Weekly Forex Currency Review 28-04-2011

Dollar weakness will continue to be a very important market focus in the short-term. There will be expectations of further central bank diversification away from the US currency which will tend to keep it under pressure. The dollar slide has, however, reached a point where it is likely to prove more harmful than beneficial for the global economy and there will be pressure for G7 action to help stabilise the currency.

 Key events for the forthcoming week

Market analysis

Dollar: 

Dollar confidence will remain very weak in the short-term amid expectations of further central bank diversification away from the US currency and momentum selling will continue to be an important factor.  The Federal Reserve will maintain a policy of very low interest rates but, at this stage, it is not planning any additional quantitative easing. The dollar remains under-valued at current levels and there will be important defensive support at times, especially as there are very important vulnerabilities in other key currencies.  Overall, despite the risk of further short-term selling, the dollar should be able to resist further heavy losses and remains overdue for a sharp correction.

The dollar was unable to secure any sustained during the week and remained under strong selling pressure with the trade-weighted index at fresh 3-year lows.

Interest rates were left on hold following the latest FOMC meeting. The Fed announced that the second phase of quantitative easing would be completed at the end of June and would not be extended. It maintained its stance that interest rates would stay at very low levels for an extended period and that there would be no tapering of the existing programme. In other words, proceeds from maturing bonds will be re-invested to keep the total stimulus constant.

In his press conference, Bernanke stated that the Fed would react to tighten policy if underlying inflation pressures increased, but he repeated previous optimism that the impact of higher food and commodity prices would be transitory.  

The Fed’s relatively dovish tone maintained underlying interest in selling the dollar and there was particular disappointment that the only references to the dollar’s value was that the appropriate policies would support the currency in the medium term.

The dollar came under heavy selling pressure following the Fed press conference and the Euro strengthened rapidly to a fresh 16-month high above 1.4850 in Asian trading on Thursday as dollar selling intensified.

In comments on Tuesday, US Treasury Secretary Geithner took a relatively tough tone on the US currency, insisting that it retains a strong US currency policy. The comments failed to have any beneficial impact with markets assuming that the Administration is content with underlying dollar weakness, but there was some speculation over a more cohesive G7 tone in attempting to curb US losses

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Structural and monetary-policy considerations will continue to battle for supremacy in the short-term. There has been a further widening of Euro-zone yield spreads which will increase pressure for an organised debt rescheduling as the alternative will be default. The ECB remains determined to curb inflation and there is the possibility of further interest rate increases, but there has already been some softening of the language.  There will also be growing unease over the impact of a strong Euro and there will be a growing risk of verbal intervention to curb further currency gains.

The Euro advanced strongly against the dollar during the week with fresh 16-month highs and also secured a generally firm tone on the crosses as markets lacked confidence in alternative currencies.

There were reports that IMF officials will lead a delegation to Greece within the next two weeks to discuss the debt burden and possible solutions and the talks will inevitably include potential debt restructuring.  The simple fact remains that without some form of restructuring, Greece will eventually default on sovereign debt. There will be further market fears over the impact of European banks as the bad-debt burden would increase further.

The Euro-zone structural considerations will remain very important in the medium term. For now, the markets are still managing to put debt fears aside and concentrate on yield considerations, but sentiment could still turn rapidly given the underlying stresses. ECB officials took a slightly more cautious stance towards interest rates with Trichet commenting that no decision had been made over a series of rate increases.

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The economy will remain very weak in the short-term due to the continuing impact of earthquake damage and the Bank of Japan will maintain an extremely loose monetary policy to support demand. From a longer-term perspective, overall confidence in the government-debt situation will also remain weak as the government will have to contend with weaker tax revenue.  There will be capital flows overseas, although it is also the case that there will be defensive inflows at times, especially when risk appetite deteriorates. Overall, the yen will find it difficult to sustain significant gains.

The dollar found support near 81.50 against the yen during the week, but it was unable to make strong headway as it was frustrated by wider weakness.

Underlying confidence in the Japanese economy remained weak after its credit rating was put on negative watch. The latest economic data continued to register the impact of earthquake damage as there was a very substantial 15.3% decline in industrial production while there was a sharp drop in household spending.

The Bank of Japan maintained a very loose economic policy with no policy changes at the latest policy meeting and there will be further interest in using the yen as a funding currency for carry trades. Underlying confidence in the economy was also undermined by a Standard & Poor’s announcement that Japan’s AA- rating was being put on negative watch.

Japanese institutions will remain an important influence and the evidence suggests that there will be further investment overseas, especially with the funds generally pessimistic over the yen.

Sterling:

Confidence in the growth outlook will remain weak in the short-term with fears of further downward pressure on consumer spending due to the impact of fiscal tightening.  There will also be expectations that the Bank of England will resist pressure for higher interest rates which will severely curtail yield support. There will be important protection from a lack of confidence in the Euro-zone economy and dollar while the UK currency will tend to out-perform when international risk appetite is firm.  It will still be difficult to justify any significant advance for Sterling given underlying vulnerabilities.

Sterling weakened in early European trading on Wednesday ahead of the GDP data release with media reports reinforcing market fears that there would be a weaker than expected reading.

In the event, there was a 0.5% GDP increase for the first quarter which was exactly in line with expectations. There was a strong rebound in services activity following the weather-related decline previously, but there was a decline in construction activity which dampened underlying demand.

There was a relief rally in Sterling following the release, but underlying unease over the economy will tend to continue, especially as there was no reported growth in the past six months.  The data is unlikely to trigger a significant adjustment in Bank of England interest rate expectations with no increase expected at the May meeting which will limit Sterling support.

The latest CBI industrial orders data was weaker than expected, but there was general optimism surrounding the manufacturing outlook. There was a further deterioration in consumer confidence according to the latest GfK survey.

Bank of England MPC member Sentance maintained his hawkish tone towards interest rates in comments on Tuesday with further calls for higher interest rates. It is, however, significant that he will leave the MPC following the May meeting.

Dollar weakness was still the dominant market influence and Sterling strengthened to a high near 1.6750 against the US currency in Asian trading on Thursday.

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International considerations will continue to have a very important impact in the short-term. The Swiss currency will remain the ultimate safe-haven, especially with all major alternatives tarnished and this will trigger underlying flows into the franc, particularly when confidence in the Euro-zone deteriorates.  The franc’s movements will also tend to remain correlated strongly with trends in risk appetite and there will be some franc selling when there is strong interest in carry trades. Nevertheless, the currency should be able to resist sustained selling pressure in the near term.

The dollar was unable to gain any traction against the franc during the week and there was a slide to fresh record lows below 0.87 against the Swiss currency late in the New York session as underlying sentiment remained weak. The Euro found support on dips to the 1.2750 area.

Volatility is likely to remain a key feature with any interest in using the franc as a funding currency will be offset by the risk of capital flight from the Euro area.

The latest trade data recorded a solid surplus, but there was a significant slowdown in the rate of export growth.

Australian dollar:

The Australian dollar dipped at times, but buying pressure generally accelerated again during the week and the currency recorded a succession of fresh 29-year highs with a peak above 1.09 against the US dollar.

There was strong momentum buying support for the currency and it also gained ground when global stock markets strengthened and risk appetite improved.

The latest inflation data was stronger than expected with a 1.6% increase in prices for the first quarter which revived speculation that the Reserve Bank would have to move to raise interest rates again

There will be momentum for further near-term Australian dollar strength, but it is increasingly vulnerable to a very sharp correction given the extent of recent gains.

Canadian dollar:

The Canadian dollar hit resistance stronger than the 0.95 level against the US dollar during the week, but retracements were limited in an environment of general US currency weakness. Although the Canadian currency dipped briefly when there was a sharp drop in metals, energy prices overall remained very supportive.

There were no major domestic influences during the week with the currency still gaining some residual support from the stronger than expected inflation data released last week.  

The Canadian dollar will continue to draw support from the high level of oil prices and speculation over higher interest rates, but valuation concerns will be a significant negative influence.

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The rupee struggled to find direction for the week as a whole, but losses were measured and it consolidated in the 44.40 area against the US dollar.

The US currency remained extremely fragile which provided important rupee support. There was further unease over the high level of oil prices with a direct impact in maintaining strong importer demand for the US currency and it maintained fears that the Reserve Bank would be forced to increase interest rates again.

The domestic and international risk profile will make it difficult for the rupee to advance strongly, but selling should be contained unless credit conditions deteriorate.

Hong Kong dollar:

The Hong Kong dollar maintained a firm tone during the week, but it was unable to strengthen through the 7.77 level against the US currency with some US dollar bargain hunting reported at lower levels.  

The HKMA stated that interest rates could be increased ahead of any move by the Federal Reserve if strong loan demand continues and there was further speculation that the currency would come under revaluation pressure in the medium term.

Longer-term revaluation speculation and expectations of a stronger Chinese yuan should continue to provide underlying support for the Hong Kong dollar.

Chinese yuan:

The yuan continued to advance during the week with a succession of fresh post-float highs against the US dollar and it was fixed close to 6.5050 on Thursday.  The currency was, however, weaker on a trade-weighted basis as the US unit remained under heavy selling pressure. Ranges were bigger than usual due to weak liquidity.

There was further speculation that the authorities would sanction a one-off revaluation or allow a faster rate of appreciation, especially if there was an informal agreement over a policy shift within Asian economies.

There is scope for a faster pace of yuan appreciation, especially if there is wider agreement within Asia over the need for a faster pace of appreciation.

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