Weekly Forex Currency Review 30-01-2009

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The US economic trends will continue to be watched very closely given the key influence on the global economy and markets while currencies will also still be influenced strongly by risk appetite. The paradox that has persisted for the past few months is liable to continue for now. The dollar will tend to gain against European currencies on bad news with defensive demand for the currency when fear increases.  In this context, any evidence of improvement could push the dollar weaker.

Key events for the forthcoming week

Dollar:

The economy will remain under pressure in the short-term as employment continues to decline. The short-term focus will tend to be on the Administration’s fiscal policy and proposals to underpin the financial sector. Even with hopes for a stabilisation in conditions, the Federal Reserve will maintain a highly expansionary monetary policy which will tend to limit dollar support, especially if bond buying is put into practice. The huge financing burden will pose additional risks to medium-term dollar stability if the Fed puts downward pressure on long-term interest rates.  

Major currencies generally struggled for direction due to uncertainty over economic and financial-market direction. Defensive dollar demand weakened early in the week, but equities were unable to sustain the advance and the US currency regained ground over the second half of the week as fears increased with the Euro back below 1.30. 

The US existing home sales data was stronger than expected with sales increasing to an annual rate of 4.74mn in December from 4.45mn the previous month. There was a significant decline in inventories as prices continued to weaken. This combination triggered some optimism that falling prices could boost sales. The new home sales data, however, was much weaker than expected with a decline to an annual rate of 331,000 from a downwardly-revised 388,000. This was the sharpest monthly decline for over 60 years while the annual rate was the lowest since the series began in 1963.

Elsewhere, jobless claims rose to 588,000 in the latest week from 585,000 previously while continuing claims were at a record high. Durable goods orders fell by 2.6% for December with an underlying 3.6% decline for the month which maintained fears over the outlook for capital spending. Consumer confidence weakened slightly further to a record low of 37.7 in January from 38.0 the previous month.

The Federal Reserve left interest rates unchanged at the latest FOMC meeting with a 0.00 – 0.25% range for the Fed funds rate. The Fed also stated that it was prepared to purchase longer-term Treasury Securities if circumstances suggested that this would be beneficial, but drew back from action at this stage.

The House of Representatives approved a US$819bn fiscal stimulus package and attention will now turn towards the Senate. The weak housing data increased pressure for further action to support the economy while banking fears continued.

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The most recent data will trigger some hopes that the German economy can start to stabilise. Nevertheless, the Euro-zone as a whole is liable to weaken further. The ECB will continue to resist any move towards a zero interest rate policy, but will be under pressure to cut rates again. Structural vulnerabilities will be an important negative factor for the Euro. The ECB still looks the most likely to resist currency debasement which should offer important protection unless the internal tensions intensify.       
       
The Euro was unable to sustain gains over the week as it was dogged by fears over the structural vulnerabilities with some rumours that Greece could decide to leave the Euro area. A lack of confidence in the global economy also undermined the Euro.

The German IFO index edged higher to 83.0 in January from 82.6 previously. The improvement reinforced hopes that the Euro-zone economy may be stabilising, although sentiment remained very fragile. Unemployment rose by 56,000 in January after a revised 33,000 increase in December while the IMF also confirmed that it expected German GDP to decline by over 2% in 2009.

ECB members, including Chairman Trichet, were generally cautious on the possibility of interest rates falling substantially from current levels, but they also repeated comments that rates could be cut by a small amount.

There were further concerns over the outlook for weaker economies as bond spreads continued to edged wider. Risk appetite faltered again following the US data on Thursday which pushed the Euro weaker and it was also unsettled by comments from Soros over the risks of the Euro collapsing if bad debts were not addressed.

Yen:  

The Japanese economy will continue to weaken in the short-term as the sharp downturn in exports undermines the industrial sector. There will be increased pressure on the Finance Ministry to resist currency appreciation while the Bank of Japan will face demands for additional action to support the economy. In this environment, the yen will find it increasingly difficult to sustain gains even with support from a lack of confidence in global financial markets.
          
The dollar pushed to challenge resistance levels around 90.70 against the yen over the week, but was unable to break above this level as exporter selling increased above this level. The yen was slightly weaker on the crosses, but was still generally resilient.

The overall moves were again influenced strongly by trends in risk appetite. There was caution over yen buying, especially with further speculation over the potential for intervention to curb yen gains.

The economic data remained extremely weak with industrial production falling by a record 9.6% in December after an 8.5% decline the previous month as inventories continued to rise. Unemployment also rose to 4.4% from 4.1% while the core consumer inflation rate fell to 0.2% from 1.0% the previous month.

The Japanese government confirmed that it would inject capital into companies undermined by the credit difficulties with an initial US$16.7bn package. The weak data increased pressure for even more policy action.

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Fears over the economy will continue in the short-term, especially as there are still major fears over banking-sector stability, while the IMF warning will also tend to undermine confidence. There is still scope for some covering of short positions and the UK will attract capital on valuation grounds, especially given severe difficulties elsewhere in the global economy. The huge deficit financing requirement will tend to act as an important barrier to significant gains.

After heavy selling pressure last week, the UK currency was able to secure some respite, primarily due to a recovery from an over-sold position. It rallied back above 1.40 against the dollar and pushed to near 0.90 against the Euro. In an unusual move, Barclays Bank issued an open trading update in an attempt to reassure markets over earnings prospects and the rally in financial stocks helped Sterling.
There were also comments from George Soros that selling Sterling offered little value below 1.40 against the dollar which helped trigger a covering of short positions.

The latest CBI retail sales survey recorded a small  improvement to -47 in January from -55 the previous month., but this was still a very weak report historically and expectations for February were at a record low.
The Bank of England announced that it would buy corporate bonds and commercial paper as part of the GBP50bn financial-support programme. Fears over an expansion of the balance sheet were offset by hopes of an improvement in credit conditions.

The underlying economic fears were still important and the IMF warned that the UK economy was liable to contract around 3.0% in 2009. Fears that the UK will under-perform the global economy continued to be a negative factor for Sterling.

Swiss franc:

Confidence in the Swiss economy will remain weak in the short-term, especially with a further sharp downturn in the important KOF index. The National Bank warnings over potential intervention to weaken the currency will also undermine the franc in the short-term. These negative factors will limit the scope for defensive franc support if risk aversion spikes higher again.  

There was significant franc volatility over the week, especially against the Euro. The franc found support close to 1.51 and strengthened towards 1.49. The dollar found support on dips towards 1.13 against the franc.

The UBS consumption index recovered to 1.15 in January from 0.96 previously. The important KOF business confidence index, however, weakened further to a record low of -0.87 in January from a revised -0.45 previously which will maintain a lack of confidence in the Swiss economy. There will be particular fears over the deterioration at a time when the German indicators have shown some signs of stability.

National Bank chairman Roth stated that interest rates would remain at a low level for a relatively long period of time. He also stated that the franc appreciation was painful and that the bank was watching the situation very closely. Nevertheless, he also remarked that the franc had not overshot yet.

Although there was further speculation over intervention to weaken the currency if it strengthens sharply against the Euro, the remarks dampened expectations of near-term action and this pushed the franc stronger against the Euro.

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The Australian dollar rallied firmly at times, but struggled to sustain the advances and was capped around 0.67 against the US currency with a decline back towards 0.64.

Domestically, consumer prices fell 0.3% in the fourth quarter following a 1.2% increase previously. The data was slightly stronger than expected and failed to have a substantial impact. Markets had already priced in further RBA interest rate cuts, butt he currency was undermined by a reported decline in consumer credit.

The aggressive interest rate cut from the New Zealand central bank also increased speculation that there would be a sizeable Australian rate cut in February.

There is the potential for limited Australian dollar appreciation if the Reserve Bank adopts a measured tone on interest rates at the forthcoming policy meeting.

Canadian dollar:

The Canadian dollar had a generally firmer tone against the week, but was unable to make a serious challenge on resistance near 1.20 against the US currency.

The local currency was again influenced strongly by degrees of risk appetite and gained ground when confidence improved. Underlying fears over the global outlook were still a negative factor, especially after a downbeat IMF assessment of 2009.

There were no major domestic economic releases over the week. There was some optimism that the government would be able to secure parliamentary approval for the budget which boosted sentiment.

The Canadian dollar has the potential for limited appreciation against the US currency with greater confidence in the global economy a pre-requisite for substantial gains.
 
Indian rupee:

The rupee was confined to relatively narrow ranges. There was evidence of dollar demand from oil importers at the end of the month which unsettled the rupee to some extent. The rupee dipped to near 49.10 against the dollar as the stock market fell.

The central bank left interest rates on hold at the latest policy view, contrary to expectations that there could be a further cut. Sentiment was still influenced very strongly by degrees of risk appetite with markets focussed on capital account trends.

Overall, there is little scope for significant Indian rupee gains until there is a stabilisation in sentiment towards the global financial sector and economy.

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The Hong Kong dollar edged stronger against the US dollar and consolidated in relatively narrow ranges around 7.7560. The local currency gained some support from a small increase in local inter-bank rates later in the week.

Trading volumes were very low over the week with market holidays surrounding the Lunar New year holiday.  There were underlying fears over the capital account as confidence towards the financial markets remained very fragile.

The Hong Kong dollar could drift slightly weaker on fears over capital outflows, although substantial losses should be avoided as the HKMA maintains stability. 

Chinese yuan:

The Chinese yuan was again confined to narrow ranges with the dollar slightly firmer at around 6.84 over the week. Trading volumes were limited due to the Lunar holidays and this made it easier for the central bank to hold the currency steady

Sentiment was dominated by exchange rate policies with a flurry of comments from domestic and global policy makers following the comments from Treasury Secretary Geithner last week.  Chinese officials denied that they were manipulating the currency and expressed their irritation with the comments. There was greater caution from US officials, although underlying tensions persisted.

Political tensions will remain an extremely important factor in the short-term and further severe tensions over exchange rate policies would risk strengthening the yuan. The central bank is still likely to maintain very tight control over the market

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