Weekly Forex Currency Review 27-08-2010

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Underlying confidence in the global economy is liable to remain weaker in the short-term which will continue to provide some significant defensive support for the US dollar and will also continue to underpin the yen.  G7 policy actions will be watched very closely given heightened speculation that the Bank of Japan will intervene to weaken the yen. Volatility levels are liable to increase in the short-term, especially with many senior fund managers on holiday during this period.               

Key events for the forthcoming week

Dollar:

The latest economic data will maintain fears over a significant slowdown in the economy, especially with all sectors looking vulnerable. The Federal Reserve will maintain an expansionary policy and there will be speculation over additional policy measures to expand quantitative easing. From a medium-term perspective, confidence in the US fundamentals will also remain very fragile, especially with the budget deficit already at unsustainable levels. The global economic conditions will also be very important for dollar sentiment and the US currency should gain important short-term protection from the general mood of caution with some defensive flows into US Treasuries.

The dollar continued to gain some defensive support during the week as confidence in the global economy deteriorated. The difficulty for the dollar was that much of the negative sentiment was triggered by weak US data and this reminded markets over the domestic vulnerability which sapped dollar strength.

The US housing data was substantially weaker than expected with existing home sales falling 27% to an annual rate of 3.83mn. Although a sharp decline was expected following the ending of tax credits, the decline increased fears that the US economy will slide back towards recessionary conditions and prompt more aggressive quantitative easing by the Federal Reserve.

New home sales also fell by 12.4% for July to a record low annualised rate of 276,000. Following the very weak existing home sales data, a disappointing reading was likely. There will, however, be greater concern over the durable goods data which recorded a much weaker than expected 0.3% gain for July while core orders fell 3.8%.

The industrial sector has been able to provide firm support during 2010 and there will be fears that this sector is now looking vulnerable. In particular, there will be concern over a sharp decline in core capital goods spending.
The latest US jobless claims data was slightly better than expected with a decline to 473,000 in the latest week from a revised 504,000 previously. There will be some relief that the immediate deterioration in data has been stemmed, but there will still be expectations of a soft labour market and underlying confidence towards the economy remained weak.

Although the data increase fears over the global economy and maintained a defensive attitude towards risk appetite which helped underpin the dollar, there were also continuing fears over the US economy and pressure for a further expansion of quantitative easing. Markets were anxiously awaiting comments from Fed Chairman Bernanke for further policy hints.

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There will be some near-term optimism that the Euro-zone economy can maintain solid growth, supported by a strong performance within Germany. There will also be expectations that the underlying divergence in performance between the stronger and weaker economies could intensify and there will be fears that growth will stall very quickly. There will be persistent fears over Euro-zone structural vulnerability and the threat of medium-term bond defaults which will tend to lessen Euro support. The Euro will remain generally more vulnerable when there is a general deterioration in risk appetite.

The Euro remained vulnerable during the week as internal yield spreads widened while there was a general deterioration in risk appetite. The Euro was generally weak on the crosses, especially against the Swiss franc, but did find some support in the second half of the week against the dollar.

The Euro was also undermined during the week by a downgrading of the Irish credit rating to AA from AA1 by Standard & Poor’s. There was a decline to lows below 1.26 against the dollar and it also tested 8-year lows below 106 against the Japanese yen as sentiment deteriorated.

In contrast, the currency drew support from a stronger than expected reading for the German IFO index.  The recent Euro-zone data has continued to suggest resilience, especially in the key German economy and this is providing some Euro support.

Stronger than expected demand in the latest Irish bond auction also provided some degree of relief for the currency even though underlying structural fears persisted.

Yen:   

Defensive demand for the yen will also tend to increase if confidence in the global economy continues to deteriorate, especially if European financial-sector fears also increase further.  The domestic policy stance will continue to be extremely important and there will certainly be a high degree of unease over the implications of yen strength. There will be further verbal warnings and there will be intense speculation over intervention to weaken the yen. The Japanese currency would weaken sharply on any intervention, but losses could be regained quickly, especially if there is no wider G7 backing for the intervention.

The dollar came under heavy selling pressure against the yen during the week with stop-loss selling an important feature once support near 85 was broken. The US currency weakened to 15-year lows near 83.50.
 
The dollar did find support below 84 and the yen weakened after Finance Minister Noda commented that he was ready to take appropriate action.

There were further hints over possible action by the Finance Ministry while the Bank of Japan indicated that it will look at fresh measures to boost the money supply. While markets continued to fret over the possibility of intervention, there was a reluctance to sell the yen, but pressure on the dollar could build quickly if there is no action.

Trends in risk appetite also remained very important and the yen will continue to gain defensive support from a lack of confidence in the US and Euro-zone economies.

The domestic economic data did not have a major influence with the inflation data close to expectations as there was a 1.1% core decline for prices in the year to June while unemployment declined to 5.2% from 5.3%. There were still fears over underlying deflationary pressure.

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The latest economic data has not increased fears over the economy at this stage. There are still likely to be expectations of a slowdown in the economy, especially with consumer incomes remaining under pressure.  There will be further divisions within the Bank of England, but the most likely outcome is that the bank will decide against any tightening at this stage and the domestic outlook is unlikely to provide strong support, especially if there are renewed fears over the banking sector.  Sterling will gain important protection from a lack of confidence in the US and Euro-zone economies and this should help stem losses.  

Sterling came under pressure against the dollar during the week and tested support below 1.54, but there was buying support at lower levels and the currency was broadly resilient

Sterling was undermined initially by the wider deterioration in risk appetite while the domestic policy concerns also increased. New MPC member Weale stated that there was a risk of the economy moving back into recession.

Sterling gained some support from a stronger than expected CBI retail sales survey which strengthened to a 3-year high. There were still important doubts whether the improvement would be sustainable given the underlying pressures on incomes.

Sterling strengthened to attack resistance levels above 1.5580 against the dollar on Thursday, but was unable to break above this level and retreated to the 1.5520 area as the Euro found support close to 0.8150. The UK currency gained some degree of support from a stabilisation in risk appetite, but there was still selling interest at higher levels with some renewed doubts over the banking sector.

Swiss franc:

The franc will gain renewed support when confidence in the global economy deteriorates and trends in risk appetite will remain very important for currency trends. Underlying fears over a renewed deterioration in the global economy are likely to sustain a firm franc tone in the near term, especially if Euro-zone structural fears intensify. Volatility is likely to remain an important near-term feature given that there will be pressure for the National Bank to curb the rate of appreciation even if sustained intervention is ruled out as a policy option.

The Swiss franc secured strong demand over the week as a whole as defensive support remained a key factor. The Euro weakened to fresh all-time low below 1.30 before finding some degree of buying interest. The dollar was also unable to make any impression on the Swiss currency and retreated to lows near 1.02.

The Swiss currency continued to gain support from a lack of confidence in the other main currencies, especially with fears that Eastern European currencies could be subjected to fresh selling pressure.

Markets remained on alert over possible National Bank action to curb franc appreciation after rapid gains even if the bank decides that a policy of sustained market action is unrealistic.

National Bank Chairman Hildebrand stated that the bank would only take action against franc strength if deflation fears returned and this will tend to limit franc selling

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The Australian dollar remained generally on the defensive and weakened to test levels below 0.88 against the US currency. The Australian dollar was hampered by a general deterioration in risk appetite, especially when commodity prices fell while the domestic investment data was also weak.

Following the General Election result neither of the main groupings secured a majority and  there was some speculation that a new election may have to be called to break the deadlock which contributed to some selling pressure on the currency.

Given the underlying global and domestic risk profile, the Australian dollar is liable to have a generally negative bias in the short-term even if losses are measured.

Canadian dollar:

The Canadian dollar was subjected to net losses during the week as risk appetite was weaker and commodity prices were subjected to selling pressure. There was a low beyond 1.0650 following a general flight from risk assets before it stabilised.

The domestic data was generally weaker than expected with a decline in retail sales and disappointing wholesale sales data which contributed to the negative tone.

The Canadian dollar will tend to remain on the defensive due to doubts over the domestic and international growth outlook. The net risks suggest that selling pressure should be contained unless there is a huge spike in risk aversion.

Indian rupee:

The rupee had a slightly weaker tone against the US dollar during the week and tested support close to 47 against the US dollar. The currency was hampered by a general decline in risk appetite as caution persisted over the global economy.

There was also month-end related demand for the dollar, but the rupee was still generally resilient with evidence that longer-term capital inflows were being sustained.

The rupee will find it difficult to make much headway given global risk conditions, but should be able to prove broadly resilient given longer-term capital inflows. 

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The Hong Kong dollar was unable to gain ground during the week and settled slightly weaker around 7.7780 against the US currency while there was support close to the 7.78 level.

A general increase in risk aversion remain a negative influence on the Hong Kong dollar. US money-market rates remained low and this provided important protection for the currency.

The Hong Kong currency should be able to resist substantial losses even if risk appetite deteriorates further, especially as the US Fed will maintain a highly-expansionary policy.

Chinese yuan:

The yuan drifted slightly weaker against the US currency with a move to just above the 6.80 level against the US dollar. Markets were still reluctant to follow the central bank’s lead and push the Chinese currency weaker and trading conditions were generally subdued during the Summer period.

Domestically, there was caution ahead of the latest PMI releases due at the beginning of September, especially with some speculation over a further slowdown. International risk appetite remained weaker and the central bank remains reluctant to sanction much flexibility while the global outlook remains uncertain.

The central bank is likely to maintain generally tight control over currency moves in the short-term, especially as doubts over the Chinese and global economic outlook are likely to be a very important feature.

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