Weekly Forex Currency Review 24-10-2008

Overall strategy: 

Markets will continue to focus on the global economy in the short-term with a further risk of aggressive de-leveraging and position adjustment as the credit shortage bites and recession fears intensify. There is still the potential for defensive support for the dollar and yen, although the US currency is likely to have increasing difficulties sustaining any further advances with at least a short-term correction of recent trends realistic.

Key events for the forthcoming week

Dollar:

Confidence in the US economy will remain weak in the short-term as the financial shocks continue to have a serious impact on the economy. The Federal Reserve is also likely to cut interest rates further to help underpin demand. The global economic situation will be an important influence and the dollar will continue to gain defensive support from fears over a global recession, especially if there are further emerging-market stresses. The dollar will, however, find it increasingly difficult to sustain gains given the deterioration in fundamentals and huge increase in deficit financing.

The dollar retained a very strong tone over the week with gains to a 2-year high against the Euro beyond the 1.26 level and it also pushed stronger on a trade-weighted basis as there were strong advances against many emerging-market currencies.

There was a significant easing in money-market rates during the week as the unlimited central bank injections of liquidity allowed stresses to ease. The easing of these pressures was offset by increased fears over global economic conditions.

There were further major emerging market stresses with notable tensions in Argentina as the government acted to nationalise pension funds while regional equity markets also fell sharply. These pressures were very important in providing underlying dollar support over the week as positions were reduced or forced to be closed.

Risk appetite remained low and the exodus from high-yield and commodity positions was also important in bolstering the dollar with fear at very high levels as metals prices fell sharply and oil prices fell to an 18-month low.

There was little in the way of US major data releases over the week with initial jobless clams rising to 478,000 in the latest week from 463,000 previously. House prices recorded a further decline for August while foreclosures increased by over 70% in the year to the third quarter although there was a small quarterly decline.

Fed Chairman Bernanke maintained a downbeat view of the economy with a warning that there had been a serious slowdown with particular concerns over a sharp downturn in auto sales. Markets continued to price in further interest rate cuts.

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The Euro-zone economy will continue to weaken, especially as the impact of weaker exports becomes an important factor. There should be some support from domestic spending, especially in the German economy which is much less at risk of difficulties within the housing sector. The ECB is likely to cut interest rates further which will undermine yield support. There are also likely to be internal stresses and any further widening of bond spreads between the individual Euro-zone countries would be a negative factor for the Euro.
       
The Euro was subjected to heavy selling pressure against the dollar and yen over the week as confidence in the Euro continued to weaken and there was substantial forced selling. The Euro dipped to 20-month lows against the dollar while it weakened to a five-year low against the yen with huge weekly moves and intense volatility.

The Euro-zone PMI data recorded a monthly decline for October which reinforced pessimism over the region. The comments from ECB officials retained the more dovish slant seen over the past week. Gonzalez-Palermo, for example, stated that there was scope to lower interest rates without undermining inflation control and this appeared a strong signal that rates would be cut again in November.

The Euro-zone current account remained in deficit for August at EUR8.4bn with net investment outflows. There will be further fears over capital outflows and sentiment will remain weak, but there may be scope for longer-term buying to emerge.

Yen:  

The economy is liable to weaken further with a lack of support from domestic demand and a further deterioration in export prospects. The Japanese Finance Ministry is likely to be increasingly uneasy over the situation and the Bank of Japan may consider an interest rate cut. It is also increasingly likely that the Finance Ministry will step-up verbal opposition or intervene to combat disorderly markets. The yen will still tend to retain a firm tone until there is a sustained improvement in confidence towards the global economy.

The yen retained a very firm tone over the week with gains to a 13-year high against the dollar with a dip to below the 95 level and major gains on the crosses with panic yen buying seen on Friday amid massive volatility.

The Japanese currency continued to gain strong support from an unwinding of positions and defensive support as fears over the global economy increased.

The Bank of Japan again downgraded its assessment of the economy with increased fears over the outlook for capital spending and growth conditions as a whole. The latest Japanese trade surplus also recorded further weakness in exports with annual growth held to 1.5% as shipments to the US continued to weaken.

There was increased speculation that the Bank of Japan could move to sanction a cut in interest rates to counter the slowdown and there was also further speculation over a second fiscal stimulus. There was also some speculation that the Finance Ministry could intervene to stabilise markets given the surge in volatility.

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The economy is likely to weaken further in the short-term as consumer spending remains under pressure. The deterioration in conditions surrounding the financial and industrial sectors will also be an important negative influence on the economy with a recession now underway. The Bank of England will cut interest rates substantially over the next few months. There should be a net trade improvement and a reduction in net capital outflows with a correction realistic. Nevertheless, Sterling is still liable to remain at risk in the short-term.

Sterling came under heavy pressure as confidence in the economy and currency continued to deteriorate. The UK currency weakened against the Euro and also dipped rapidly to a five-year low against the dollar with a trough below the 1.57 level.

Bank of England Governor King issued a downbeat assessment with a warning that it was likely that the economy was entering a recession with a difficult few months ahead. King also stated that there was the risk that Sterling would fall further and faster than expected previously which triggered another wave of negative sentiment towards the currency. King also stated that the bank had room to act on rates.
 
There was little sign of relief from the economic data over the week. The CBI industrial survey recorded a decline in the orders component to a five-year low while the overall quarterly survey was at a 30-year low. The housing survey remained weak, although there was some tentative evidence of an improvement in buyer interest UK retail sales fell 0.4% in September with the annual increase at a three-year low of 1.8%, although there will be some relief that the decline was not even sharper.  The latest GDP data recorded a 0.5% decline for the third quarter, the first decline for over 15 years.

There was also a small recovery in monthly BBA mortgage approvals even though there was an annual decline of over 50%. while the latest government borrowing data registered a record GBP37.4bn deficit for the first six months of the fiscal year.

Swiss franc:

The Swiss franc will continue to gain defensive support in the short-term as global economic fears increase. The reduction in net franc borrowing will also tend to underpin the currency, especially if European banking stresses increase. There will be fears over the domestic economy and there will also be the potential for a National Bank interest rate cut in December. The franc should retain a firm tone, but will struggle to secure strong gains.

The Swiss franc maintained a firm tone against the Euro over the week and pushed to highs near 1.47. The Swiss currency weakened to 2008 lows beyond 1.17 against the dollar as the US currency retained all-round strength with extreme volatility.

The franc gained defensive support as market stresses remained at an elevated level with fears over global economic conditions escalating. There was further evidence of a reduction in Swiss-franc denominated loans as Eastern European currencies came under selling pressure as economic fears intensified.

There were no major economic releases over the week while National Bank member Hildebrand stated that inflation pressures were easing and that there would be scope for some action on interest rates.

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The Australian dollar dipped to lows below the 0.66 level against the US currency during the week and it was subjected to renewed selling on Friday as market tensions intensified with a decline to below the 0.65 level.

The Australian currency was undermined by a sharp decline in metals prices as global economic fears increased while there risk appetite remained at extremely low levels with stock markets unable to sustain any gains

The inflation data was slightly stronger than expected with a 1.3% increase in prices for the third quarter, although the impact was limited as inflation data has been overtaken by events with markets expecting further rapid interest rate cuts.

The Australian dollar moves will remain correlated strongly with trends in risk aversion and the degrees of confidence in the global economy. Some corrective recovery is realistic in the short-term with volatility at extreme levels.

Canadian dollar:

There was intense volatility in the Canadian dollar over the week. From a peak close to 1.13, the Canadian currency weakened dramatically to lows near the 1.28 level as the US currency secured rapid gains.

The Bank of Canada sanctioned a 0.25% cut in interest rates to 2.25% compared with expectations of a 0.50% cut while the bank also suggested that rates would be cut further over the next few months.

The Canadian dollar continued to suffer from the sharp decline in commodity prices and the downgrading of growth prospects both for Canada and globally.

The Finance Ministry suggested that there could be a further fiscal stimulus to help support the economy, but confidence in the economy remained extremely fragile.

The Canadian dollar will remain vulnerable if there are increased fears over the global economy, but there is scope for a corrective recovery following rapid recent losses.

Indian rupee:

The rupee remained under serious pressure as stresses in global markets remained at elevated levels. The rupee dipped to record lows beyond the 50.0 level against the dollar as underlying US currency demand remained strong.

There was central bank intervention to help support the currency and it regained the 50.0 level on Friday. The central bank also acted to cut interest rates with the key lending rate reduced by 1.0% to 8.0%. The government lifted restrictions on foreign borrowing in an attempt to boost the economy.

The degrees of risk appetite and global growth fears will tend to remain dominant for now with the rupee under pressure unless there is a sustained recovery in risk appetite.

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The Hong Kong dollar remained strong at close to the 7.75 band limit and the HKMA injected US$600mn into the market on Thursday to prevent the currency breaching the limit. Liquidity levels remained low and this tended to keep the currency firm.

There were still fears over the local economy as growth prospects slow while there we important stresses surrounding CITIC Pacific, especially as the Hang Seng index remained under pressure. Market rates eased slightly later in the week.

The Hong Kong dollar should retain a firm tone in the near term with the HKMA continuing to intervene to prevent gains through the 7.75 lower limit.

Chinese yuan:

The Chinese yuan  remained trapped in a relatively tight range against the dollar over the week as the central bank continued to promote stability. The currency did, however, secure further sharp gains against the Euro.

The GDP data recorded a slowdown in growth to 9.0% in the third quarter from 10.1% previously while industrial output growth slowed to a six-year low as growth faltered. There were further expectations that the authorities would promote growth.

The NDF market continued to signal modest yuan depreciation for the next year.

The Chinese authorities will remain concerned over the growth outlook and will have a bias towards lowering interest rates. The principal concern is likely to be to avoid instability with a resistance to any near-term appreciation against the dollar. 

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