Weekly Forex Currency Review 23-07-2010

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Confidence in the US economy has remained generally weaker and this will tend to undermine fundamental support for the US currency. Demand for the dollar is liable to be determined to an important extent by trends in the global economy. Fears that impetus in the global growth will deteriorate is still likely to provide some protection to the US currency even if confidence is firmer in the near term.                   

Key events for the forthcoming week

Dollar:

There will be further expectations of a slowdown in the US economy over the next few months, especially with generally downbeat comments from the Federal Reserve chairman. There will also be some further speculation that the Fed will take additional steps to support the economy. The dollar will, therefore, not be in a good position to gain support on fundamental grounds.  There will also still be unease over the global economy and the dollar can secure defensive support particularly as capital outflows from the US into emerging markets are liable to be more limited. There is scope for dollar resilience despite initial losses.
   
The dollar was unable to make significant headway during the week with the currency undermined by a lack of confidence in economic prospects and a deterioration in yield support. The dollar dipped to lows just beyond 1.30 against the Euro and was also generally fragile on a trade-weighted basis.

The US housing starts data was weaker than expected with a 5% weekly decline to an annual rate of 0.55mn, but there was a monthly gain in permits which helped cushion the impact. The NAHB sentiment index dipping to 14 for July from a revised 16 previously and this was the lowest figure for 15 months. There was still unease over the US economic trends with persistent speculation over a deterioration in conditions

The US economic data was mixed later in the week, but markets looked to put a positive outlook on the figures, especially as corporate earnings results were generally favourable. Existing home sales fell less than expected to 5.37mn for June from 5.66mn the previous month as tax credits expired. The jobless claims data was weaker than expected with an increase to 464,000 for the latest week from a revised 427,000.

Fed Chairman Bernanke was generally cautious with comments that economic outlook was unusually uncertain. He stated that financial conditions were less favourable for growth, but there was some optimism that loan losses had peaked while there were comments that the economy was moving ahead moderately. Bernanke also stated that it was evaluating various methods to shrink the balance sheet.

There was some relief that the Fed did not announce a cut in interest rates payable on excess reserves, but Bernanke did outline potential additional support measures if they were required and this reinforced a lack of yield support for the dollar and the dollar failed to extend gains beyond 1.2750 against the Euro.

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Confidence surrounding the Euro-zone remains more stable and there will be relief if the bank stress-test results do not reveal any major surprises. The most recent economic data has also been better than expected which will ease fears surrounding a renewed downturn in the economy. There are still very important vulnerabilities on structural and cyclical grounds and confidence could still erode rapidly within the next few weeks. The Euro will also remain geared to global economy and will be in a better position to sustain the recent recovery if risk appetite remains firmer.

The Euro came under pressure at times during the week, but did prove to be broadly resilient and the Euro corrected quickly from initial weakness. The Irish credit rating was downgraded to Aa2 from Aa1 by Moody’s, on persistent fiscal weakness with the outlook described as stable.

There was a weak Hungarian debt auction which tended to undermine Euro sentiment to some extent following the setback on IMF talks. There was some wider negative impact on the Euro with fears that there would be a contagion effect on weaker Euro-zone economies such as Greece and Spain.

The Euro also spiked higher in European trading on Tuesday and pushed to fresh 10-week highs above 1.3020, helped in part by higher than expected German producer prices, although the Euro was unable to sustain the advance.

The Euro-zone data later in the week was stronger than expected which provided some degree of support for the currency. The PMI index for the manufacturing sector strengthened to 56.0 for July from 55.5 the previous month. The industrial orders data was also stronger than expected with a sharp 3.8% monthly increase for May which triggered some improvement in confidence surrounding the manufacturing sector. The German IFO index also rose strongly to 106.2 from 101.8 which boosted the Euro.

Yen:   

The yen will continue to gain some protection from doubts over the US economy. Overall trends in risk appetite will also be important and the yen will gain when risk appetite deteriorates. The Japanese fundamentals will remain under close scrutiny and there will be further speculation that the Bank of Japan and Finance Ministry will take further action in an attempt to block yen appreciation much beyond current levels. In this context, the yen will find it difficult to sustain any strong advance from current levels.

The yen maintained a firm tone for much of the week, but there was selling pressure at higher levels due to reservations over the risk of measures to weaken the yen. The dollar found support on dips to below 86.50 as the yen tested 7-month highs.

There were media reports that the Bank of Japan would take additional policy steps if the yen appreciated to the 85 area which curbed yen buying support.

During the remainder of the week, markets continued to speculate over additional central bank action to curb yen gains. The Asian Development Bank (ADB) also issued more optimistic forecasts for the Asian economy which lessened defensive yen demand to some extent.

Cautious remarks on the economy by the government had a small negative impact on the yen, although the official Cabinet Office assessment was left unchanged in the July report. As risk appetite improved, the yen lost some support on the crosses with the Euro finding support on dips to the 110 region.

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There will be uncertainty over UK growth trends with mixed signals likely to persist. There will also be uncertainty over the Bank of England policies, especially with speculation of increased divisions within the MPC. This uncertainty is liable to translate into increased Sterling volatility over the next few weeks. Initial support triggered by the GDP data could still falter quickly. The currency will be vulnerable to renewed selling pressure if there is a sustained deterioration in confidence surrounding the global economy. A lack of confidence in other economies will continue to provide important protection.  

Sterling weakened to a low close to 1.5150 against the dollar on doubts over the UK economy and reservations over the global economic environment, but then found buying support with evidence of solid corporate demand.
The UK government borrowing requirement rose to GBP14.5bn for June compared with expectations of around GBP13bn. The data reminded markets over the very serious budget situation and the difficulties in bringing the shortfall under control.

The latest housing data was also weaker than expected with a dip in mortgage approvals for June.  The latest UK retail sales data was also stronger than expected with a 0.7% monthly increase for June following a revised 0.8% gain the previous month.

The data helped maintain expectations of solid consumer spending trends in the near term and there was a much bigger than expected increase in GDP with a reported 1.1% increase for the second quarter.

The Bank of England MPC minutes recorded a 7-1 vote for unchanged interest rates at the July meeting with Sentance voting for an increase for the second successive meeting. The minutes revealed that there were discussions to consider both a modest tightening and loosening of conditions. The bank was uneasy over the inflation outlook, but also expected growth to be weaker than expected. These expectations were repeated in comments by bank officials during the week.

Swiss franc:

The franc will lose some defensive support if there is a sustained improvement in sentiment surrounding the Euro-zone, satisfactory bank-sector tests and reduced fears over credit ratings. There will still be some underlying defensive demand for the Swiss currency and the possibility of strong safe-haven buying if Euro fears intensify again. Given these fears, there is unlikely to be strong near-term selling pressure on the franc.

The Swiss currency initially came under pressure against the Euro, but gained support at levels close to 1.36 before regaining ground. The dollar dipped to re-test six-month lows just below 1.04 against the franc.

There was a monthly increase in the Swiss trade surplus which provided some underlying franc support with reduced fears that exporter competitiveness was at risk.

There was uncertainty over the  potential for central bank action. The National Bank recorded losses of CHF14.1bn for the first half of 2010 which reinforced market speculation that the central bank would not be in a position to intervene.

There was still some speculation that it could consider intervention if there were sharp gains for the franc. The primary trigger for a Euro rally was a wider improvement in risk appetite rather than a major reduction in franc demand.

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The Australian dollar had a generally fragile tone during the first half of the week with a test of support below 0.87 against the US dollar. There was buying support at lower levels and there were gain to above 0.8950 with the currency gaining support from rising equity markets.

Despite a decline in business confidence, there was some speculation that the Reserve Bank would consider a further increase in interest rates which provided important support for the Australian dollar.

The Australian dollar moves will continue to be influenced strongly by trends in risk appetite. Overall, even with the possibility of initial gains, the Australian dollar will find it difficult to make much headway given the international risk profile.

Canadian dollar:

The Canadian currency found support close to 1.06 against the US dollar and then secured a firmer tone with an advance to the 1.0350 area.

The Bank of Canada increased interest rates to 0.75% from 0.50% at the latest policy meeting and suggested that rates were likely to increase again. There was some caution over the outlook for next year by the central bank.

The currency was able to draw support from an improvement in risk appetite which helped offset underlying doubts over the global economy.

Volatility levels are liable to remain higher in the short-term. The Canadian can certainly prove to be resilient, but is likely to find it difficult to make much headway given doubts over the global growth outlook.

Indian rupee:

The rupee dipped to six-week lows against the US currency during the week as it tested levels beyond 47.30 against the US currency. There was firm corporate demand for the US currency and the rupee found it more difficult to gain support when risk appetite improved.

There was increased unease over the trade account trends and fears that underlying capital inflows were weakening. Nevertheless, a rebound in global stock markets and some general weakening of the US dollar provided some support for the rupee.

Despite losses when international risk appetite deteriorates, the rupee should be able to prove broadly resilient given longer-term optimism towards fundamentals. 

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The Hong Kong dollar found support close to 7.78 against the dollar during the week. A softer tone for the US currency and a rebound in global equity markets provided some degree of support for the local currency.

There was still some degree of unease over the global economy which tended to limit demand for the Hong Kong dollar.

The Hong Kong dollar trends will be influenced by developments in risk appetite and the Chinese yuan. Given the softness in US rates and a fragile US currency, the Hong Kong dollar should be able to resist substantial losses.   

Chinese yuan:

The Chinese yuan was unable to make further headway against the US dollar during the week and edged slightly weaker with further evidence that the central bank wanted to encourage two-way activity and discourage speculative capital inflows.

The Chinese authorities stated that the yuan would be managed against a basket of currencies rather than the dollar. This maintained some expectations that declines against the dollar could be tolerated or even encouraged, especially if there are wider US currency gains.

The central bank is likely to maintain a considerable degree of control over the currency moves. There is likely to be resistance to sharp yuan gains unless there is a sharp international decline in the US dollar’s valuation

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