on hold.  There was further concern over the inflation outlook with a warning that the headline rate was set to move above the 5.0% level in the short-term, but members were also more concerned over the downside growth risks with a particular focus on consumer spending.

Following the minutes, there was a further scaling back of interest-rate expectations with doubts whether an increase would be sanctioned this year.

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International considerations will tend to dominate in the short-term. The Swiss currency will remain the ultimate safe-haven, especially with all major alternatives tarnished and this will trigger underlying flows into the Swiss currency.  The franc’s movements will also tend to remain correlated strongly with trends in risk appetite and there will be some franc selling of confidence in the global economy improves. Nevertheless, sustained weakness looks unlikely for now given the vulnerabilities elsewhere.

The dollar was unable to sustain buying support against the franc during the week and weakened to fresh record los near 0.8850 later in the week as the franc was able to resist heavy selling pressure on the crosses.

The Euro advanced against the franc in European trade on Wednesday with some speculation over corporate buying, although it was unable to break above the 1.30 level. A subdued franc tone on the crosses was not sufficient to support the dollar and it retreated to fresh record lows near 0.8850 before stabilising later in the Asian session.

There will be some reduction in defensive franc demand if there is a sustained improvement in risk appetite, especially if there is a move into high-yield currencies. There will still be reservations over selling the franc aggressively and using it as a funding currency for carry trades, especially given persistent vulnerabilities surrounding the Euro-zone.

Australian dollar:

The Australian dollar dipped at times, but buying pressure generally accelerated during the week and the currency recorded a succession of fresh 29-year highs with a peak above 1.07 against the US dollar.

There was strong momentum buying support for the currency and it also gained ground when global stock markets strengthened and risk appetite improved. The Finance Ministry suggested that it would not intervene to weaken the currency.

The latest Reserve Bank minutes suggested that the central bank was satisfied with the current level of interest rates and it also expressed some reservations over the growth outlook.

There will be momentum for further near-term Australian dollar, but it is increasingly vulnerable to a very sharp correction given the pace of recent gains.

Canadian dollar:

The Canadian dollar weakened briefly to beyond 0.97 against the US dollar early in the week, but then gained fresh support and pushed to fresh 3-year highs beyond 0.95.

The latest inflation data was sharply higher than expected with a 1.1% monthly increase for March which put the headline annual rate to over 3% and renewed speculation that the Bank of Canada would need to increase interest rates again.

The trends in commodity prices and risk appetite remained extremely important and a recovery in global confidence provided solid support for the currency.

The Canadian dollar will continue to draw support from the high level of oil prices and speculation over higher interest rates, but is vulnerable to a sharp retreat.

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The rupee had a slightly weaker tone during the week, but losses were measured as there were conflicting pressures on the currency.

The US dollar was generally fragile which provided important support. The local stock market also registered a solid tone which limited fears over potential capital outflows. 

There was unease over the high level of oil prices, especially as it increased fears that the Reserve Bank would be forced to increase interest rates again to curb underlying inflationary pressure.

The domestic and international risk profile will make it difficult for the rupee to advance strongly, but selling should be contained unless credit conditions deteriorate.

Hong Kong dollar:

The Hong Kong dollar maintained a firm tone during the week and temporarily strengthened through the 7.77 level against the US dollar as the US unit remained under pressure.

A recovery in risk appetite helped protect the local currency as equity markets rallied. There was further speculation that the Chinese authorities would let the yuan strength at a faster rate which also provided speculative support for the Hong Kong currency.

Longer-term revaluation speculation and expectations of a stronger Chinese currency should provide underlying support for the Hong Kong dollar.

Chinese yuan:

The yuan has maintained a strong tone during the past few sessions. The central bank has continued to guide the currency stronger with a succession of higher fixes with a move to near 6.523 against the dollar on Thursday.

Inflationary pressures have continued to be an important focus during the week with stronger warnings over the inflation outlook from Chinese officials. This increaseAd speculation that the Central bank would target a faster rate of yuan appreciation or a one-off currency valuation to help dampen imported inflation.

There is an increased risk that the pace of yuan appreciation will be allowed to accelerate or that there will be a one-off revaluation of the Chinese currency.

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