Weekly Forex Currency Review 26-02-2010

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The Euro-zone outlook will remain a key near-term focus with fears over the structural outlook still a crucial factor as wider issues surrounding sovereign debt also remain an important element. There is also the risk that confidence in the global economic outlook will weaken further which will maintain some defensive demand for the US dollar and Japanese yen.             

Key events for the forthcoming week

Dollar:

The most recent economic data will dampen optimism to some extent and there will be reduced speculation over a near-term increase in interest rates which will also tend to dampen dollar demand on yield grounds. There will still be expectations that the US economy will out-perform the Euro-zone and there will also be defensive dollar demand if confidence in the global economy deteriorates and buying pressure could intensify if there is an unwinding of carry trades. Fears over medium-term fundamentals will tend to limit the scope for strong dollar buying support.

The dollar maintained a generally firm tone over the week and strengthened to fresh nine-month highs against Sterling while also testing nine-month highs near 1.3450 against the Euro.

The dollar gained support from a lack of confidence in the European economies and a more tentative attitude towards risk. Its performance elsewhere was more subdued and it did correct weaker in choppy trading conditions.

There was a rise in US durable goods orders for January which provided some scope for optimism over the industrial sector. In contrast, there was a significant increase in jobless claims to 496,000 in the latest week from a revised 474,000 previously. The data is inevitably erratic on a weekly basis, but the recent deterioration, allied with poor readings for consumer confidence, increased unease over a potentially weaker labour market.

Consumer confidence also dipped sharply to 46 for February from a revised 56.5 the previous month and this was the lowest figure for 10 months as confidence in the labour market deteriorated. There was also a weak reading for US new home sales with an 11.3% monthly decline to a record low.

Fed Chairman Bernanke stated that economic conditions were improving and that deterioration in the labour market was also easing. There were also comments that the Fed would eventually need to tighten policy as the recovery improves. Nevertheless, Bernanke retained his comment that interest rates would need to stay at exceptionally low levels for an extended period and there was no suggestion of a near-term policy tightening. In response, futures markets cut the chances of a Fed funds hike by November to around 50%

Bernanke stated that public debt fears could hurt the dollar. These type of comments will always attract attention and have an important negative currency reaction with the dollar significantly weaker following the remarks.

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Euro-zone structural vulnerabilities will continue to be key market focus in the short-term. Confidence in the Greek economy will remain very weak and there will also be fears that any support package will intensify medium-term stresses within the Euro area, especially with the threat of tensions with Germany. There will also be pressure on the ECB to delay any monetary tightening which will tend to curb Euro demand. 

The Euro remained under pressure during the week as sentiment towards the region and currency remained generally very weak. The currency did, however, manage to rally from its worst levels with some evidence of central bank interest in buying the currency.

The German IFO index of business confidence was weaker than expected with a decline to 95.2 for February from 95.8 the previous month and contrary to expectations of a slight increase. The data is likely to have been distorted by bad weather, but the deterioration reinforced a lack of confidence in the Euro-zone economy and pushed the Euro significantly weaker.

There were fresh warnings on Thursday from credit-rating agencies Moody’s and Standard & Poor’s that Greece’s debt ratings faced further downgrades while there were further political stresses within Greece over the issue of budget cuts.

There were fears over the risk of a debt default by Greece and that any support for the country would compromise underlying cohesion.

Yen:  

The Japanese currency will still tend to gain some support when international risk aversion rises. Potential support for the Japanese currency will tend to intensify if there is sustained downward pressure on commodity prices and an aggressive tightening by Japan. Underlying confidence in the Japanese economy will still be very weak which should limit the scope for strong yen gains.

The yen was generally robust during the week with gains to a peak below 89 against the dollar while it made strong gains against the Euro and Sterling before a partial recovery late in the week.

Bernanke’s generally dovish comments on the US economy and interest rate outlook curbed dollar support on yield grounds and this remained an important factor in curbing near-term dollar demand.

Markets struggled to find a decisive trend on risk appetite, but the general tone was more cautious which helped to underpin the Japanese currency.

Japan recorded a trade surplus for January which provided some yen support, although this month’s data is often distorted

The yen will tend to gain some support on fears of sovereign defaults in other major countries, especially if fears over the global economic outlook increase. Potential yen support will still be limited by the fact that confidence in Japan’s economy will also remain weak, especially as government-debt stresses persist.

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The recent economic data, allied with generally downbeat comments from the Bank of England, will tend to undermine confidence in the economy and also increase fears that the economy could move back into recession. Fears over the growth outlook will tend to intensify fears over the government-debt situation. Confidence will also tend to deteriorate if it looks like there will be an indecisive result in the general election which is likely to be held in May.

Sterling was subjected to further and at times heavy selling pressure during the week. There were lows near 1.52 against the dollar while it also lost ground against the Euro.

After initial stability, the currency was then subjected to heavy selling pressure following testimony from Bank of England officials on the inflation report.

Governor King stated that the economic recovery remained very fragile and that further quantitative easing remained a possibility with the decision reviewed on a monthly basis. The generally downbeat comments undermined Sterling support even though King also stated that the impact of quantitative easing had not yet been felt.

Underlying confidence in the economy also remained very weak as debt fears persist and there was also a weaker than expected reading for mortgage approvals which fell sharply for January.

The latest investment data was also weak with a further 5.8% contraction for the fourth quarter of 2009. Although based on different surveys, there was some unease that the data could signal a weaker than expected figure for revised fourth-quarter GDP data due on Friday.

There was stronger than expected figure for the latest CBI retail sales survey, but the potential positive impact was offset by persistent structural fears as confidence in the debt situation remained very weak. Bank of England MPC member Barker also warned that the UK economic recovery was not strong which reinforced negative market sentiment.

Swiss franc:

The Swiss currency will continue to gain defensive support from fears over the Euro-zone economy and there is still the possibility of strong buying support if Euro fears intensify. Any sustained deterioration in global risk appetite would also tend to underpin franc demand. Speculation over National Bank intervention to curb franc strength will still be a very important market feature and volatility levels are liable to remain higher as market rumours of bank action will persist.

The dollar advanced to highs above 1.0850 against the Swiss franc, but was unable to sustain the advance and retreated back towards 1.0750 late in the week. The Euro spiked higher against the franc at one point on suspected National Bank intervention, but failed to sustain the gains and weakened back to towards the 1.46 region.

The franc continued to draw defensive support from the lack of confidence in the Euro-zone while there was a solid reading for the UBS consumer confidence index.

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The Australian dollar pushed above the 0.90 level against the US dollar, but was unable to sustain the gains and weakened back to test support in the 0.8850 region against the US currency.

The currency drew initial support from generally upbeat comments from Reserve Bank of Australia officials which reinforced expectations of higher interest rates.

Commodity prices came under selling pressure later in the week and risk appetite was also generally weaker which undermined sentiment.

There will be expectations of higher interest rates in the near term, but the Australian currency is liable to remain constrained by global economic fears in the near term.

Canadian dollar:

The Canadian dollar strengthened to highs just beyond 1.04 against the US dollar, but was unable to sustain the gains and dipped relatively sharply to lows near 1.0680 before finding support.

Confidence in the Canadian economic fundamentals was still strong, but a combination of weaker risk appetite and declining commodity prices had an important negative impact on the currency.

The Canadian dollar will again find it difficult to make strong gains given the doubts over global economic trends, but an absence of debt fears should help limit selling pressure on the currency.

Indian rupee:

The rupee had a slightly weaker tone over the week, but was able to resist heavy selling pressure and consolidated around 46.50 against the US currency.

The local stock market found it very difficult to make headway amid unease over the global economy and there was further speculation over capital outflows which tended to undermine the currency. There was some investor caution ahead of the 2010 budget presentation.

The rupee will find it difficult to appreciate significantly in the short-term given that confidence in the global economy is likely to remain generally fragile.

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The Hong Kong dollar was confined to narrow ranges during the week, consolidating around 7.765 against the US dollar.

There was a mood of uncertainty over local stock-market direction and unease over the potential for further monetary tightening by the Chinese authorities and this tended to curb demand for the Hong Kong dollar.

The currency did gain some support from Fed Chairman Bernanke’s comments over the need for low interest rates.

There is likely to be a relatively high degree of regional policy uncertainty which could undermine the Hong Kong dollar, although selling pressure overall should be contained.

Chinese yuan:

The Chinese markets were still subdued following the New-Year break and the spot rate remained confined to narrow ranges.

There was still a high level of speculation over potential changes to the yuan regime with further speculation that there could be a near-term currency revaluation.

The Commerce Ministry maintained a pledge over currency stability, but there were also comments that stress tests would be carried out to assess the potential impact on exporters of a stronger exchange rate. The overall tone suggested a considerable degree of internal debate over the exchange rate issue.

Speculation over a yuan revaluation or gradual appreciation of the currency by re-starting the crawling peg appreciation is likely to remain a key short-term feature and a policy change is likely to be considered.