Weekly Forex Currency Review 29-01-2010

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Overall confidence in the global economy is likely to remain slightly weaker in the short-term with expectations that monetary and fiscal policies will not be able to provide as much support over the next few months. In this environment the dollar should be able to gain some defensive support while confidence in the Euro-zone economy is likely to remain generally weak.

Key events for the forthcoming week

Dollar:

There will be expectations of a firmer US economy, especially if there is a robust reading for fourth-quarter growth. There will still be expectations that the Fed will be very cautious over raising interest rates and confidence in the economy could also falter very quickly given underlying vulnerability. The dollar will gain some support on defensive grounds if there is a further deterioration in risk appetite. The US currency will also gain some support on a lack of confidence in the other key currencies. Weak dollar fundamentals will continue to limit the scope for gains.

The dollar maintained a firm tone during the week as defensive demand persisted on a lack of confidence in other major currencies. The US currency tested six-month highs below 1.40 against the Euro with a peak near 1.3910 on Friday.

Developments surrounding Fed Chairman Bernanke’s nomination for a second term continued to be watched closely There was also some speculation that there would be an informal pact for Bernanke to pledge low interest rates in return for Senators supporting his nomination.

In the event, Bernanke was confirmed for a second term in a Senate vote on Thursday This eased market uncertainty over the Fed situation and provided some degree of relief to equity markets.

The existing home sales data was weaker than expected with a drop to an annualised rate of 5.45mn for December from 6.45mn the previous month, but prices rose and inventories declined which should provide some support early in 2010.

New home sales also declined to an annual rate of 342,000 for December following a revised figure of 370,000 the previous month. There was evidence that sales demand triggered by tax credits was fading which tended to undermine overall sales.

Other housing data was mixed with the national data recording a small increase in prices for November, while the Case-Shiller data suggested that momentum was stalling with prices edging lower for November and October.

The latest consumer confidence data was stronger than expected with a 16-month high of 55.9 for January from a revised 53.6 the previous month. Jobless claims only declined to 470,000 in the latest week from a revised 478,000 previously.

Headline durable goods rose 0.3% for December which was well below consensus expectations while there was a 0.9% underlying increase for the month. Underlying confidence in the economy remained fragile with continuing fears over the durability of the current recovery.

As expected, the Federal Reserve left interest rates in the 0.00 - 0.25% range following the latest meeting. The Fed adopted a slightly more optimistic tone towards the economy, but was still very cautious over underlying trends. The Fed also maintained the commitment to maintaining low interest rates for an extended period while there was a promise to gradually withdraw quantitative measures.

The vote was not unanimous as Regional Fed Governor Hoenig dissented with a preference for the extended period references to be removed. The majority will hold sway in the short-term, but there was some speculation over further calls for a less aggressive policy which provided some limited dollar support.

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Structural vulnerabilities within the Euro-zone will continue to be key focus in the short-term and there will be persistent fears over weakness in economies such as Greece. There will also be some further speculation over more extreme developments such as a debt default, especially if there is any further widening in yield spreads. It will be difficult for the Euro to secure a strong recovery without an improvement in underlying confidence surrounding the weaker economies. 

The Euro remained under pressure during the week and with significant losses against the dollar. The Euro also lost significant ground on the crosses with six-month lows against Sterling and nine-month lows against the yen.

The German IFO index was firmer than expected with a rise to 95.8 for January from 94.6 previously, but the Euro was unable to gain much support from the data as stresses continued. The other data was firm, but was generally close to expectations

Underlying confidence in the Euro-zone economy remained weak with further unease over the debt situation within Greece and further speculation that pressures could spread to other countries with some rumours of a forthcoming debt-rating downgrade for Portugal.  Officials were unable to offer strong reassurance over the week.

Yen:

The Japanese currency will still tend to gain some support when risk aversion rises, especially if confidence in the 2010 economic outlook deteriorates further. There will also be a further lack of confidence in other major currencies which will provide net yen support. Underlying confidence in the Japanese economy will also remain generally weak in the short-term with continuing fears over the government-debt situation. In this environment, it may be difficult to secure a decisive move for the yen.

The yen was firm on the crosses, especially against the Euro with a none-month high, but struggled to make much headway against the dollar with the US currency finding support below the 89 level and settling near 90.

Risk appetite remained generally weaker with caution surrounding the global economic outlook as there was further speculation over monetary tightening and loan restrictions in China.

Domestically, the latest trade data was slightly stronger than expected with exports rising 12.1% over the year to December. The data provided some relief over economic trends, but there was still be pressure on the Bank of Japan to curb yen appreciation.

The monthly Tankan manufacturing index strengthened to -19 for the latest reading which was the highest level since September 2008 which helped improve sentiment towards the economy slightly, but inflation figures were slightly worse than expected.

The Bank of Japan left interest rates at 0.1% following the latest council meeting. It maintained an easing bias for policy, but was slightly less concerned over the deflation outlook. The yen was also undermined to some extent by Standard & Poor’s decision to put Japan’s credit rating on negative watch.

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Policy uncertainty will continue to be a key feature and expectations surrounding interest rates are liable to shift several times over the next few months. There will be some near-term protection from expectations that the Bank of England will be forced into an early interest rate increase to stem inflationary pressure. There will still be serious fears over the structural outlook and confidence could deteriorate rapidly as political stresses increase. 

Sterling held a firm tone against the Euro during the week and pushed to a six-month high. The UK currency was broadly resilient against the dollar and held above the 1.60 level with relatively narrow ranges.

The GDP data was weaker than expected on Tuesday with a reported expansion of 0.1% for the fourth quarter compared with expectations of a 0.4% expansion. The data reinforced expectations of a subdued and very fragile economic recovery during 2010.

As well as the direct impact, there were also be fears that weaker than expected growth will reinforce upward pressure on the budget deficit which will tend to undermine Sterling support, especially given the degree of market unease already. The latest mortgage approvals data was also weaker than expected which reinforced fears over the economic outlook.

Bank of England MPC member Sentance was optimistic that there would be an upward revision to the fourth-quarter GDP data which boosted Sterling amid expectations that the bank could move to an early increase in interest rates. Nevertheless, Sentance also still voiced some concerns over the economy and there was a high degree of uncertainty in his comments.

Swiss franc:

The Swiss currency is likely to gain some further defensive support from fears over the Euro-zone economy, especially if structural fears within the region intensify. There will also be franc support if there is a sustained deterioration in global risk appetite. The National Bank will still be concerned over the implications of franc strength and there will be pressure for intervention to stem further currency gains.

The dollar pushed to 2010 highs against the Swiss franc during the week with a high just above 1.0550.  The franc resisted significant losses against the Euro and consolidated close to the 1.47 region.

The franc continued to gain some defensive support from generally weaker risk appetite and a lack of confidence in the Euro outlook. There was pressure for National Bank intervention and Bank Chairman Hildebrand stated that the bank would decisively resist franc appreciation.

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The Australian dollar was more vulnerable during the week and dipped to test support levels below the 0.90 level against the US dollar with lows just below 0.89. The currency was hampered by a firmer US currency and by a general deterioration in risk appetite over the week.

Stronger than expected inflation data with increased speculation that the Reserve Bank would increase interest rates at the February meeting, but the currency failed to sustain gains as international trends dominated.

The Australian dollar performance will remain linked strongly with trends in risk appetite. Further corrective declines are realistic, although heavy selling pressure should be avoided.

Canadian dollar:

The Canadian dollar continued to lose ground against the US dollar over the week with lows near 1.07 against the US currency.

Risk appetite was generally weaker while there was also downward pressure on commodity prices which sapped support for the Canadian currency.

The relative debt situation should help limit further Canadian dollar losses in the near term even if it remains generally on the defensive in the near term.

Indian rupee:

The rupee was generally weaker during the week and dipped to 3-week lows near 46.35 against the US dollar. The US currency was generally firmer in global markets while there was also significant downward pressure on the local stock market which fell for six consecutive days. Given the importance of capital flows, the rupee remained very sensitive to stock-market moves.

There was further uncertainty ahead of the central bank’s policy review amid some fears that a tightening will be flagged and in the event the bank lifted the cash reserve rate by 0.75% to 5.75%.

The rupee is liable to remain more on the defensive in the short-term on subdued capital inflows, although heavy losses should be resisted given confidence in the domestic economy.

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The Hong Kong dollar weakened to lows near 7.777 against the US dollar during the week. There was further downward pressure on the local stock market which declined for six consecutive days.

Global markets were generally weaker while there was also speculation over further capital repatriation by Chinese banks. There was some relief late in the week with a move back to the 7.7715 region as bourses attempted to stabilise.

Although there will further speculation over weaker capital inflows, the Hong Kong dollar should be able to resist more than limited near-term losses.

Chinese yuan:

The Chinese central bank maintained tight control of the spot market as it resisted underlying pressure for a move to let the yuan appreciate

There was further effective policy tightening by the central bank as reserve requirements rose while there were also demands for bank lending to be curbed.

Political factors remained important as the Commerce Ministry stated that there was pressure on the yuan to rise. Deputy central bank head Zhu stated that a stable yuan was good for China and the world economy which maintained expectations of continued near-term resistance to a shift in exchange rate policy.

The authorities will still want to resist pressures near-term currency-policy changes given the preference for protecting exports, but underlying pressures will continue.