Weekly Forex Currency Review 30-05-2008

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Overall strategy:

The trends in oil and wider commodity prices will continue to have an important short-term impact on the major currencies. The dollar will tend to secure further relief if there is a further decline in energy and metals prices, especially with higher US bond yields. Confidence will quickly crumble if there is evidence of renewed US economic deterioration.  Next week's events will be very important for market sentiment over the next few weeks.                      

Key events for the forthcoming week

Dollar:

There has been tougher rhetoric from Federal Reserve officials as inflation concerns have increased. At this stage, there has also been no evidence of further deterioration in the economy and futures markets have moved towards pricing in higher interest rates during the fourth quarter of 2008. This assessment of US prospects may be over-optimistic, but the increase in yields will still provide some initial dollar support. There is also evidence of stronger investment flows into the US economy which will underpin the currency. The dollar should have a firmer short-term tone, but will be vulnerable to fresh selling if there is evidence of a renewed downturn in the economy.
 
After initial vulnerability in subdued, holiday-influences trading, the dollar gained ground over the week as whole. There was a move to a three-week high against the Euro as the currency challenged resistance levels below 1.55.

Dollar moves were again correlated strongly with oil and energy-price trends during the week. As oil prices weakened, the US currency secured a generally firmer trend against the Euro. The US data remained fragile, but there was some evidence of resilience and hints that conditions could recover over the second half of 2008.

Consumer confidence fell to a fresh 16-year low of 57.2 for May from a revised 62.8 the previous month as expectations also remained weak. The Case-Shiller house-price index recorded a 14.4% decline in the year to March.

There was a small recovery in new home sales for April to an annual rate of 526,000 from a revised 509,000 previously. There was a significant drop in inventories for the month while prices rose which suggested some scope for a recovery in the new-housing sector. Existing home sales also increased for the month, but the inventory and price trends were less favourable which maintained underlying fears.

Comments from Fed officials continued to suggest that the central bank would reject further interest rate cuts while there was increase speculation that interest rates would need to rise over the second half of 2008 to help stem inflationary pressure. Regional Fed Fisher was particularly hawkish in his comments with comments that the Fed would need to raise rates sooner rather than later if inflation expectations rose further.

Durable goods orders fell by 0.5% in April after a revised 0.3% decline the previous month, but underlying orders rose for the second month which sparked some degree of optimism over prospects. Elsewhere, jobless claims were little changed in the latest week while first-quarter GDP growth was revised up to 0.9% from 0.6%.

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The Euro-zone data has continued to suggest a sharp slowdown in growth. There will also be some fears over the potential for a more severe slowdown, especially with evidence of very difficult conditions in economies such as Spain and downward pressure on consumer spending. The ECB will maintain a tough near-term stance on interest rates to curb inflationary pressure. Underlying sentiment is liable to weaken, however, with the threat of capital outflows which will tend to undermine the Euro.  
       
The Euro put in a mixed performance over the week as it gained ground against low-yield currencies, but lost ground against the dollar and Sterling

The Euro-zone economic data remained generally downbeat over the week. German consumer confidence weakened in May while indicators of French confidence also continued to deteriorate as housing starts weakened to a record low. The data also suggested that the Spanish economy remained under pressure.

Consumer confidence weakened further and there was a surprise increase in German unemployment, the first rise for 12 months. German retail sales also continued to decline in April with a sharp 1.7% decline, although business confidence held steady.

The trade account has not been a significant focus, but the latest current account data did spark some interest. There was a deficit of EUR15.3bn for March which was the widest shortfall since the Euro's creation in 1999. There was also a wider deficit on direct investment flows which suggested that confidence was faltering to some extent.

The ECB continued to take a tough stance on inflation and interest rates in public comments with warnings that rates could be increased if inflation failed to decline. The inflation concerns were fuelled by a renewed increase in provisional German inflation to 3.0% in May from 2.6% the previous month.

Yen

The domestic economic trends are likely to remain generally weak in the short-term while there has been clear evidence of a deterioration in the export sector. The yen moves will still tend to remain correlated strongly with degrees of risk appetite and trends in global asset prices. Overall, there is the risk of further yen losses in the near term even though exporter selling will increase.  
                    
After surviving a test of support below the 103.0 level early in the week, the US currency had a firmer tone and challenged highs near the 106.0 level. The yen was generally weak against the Euro.

The yen was undermined by a general improvement in risk appetite during the week and there was further evidence of retail yen selling as overseas bond yields increased.

The domestic data was generally weak with retail sales rising only 0.1% in the year to April despite the influence of higher spending on energy-related items. Household spending also fell 2.7% in the year to April while industrial production continued to decline and the unemployment rate increased to 4.0% from 3.8%.

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There will be further serious concerns over the economic outlook, especially as the increase in energy costs will reinforce downward pressure on consumer spending. There will also be further concerns over the inflation outlook, especially with inflation expectations rising. In this environment, the Bank of England will want to resist lower interest rates unless there is severe deterioration. The yield considerations will underpin Sterling, especially if overall risk appetite remains higher. Nevertheless, the UK currency will still struggle to secure more than limited gains given the domestic economic risks.
 
Sterling was generally weaker against the dollar over the week, but the overall performance was still one of resilience given the poor economic data and the UK currency strengthened to 3-week highs near 0.7850 against the Euro.

The latest BBA mortgage approvals data recorded a small increase in April from March, but there was still a decline of close to 40% over the year. The Nationwide house-price survey also recorded a further 2.5% decline in prices for May to give an annual decline of 4.4%, the sharpest decline since 1992.

The latest CBI retail survey suggested some recovery in sales was possible in June after a slower decline in May while the prices component was at a16-year high. Consumer confidence continued to weaken in the latest Gfk survey with a reading of -29 which was the weakest reading since 1990.

The UK currency continued to gain some support from a general increase in risk appetite while fears over the Euro-zone outlook also provided some Sterling relief.

Swiss franc

The export data will increase optimism that the economy will prove resilient, but there is still the risk of a sharp slowdown which will tend to undermine confidence in the franc to some extent. The defensive qualities of the Swiss currency will be much less important if there is a sustained improvement in risk appetite as the franc will again be vulnerable to use as a funding currency. The franc is vulnerable to some further selling, but heavy pressure look unlikely.  
 
The Swiss franc failed to sustain gains seen last week and had a generally weaker tone. The franc weakened back to 1.63 against the Euro while the dollar tested levels above the 1.05 level.

The trade surplus increased to CHF1.57bn in the latest month as export growth remained robust. The latest UBS consumption index also remained firm in the latest month which will ease immediate fears over the economy.

National Bank Chairman Roth maintained a focus on inflation, although he also suggested that the franc had appreciated too far against the US dollar. The inflation concerns suggested that the bank will be very reluctant to cut interest rates.

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The Australian dollar pushed to a 25-year peak against the US currency during the week with a high around the 0.9650 level before a corrective retreat to 0.9550.

There was again a strong commodity-price influence. The currency gained ground as oil and metals pries rose, but was then subjected to a sharp correction weaker.

The domestic data influences were limited, but there was further speculation that the Reserve Bank would increase interest rates again to stem inflationary pressure.

The Australian dollar will remain vulnerable to a deeper correction given the risk that commodity prices will weaken further, but there will be strong short-term investor demand on dips given the yield support.

Canadian dollar

The US dollar was unable to regain parity against the Canadian currency and there was a renewed test of support levels close to 0.98 before consolidation in the middle of recent ranges. Currency moves were still influenced strongly by oil prices as the Canadian dollar was boosted by a surge in prices before a retreat.

The local currency also drew support from an improvement in risk appetite while there was optimism over potential merger-related capital flows.

The current account recorded a CAD5.6bn surplus for the first quarter of 2008 which will ease any immediate fears over the balance of payments situation.

The Canadian currency will gain some support on evidence that balance of payments conditions are still favourable. Nevertheless, the currency will still be vulnerable to a deeper correction given the recent benefit from oil price strength.

Indian rupee:

The rupee resisted a decline to fresh lows during the week and generally consolidated around the 42.80 level against the US currency before a move to 42.50 on Friday.

There was strong dollar demand from oil importers surrounding the month-end period while energy prices were also still at damaging levels. Oil prices did, however, decline from peak levels which provided some rupee relief.

There was evidence of state banks selling dollars when the rupee weakened and there was also some suspicion that the central bank was supporting the currency. Overall capital flows were less supportive, although there was some evidence of stabilisation after the government announced it would relax rules on overseas inflows.

Overall, unless there is a fresh surge in oil prices, there should be scope for some further corrective recovery in the rupee on a stabilisation in capital flows.   

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The Hong Kong dollar has generally traded weaker than the central rate of 7.80 against the US dollar. Over the second half, the local currency dipped to a 4-month low around 7.8060 before consolidation around 7.8040.

The US currency was supported by higher US yields even though Hong Kong inter-bank rates were also generally higher.

There was some unease over the regional growth outlook and a weaker tone for many Asian currencies, allied with a dip in the Hang Seng index, was a negative influence.
 
The Hong Kong currency should continue to find near-term support weaker than  the 7.80 level against the US currency, especially with inflation concerns likely to persist which will put some upward pressure on longer-term yields. 

Chinese yuan

The yuan retained strength against the dollar during the week and pushed to fresh post-float highs beyond 6.94 against the US dollar with firm gains against the Euro.

The central bank condoned the appreciation and appeared to be encouraging faster rate of appreciation, especially as the US currency was generally firm.

The latest currency reserves data suggested that there had been further short-term inflows. There was further speculation that the bank would counter speculative flows by allowed a short period of firm gains before pushing the currency weaker again.

Net capital flows should continue to provide underlying yuan support. The central bank will continue to discourage speculative inflows and, in this context, may let the yuan drift weaker after any further initial appreciation.   

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