Weekly Forex Currency Review 30-04-2010

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Euro-zone vulnerability will remain an extremely important market focus in the short-term. There will be fears that contagion will spread further within Europe. These fears could be important in providing near-term dollar support despite the underlying US vulnerability.                 

Key events for the forthcoming week

Dollar:

The US data will maintain expectations that the economy will out-perform the Euro-zone over the next few months. There will certainly be unease over the US fundamentals with debt still a clear focus and the longer-term outlook will cause concern. For now, the European structural fears will tend to over-shadow the US weaknesses in the near term. There is also likely to be greater reservations over capital flows from the US which will tend to provide some degree of dollar protection with the potential for reduced capital outflows.

The dollar pushed higher over the week as a whole, primarily due to a persistent lack of confidence in the European economies with the US currency strengthening to a 12-month high against the Euro. The dollar weakened from its best levels with no additional support from the Federal Reserve.

The US new home sales data was stronger than expected with an increase to an annual rate of 411,000 for March from a revised 324,000 the previous month. The durable goods orders data was mixed as a headline decline in orders was offset by a sizeable underlying increase as a decline in aircraft orders undermined the headline figure.

The US jobless claims data was relatively close to expectations with a decline to 448,000 in the latest week from 459,000 previously which does not suggest a major change in the labour market.
The US consumer confidence data was stronger than expected with an increase to 57.9 for April from a revised 52.3 the previous month. The latest Case-Shiller house-price index recorded an annual increase of 0.6%, the first increase for three years, although it was slightly below consensus forecasts.

The Federal Reserve held interest rates in the 0.00-0.25% range following the latest FOMC meeting. The statement was more optimistic on the economy with comments that activity has continued to strengthen while the labour-market was beginning to improve.

The Fed did, however, also maintain its commitment to keeping interest rates at exceptionally low levels for an expended period. In a repeat of the previous two meetings, Regional Fed Governor Hoenig dissented and called for the extended period reference to be dropped.

President Obama announced three nominations for the Federal Reserve board including San Francisco President Yellen as Vice Chairman. Yellen is generally considered one of the more dovish regional presidents and there was speculation that the FOMC balance will shift more towards favouring low interest rates.

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The Euro-zone structural outlook will remain a very important focus in the short-term. There is likely to be agreement on additional support for Greece, but it will be very difficult to contain the underlying pressures with the risk of increased tensions in other Euro-zone economies. Any further credit-rating downgrades would undermine sentiment. There will also be fears that ECB policy will be compromised over the next few months. The Euro will find it very difficult to sustain any corrective rallies.

The Euro remained under pressure for much of the week as there was a persistent lack of confidence in the Euro-zone economy as structural fears continued to dominate. The Euro weakened to lows near 1.31 against the dollar before a corrective rally.

Greece’s rating was cut by two notches to BB+ from BBB- which put the long-term rating in the junk category. In addition, the Portuguese rating was cut to A- from A+. The action on Portugal increased fears over regional contagion and pushed the Euro sharply weaker with fears that Spanish markets could also come under pressure.

The Euro came under renewed selling pressure as Standard & poor’s did indeed downgrade the Spanish credit rating. The downgrade reinforced market fears that contagion could become a very important market factor.

Later in the week, the Greek finance ministry suggested that agreement on the support package would be achieved within days while there were also suggestions that VAT would rise to at least 23% from 21%. The government would also be committed to spending and pension cuts. There was additional pressure on the German government to back a support package despite the domestic political constraints. Standard & Poor’s backed the current Irish credit rating which provided some degree of support for the currency.

The evidence suggested that that there has been heavy institutional Euro selling over the past few weeks. Put options within the derivatives markets are now at their most expensive since November 2008 which also indicated the important lack of confidence in the single currency.

Yen:  

Trends in risk appetite will remain important and the Japanese currency will gain some degree of support if there is a sustained downturn in equity markets. A Chinese yuan revaluation would also provide near-term support for the yen. The yen will tend to be vulnerable on yield grounds and there are also fears over the Japanese economic fundamentals given warnings over the credit-rating outlook. Overall, the yen is not well placed to secure strong support and is liable to drift weaker.

The yen gained in the middle of the week as equity markets were subjected to downward pressure and the European structural fears undermined risk appetite. The Japanese currency was unable to sustain the gains as there was still underlying interest in selling the currency. From lows near 93, the dollar was able to rally back to the 94.20 area.

There were still some reservations over the Japanese fundamental outlook with some speculation that there could be a credit-rating downgrade. The economic data was broadly in line with expectations, although the increase in industrial production was lower than expected with a 0.3% monthly increase.

The major Japanese funds still cautious over the outlook for major bond markets which tended to dampen capital outflows, especially with major unease over the European economies.

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The government-debt situation will remain an important focus in the short and medium term. There will be fears that an indecisive election result will compromise efforts to reduce the deficit while Sterling vulnerability will also be increased by the general focus on credit ratings and wider European stresses. Sterling will also tend to lose support if there is a sustained deterioration in risk appetite. The persistent lack of confidence in the Euro-zone economy will also provide some degree of protection with possible defensive inflows. Sterling is still likely to make much headway given the underlying vulnerability. 

Sterling came under significant selling pressure during the middle of the week with lows below 1.5150 against the dollar, but it found support at lower levels and rallied later in the week to a high near 1.54. The UK currency hit three-month highs near 0.86 against the Euro before a limited corrective retreat as confidence in the Euro remained weak.

There was little in the way of major economic data during the week. The Hometrack organisation reported a ninth successive increase in UK house prices which helped boost confidence in the economy. There was also a firm Nationwide house-price survey which recorded a 1.0% monthly increase for April while consumer confidence edged lower over the week.

The Euro-zone structural concerns had a mixed impact. There were some concerns that the UK credit rating would also be downgraded in the medium term. There were also persistent concerns over an indecisive election result which could delay action on cutting the budget deficit.

In contrast, there was also some speculation that the UK would benefit from a lack of confidence in the Euro-zone with potential investment inflows from the Euro-zone. The opinion polls continued to suggest that no party would be able to secure a majority in the forthcoming parliamentary election.

Swiss franc:

The Swiss currency will continue to gain defensive support from a general lack of confidence in the Euro and Euro-zone economy, especially after a further round of credit-rating downgrades. The National Bank will still be an important focus and there will be continuing pressure on the central bank to prevent renewed gains against the Euro. Overall, the dollar should be broadly resilient against the Swiss currency even with limited headway.

The dollar pushed to highs near 1.0950 against the Swiss franc during the week which was the highest level since July 2009. The dollar was unable to sustain the gains and dipped back to the 1.08 region on Friday. The Euro held above 1.43 against the Swiss currency with a strong suspicion that it was being supported above this level by persistent National Bank intervention.

The credit-rating downgrades for Greece, Spain and Portugal tended to maintain a defensive flow of funds into the Swiss currency on a widespread lack of confidence in Euro instruments.

The latest UBS consumption index was also firm with a significant advance for March which maintained optimism over the Swiss economy. There was a small decline in the ZEW confidence index while there was a solid trade surplus for March.

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The Australian dollar was subjected to significant pressure in the middle of the week, but found buying support close to 0.9150 level against the US currency and rallied back to the 0.93 level as buying support on dips remained a key factor.

The headline Australian inflation data was in line with expectations with a 0.9% quarterly increase. A higher than expected underlying figure provided some degree of support for the currency on expectations that interest rates could be increased further.

Underlying Australian dollar sentiment should remain generally firm for now with expectations of further carry-related inflows. The evidence still suggests that the currency will find it difficult to make further significant headway.

Canadian dollar:

The Canadian dollar weakened to lows beyond 1.02 against the US currency in the middle of the week before strengthening back towards the parity area.

Trends in risk appetite remained important and the Canadian currency weakened sharply when equity markets came under pressure while the currency rallied as stock markets and commodities were able to find more secure ground.

The Canadian dollar should remain generally firm in the short-term, especially given expectations of higher interest rates at the June meeting. It will still be difficult for the Canadian currency to sustain an advance much beyond current levels.

Indian rupee:

The rupee did weaken in the middle of the week as risk appetite deteriorated, but was able to resist heavy losses and consolidated in the 44.50 region against the dollar.

A generally dovish tone by the US Federal Reserve helped underpin the rupee during the week as short-term US yields remained at low levels. There was still confidence in the regional economy which helped support the currency.

The rupee should be able to maintain a relatively firm tone against the dollar in the near term, especially as confidence in the regional economies should remain firm. 

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The Hong Kong dollar weakened to lows near the 7.7680 region as risk appetite deteriorated before finding some degree of support as markets stabilised.

There were also some fears over the further policy tightening by the Chinese authorities which maintained some degree of fears over net capital outflows from Hong Kong.

Any Chinese yuan revaluation would tend to be a net positive for the Hong Kong dollar. Volatility levels are liable to remain higher in the short-term.

Chinese yuan:

The spot yuan rate remained broadly steady over the week while there was again no move by the authorities to revalue the Chinese currency.

Speculation over a near-term revaluation faded slightly during the week as attention tended to focus more on the European economies, but there was still an expectation of a medium-term move. The IMF stated that the yuan was under-valued and did recommend a revaluation. A weaker Euro also triggered some speculation that the Chinese authorities would be more reluctant to let the yuan strengthen.

There was some degree of vulnerability in the equity markets with share prices falling to a 7-month low while there was further tightening measures in the property sector.

Speculation over an adjustment to the yuan regime within the second quarter will remain very high. There is a certainly a strong possibility of at least a limited policy move which could be sanctioned in the very near term.