Weekly Forex Currency Review 25-06-2010

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The global economic trends and stresses within the financial sector will continue to have an important impact in the short-term. There are likely to be persistent fears over a renewed tightening of credit conditions, especially within the Euro-zone and this is likely to maintain some defensive demand for the US dollar.                  

Key events for the forthcoming week

Dollar:

The US economic data will reinforce unease over the risks of a renewed deterioration in conditions during the second half of 2010. There will also be additional pressure on the Federal Reserve to resist any monetary tightening while weaker growth would reinforce medium-term budget debt fears. In this environment, the dollar is not in a good position to secure firm buying support on domestic grounds. There is still the potential for defensive US currency demand, especially as there are likely to be growing doubts over the global economy while liquidity stresses could trigger strong dollar gains.

The dollar dipped at the beginning of the week following the Chinese move to give the yuan greater flexibility. Although it regained ground, the US currency was unable to regain momentum as domestic currency support was weaker. There was some defensive dollar support as risk appetite was fragile.

As far as the economic data is concerned, the US housing data was weaker than expected with a decline in existing home sales to 5.66mn for May from a revised 5.79mn the previous month. Markets had been expecting a rise in sales ahead of a tax-break expiry and the decline will reinforce fears over a deterioration in second-half housing prospects.

US new home sales fell sharply to an annual rate of 300,000 in May from a revised 446,000 the previous month and this was a record low reading for sales.

Headline durable goods orders fell 1.1% while there was a 0.9% underlying monthly increase. The jobless claims data recorded a decline to 457,000 from a revised 476,000 previously. There was unease over fragility within the labour market while there will also be persistent doubts over the housing sector
As expected, the Federal Reserve left interest rates on hold at the 0.00-0.25% range following the latest FOMC meeting. The statement was slightly more pessimistic than previously with comments that financial conditions were now less supportive of growth.

Although Regional Fed President Hoenig again dissented against the decision to maintain rates at very low levels for an extended period, there will be reduced expectations of a near-term rate hike. The statement undermined the dollar with the Euro able to bounce back above the 1.23 level

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Underlying confidence in the Euro-zone economy and Euro will remain very fragile with continuing doubts whether the Euro area will survive in its current form.  There will also be fears that banking-sector stresses will intensify over the next few weeks. From a longer-term perspective, a further orderly currency decline is unlikely to meet serious opposition, especially as a weaker currency would help underpin export growth. There is liable to be friction between national governments and the ECB which will make it difficult for the Euro to sustain a significant rally.

The Euro probed resistance levels above the 1.2450 level against the US dollar in early European trading on Monday, but was unable to sustain the advance and drifted back over the following 24 hours.

Initial gains following the Chinese currency move faded even though international risk appetite was still generally stronger. ECB President Trichet stated that there could be tougher penalties on governments who broke fiscal rules and this reminded investors that there were still important structural vulnerabilities within the Euro area. There was also a downgrading of BNP Paribas’ credit ratings which reinforced fears over the European banking sector.

Later in the week, there was a renewed widening in Greek credit default swaps which unsettled the Euro while there were also rumours that ratings agency Fitch was going to put the French rating on negative watch for a possible downgrade. There were also comments from financier George Soros that Germany could bring down the Euro

The German IFO index rose slightly to 101.8 for June from 101.5 the previous month which was contrary to expectations of a small monthly decline. The Euro-zone industrial data did not have a major impact with the PMI manufacturing index declining to a four-month low and there will be unease that the German new orders index dipped to near the 50 level.

The Euro was able to prove more resilient over the second half of the week with some reduction in speculative short positions.

Yen:   

The yen will tend to gain support when risk appetite deteriorates, especially as there are likely to be persistent doubts over the global economy which will limit interest in carry trades. There will also be unease over US and Euro-zone fundamentals which will tend to curb selling pressure on the yen. There has been some anticipation of improved Japanese fundamentals in the medium term, but confidence will remain fragile and the yen will find it difficult to sustain any substantial near-term gains.

There was confidence in the regional economy and currencies following China’s currency move and this helped underpin the Japanese currency. The dollar dipped to the 90.25 area against the yen on Monday before strengthening to the 90.70 area as improved risk appetite curbed demand for the yen.

The decline in stock markets during the week helped underpin the Japanese currency as interest in carry trades faded. The dollar also lost support following the US Federal Reserve statement as dollar support declined with US Treasuries at an 8-month low.

There was some slowdown in Japanese export growth according to the latest trade data which may trigger some degree of caution over yen appreciation, although the impact will be limited unless fears over the global economy intensify.

The dollar weakened to lows near 89.20 as global equity markets retreated and there was a further decline in US Treasury yields.

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The restrictive budget presented by the government will strengthen expectations that the UK will maintain its AAA credit rating which will help underpin sentiment. There will also be expectations of firm near-term consumer spending trends with buying ahead of next year’s sales tax increase. There will still be doubts whether the Bank of England will be in a position to increase interest rates significantly. There will also still be doubts over the longer-term trends and the structural position is still very fragile, especially if financial-sector fears increase. In this context, rallies are liable to fade relatively quickly.
 
Sterling maintained a firm tone over the week with the currency gaining support from an impression of improved domestic fundamentals.

The UK government statement was broadly in line with expectations as the administration pledged to eliminate the structural budget deficit within 5 years through a mixture of spending cuts together with tax increases.

The principal tax proposal was an increase in the sales to tax to 20% from 17.5%, but the increase will not be introduced until the beginning of 2011.  A delay in increasing taxes will tend to lessen near-term fears over a renewed downturn in consumer spending which will also provide some degree of Sterling support as it will help lessen the immediate threat of a slide back into recession. Moody’s stating that the fiscal measures would help the UK maintain its AAA credit rating.

The Bank of England minutes recorded a 7-1 vote for unchanged interest rates at the June meeting with 1 vacancy on the 9-member MPC. Sentence dissented against the decision and voted for an immediate increase in rates to 0.75%. The vote for an increase increased speculation that the bank could move towards an earlier than expected tightening which would also provide some Sterling support.

The UK currency pushed to a 5-month high on a trade-weighted basis while the currency also pushed to a 19-month high against the Euro given expectations that UK interest rates would be increased earlier than expected.

There was tough resistance close to the 1.50 level and Sterling was subjected to profit taking against the dollar and Euro.

Swiss franc:

The franc will continue to gain defensive support from a general lack of confidence in the Euro and Euro-zone economy. The National Bank policies will remain under very close scrutiny in the short-term and there have been clear suggestions that the bank will not intervene in the short-term, especially as there are reduced fears over the risk of deflation. The bank will still be under pressure to prevent substantial currency gains. The dollar should also be able to resist substantial selling pressure.

The Swiss franc maintained a strong tone over the week as there was no move by the central bank to restrain the currency. The Euro weakened to test record lows below 1.36 against the Swiss franc while the dollar dipped to lows below 1.10.

The comments from National Bank members continued to maintain expectations that there would be no near-term intervention to weaken the Swiss currency. Jordan, for example, commented that the risks of deflation had largely disappeared for now which lessened the pressure for a weaker Swiss currency.

The trade surplus narrowed sharply for May, but the underlying export performance was firm which will also tended to lessen immediate fears surrounding competitiveness and ease pressure for franc gains to be resisted.

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The Australian dollar hit selling pressure above 0.8850 against the US dollar and there was a generally weaker tone over the second half of the week as equity markets weakened for four consecutive sessions with lows near 0.86. Commodity prices also dipped and global freight rates also continued to decline.

There was political uncertainty with Prime Minister Rudd facing a leadership challenge and this resulted in a swift change of leaders with Gillard elected as the new leader and Prime Minister.

The Australian dollar moves will continue to be influenced strongly by trends in risk appetite and degrees of optimism over the world economy. Volatility is liable to remain higher and the currency will find it difficult to make much headway.

Canadian dollar:

The Canadian dollar pushed to a high beyond 1.02 against the US dollar as risk appetite improved, but it was unable to sustain the advance and weakened back to lows near 1.0450.

There was a more cautious attitude towards risk during the remainder of the week as equity markets came under pressure and there were renewed doubts surrounding the global economy.   

Volatility levels are liable to remain higher in the short-term and the Canadian dollar will find it difficult to secure significant gains given the global risks.

Indian rupee:

The rupee strengthened sharply following the announcement that the Chinese yuan would be given greater flexibility and there was a peak close to 45.70 against the US dollar.

There was optimism over capital inflows as confidence in the regional economy improved and there were estimates of net inflows of around US$1.7bn for June.

The rupee drifted weaker over the remainder of the week as there was a more cautious attitude towards risk appetite

Despite losses when international risk appetite deteriorates, the rupee should be able to maintain a solid tone given underlying optimism over longer-term capital flows.  

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The Hong Kong dollar strengthened sharply following the announcement of greater flexibility for the Chinese yuan with the spot rate moving to highs just beyond 7.77 against the US currency.

There were expectations of regional capital inflows while underlying risk appetite also improved. The currency failed to sustain the gains with a gradual drift weaker as the mood of optimism faded.

The Hong Kong dollar trends will be influenced by developments in risk appetite and the Chinese yuan with only limited near-term currency gains realistic.

Chinese yuan:

Over the weekend, the Chinese central bank announced that it would give the currency greater flexibility with increased daily ranges. There would still be a restriction on daily currency moves and there was also a rejection of  a one-off revaluation for the currency.

The spot yuan rate did move significantly, although there were declines and advances with the currency strengthening to a post-revaluation high close to 6.79.

There was still significant US criticism of the move from within the US congress with demands for much greater action by the authorities.  

There will be greater daily fluctuations for the Chinese yuan, but the central bank is still likely to resist substantial near-term appreciation, especially if there is evidence of any deterioration in global growth conditions.

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