Weekly Forex Currency Review 29-10-2010

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Central bank interest rate decisions will be a key focus in the short-term with five banks due to make announcements over the following week. The stance adopted by the monetary authorities will have a very important influence on currency markets over the remainder of the fourth quarter with a particular focus on the US Federal Reserve. Markets will also be on high alert for the possibility of co-ordinated policy moves.              

Key events for the forthcoming week

Dollar:

In the short-term, markets will continue to focus strongly on Federal Reserve policies. There is still an important degree of uncertainty, but it looks likely that there will be further bond purchases over the next few months. The implications will tend to be negative for the dollar, especially given fears over the medium-term vulnerabilities. There will also be expectations that the US will be content to see a weaker US dollar. The US currency could gain some support on optimism that growth conditions will improve. Nevertheless, the dollar will find it very difficult to gain strongly unless fears over the European economies intensify.  

The dollar advanced for the week as a whole, but it was unable to sustain its best levels as underlying confidence remained extremely fragile. The Euro found support on dips towards 1.37 against the US currency.

As far as the US economic data is concerned, jobless claims to 434,000 in the latest week from a revised 455,000 previously which should provide some degree of relief as the data over the past few weeks as a whole has shown a clear improvement.

The headline durable goods data was stronger than expected with a 3.3% gain for September, but the underlying figure excluding erratic transport orders was weaker than expected with a 0.8% monthly decline and there was a generally weak tone.

US existing home sales rose to an annual rate of 4.53mn from a revised 4.12mn the previous month which provided some degree of relief over potential housing-market trends, although the impact was measured given the recent distortions caused by tax changes and proposals to curb foreclosures. New home sales rose to an annual rate of 307,000 from a revised 288,000.

Federal Reserve policy intentions remained an extremely important focus over the week. There was a further debate as to whether there will be a gradualist approach or a more aggressive ‘shock’ programme by the central bank. Sentiment swung towards a more limited policy which provided dollar support, especially as there was a rise in US Treasury yields to the highest level for 5 weeks.

Later in the week, there was fresh speculation that the FOMC could adopt a more aggressive stance on bond buying with a multi-month programme above US$500bn. This reversal of speculation lowered US Treasury yields and also cut demand for the dollar, but uncertainty remained a key feature ahead of next Wednesday’s meeting.

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The German economy still appears to be performing well which will help underpin the Euro-zone growth figures as a whole. There will also be some speculation that the ECB will look towards a tighter policy relatively quickly. There will still be a high degree of concern over the weaker peripheral economies and there will also be fresh doubts over the ability to meet budget targets, especially if tax revenue is depressed. In this context, structural fears surrounding the Euro-zone could return very quickly which would put the Euro under renewed pressure  

The Euro was not the centre of attention for much of the week, although there were still potentially important developments from a medium-term perspective.

The industrial data remained strong, but consumer trends were less encouraging with German retail sales falling sharply for September.

The Greek Finance Ministry stated that revenue growth had been weaker than expected during 2010 which will make budget deficit compliance even more difficult while there were also reports that Portugal’s 2011 budget negotiations had broken down. The Euro will remain vulnerable if there is any further widening of internal yield spreads.

The latest ECB survey recorded a tightening in lending standards during the fourth quarter as banks maintained an extremely cautious stance. The lack of credit availability will make it more difficult for the ECB to withdraw extraordinary liquidity and will also maintain market fears over the health of the banking system. There will also be fresh concerns over the structural vulnerabilities.

Yen:

The Bank of Japan will maintain an expansionary monetary policy with the possibility of additional quantitative easing. There will still be a lack of confidence in the global growth outlook which will stem selling pressure on the yen and there will also be longer-term fears over currency debasement elsewhere which will maintain caution over capital outflows from Japan. There will be pressure for the Bank of Japan to intervene if the dollar weakens to record lows and volatility is liable to increase again.

The yen dipped sharply in the middle of the week, but then secured an important reversal with the dollar weakening back towards record lows with a retreat to 80.50.

Finance official Igarashi stated that yen intervention would be most effective when it came as a surprise while Finance Minister Noda stated that the Monday FX moves appeared one-sided.

The Bank of Japan left interest rates in the 0.0-0.1% range following the latest policy meeting and announced no new measures. The next meeting has, however, been brought forward to next week which suggests that there is the possibility of co-ordinated action following the FOMC meeting

There were increased concerns over the regional growth outlook following weaker than expected Korean industrial data and the Japanese data was also significantly weaker than expected with a 1.9% decline for October, the fourth consecutive decline.

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The latest GDP figure has eased immediate fears over the economy and there will be reduced expectations of any further quantitative easing at the forthcoming Bank of England meeting. The economy will, however, remain vulnerable and sentiment could reverse very quickly, especially if there are further negative developments surrounding the housing sector. Sterling will secure near-term relief from the positive credit ratings news and will also gain longer-term protection from a lack of confidence in the other major economies.

Sterling had a slightly vulnerable tone early in the week, but resisted selling pressure and then advanced strongly with a peak above 1.5950 against the dollar while there was a strong recovery to near 0.87 against the Euro from lows beyond 0.89.
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There was some speculation over a stronger than expected GDP figure. In the event, the data was even stronger than the rumours with a 0.8% third-quarter expansion compared with expectations of a 0.4% gain.

The data eased immediate concerns over the growth trajectory and lessened speculation over an immediate Bank of England move to boost the quantitative easing programme. Confidence is liable to be fragile and there are still very important risks over the next few months as fiscal tightening saps confidence. Business confidence surveys will be watched very closely next week and a sharp slowdown would undermine sentiment.

Sterling also gained support from a fresh report by ratings agency Standard & Poor’s. The UK AAA rating was affirmed and the negative outlook was also revised to stable following the government’s committed stance on spending restraint.

The UK economic data offered some support with the latest CBI retail sales survey still robust at 36 for October while there was a slight improvement in consumer confidence for the month

With major doubts over the US and Euro-zone outlooks, Sterling could continue to gain some near-term support as an alternative reserve currency, especially if ratings agencies maintain a favourable outlook.

Swiss franc:

There will be some concerns over Swiss economic trends and there will also be speculation that the National Bank is quietly encouraging the Swiss currency to weaken. The franc will, however, continue to gain defensive support from expectations that other major central banks will pursue further quantitative easing and also directly or indirectly promote a weaker currency to help boost trade conditions. In this context, the franc should still be able to resist heavy selling given the vulnerabilities within the Euro-zone and global economy.

The dollar found support on dips towards the 0.96 level against the franc and rallied strongly to a high above 0.99 before hitting fresh selling. The franc was generally on the defensive against the crosses, especially against Sterling.

There was a slowdown in the UBS consumption index which increased speculation that the economy was slowing sharply.

National Bank Chairman Hildebrand stated that monetary policy was appropriate despite risks that very low interest rates will fuel asset-price bubbles, especially in the housing sector. There will be some pressure on the central bank to adopt a more restrictive policy during 2011

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The Australian currency fell sharply following the latest consumer inflation data with a headline reading of 0.7% compared with expectations of 0.8% while the core rate dipped to a five-year low. There was a significant adjustment in market interest rate expectations following the data with the chances of a November increase cut to below 30% from near 50%.

There was an improvement in business confidence according to the latest survey while private-sector credit growth remained weak. The currency did find support below the 0.97 level, but rally attempts were stifled by a deterioration in risk appetite.

Markets will want to maintain a bullish tone in the near term, although a further period of correction is likely if interest rates are not increased.

Canadian dollar:

The Canadian dollar found support close to 1.0350 against the dollar during the week and strengthened to just below 1.02, but it was unable to make strong headway and ranges were generally narrower.

There was a slightly more cautious attitude towards risk which curbed demand for the Canadian dollar as markets continued to fret over G7 growth prospects. There was little in the way of domestic economic data releases with wider US currency trends tending to be dominant

The fundamentals suggest that the Canadian dollar should be able to resist heavy selling pressure while it will remain difficult to sustain advances beyond parity.

Indian rupee:

The rupee was unable to extend gains in the latest week and dipped to a two-week low around 44.65 against the US dollar.  The currency was hampered initially by a generally firmer US currency and the trend in risk appetite was also less favourable for the currency late in the week as Asian markets dipped.

Short-term capital flows were also less supportive for the rupee as IPO-related inflows faded and there was some return of funds from over-subscribed issues, a trend which will continue over the next few weeks.

The rupee should remain broadly firm given, although it may be difficult to resume gains in the near term, especially with adverse capital-account trends. 

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The Hong Kong dollar secured a firmer tone over the week and there was a further test of resistance beyond the 7.7550 level against the US dollar even though the US currency had a slightly firmer tone

There was further speculation of longer-term capital inflows given the possibility of a currency revaluation if the yuan strengthens sharply.

The Hong Kong dollar should maintain a generally firm tone in the short-term, especially with speculation over a medium-term breaking of the peg.

Chinese yuan:

The yuan retained a weaker tone during the week and dipped to beyond 6.69 which was its lowest level in October. The Chinese currency was undermined by a firmer US currency at times, although there was also strong evidence that the central bank was pushing the currency weaker and encouraging two-way flows.

There was further international political pressure for a stronger yuan and there were concerns that tensions would rise further following the US congressional elections

There was also caution ahead of the forthcoming PMI data with markets unsure over the growth trends and whether the central bank would need to adopt further tightening

There will be strong expectations of further yuan appreciation in the medium term due to underlying capital inflows. The central bank will continue to resist any rapid pace of currency appreciation.

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