Weekly Forex Currency Review 01-06-2007

Overall strategy

The dollar will look to gain further support from recent yield trends, especially if 10-year Treasury bond yields rise to the 5.0% level. The US currency will still face tough barriers to strong gains, especially with persistent central bank dollar selling on rallies. There are still very high risks associated with global carry trades and volatility levels are set to increase.

Key events for the forthcoming week

Dollar

There should be further optimism over the US economy, especially if there is a firm monthly payroll report this Friday. Improved yield spreads will offer important dollar support with the 10-year US bond yields rising to the highest level since January as markets consider a Fed rate cut less likely. The US currency will still be hampered by the threat of central bank selling on significant gains and there will be further unease surrounding the housing sector.  Carry trades will tend to undermine the dollar against the Euro.     

The dollar again challenged key resistance close to 1.3410 against the Euro and secured gains for May as a whole, but was unable to break this key resistance level.

The US economic data failed to provide clear direction for much of the week, but forecasts had a generally firm tone. Consumer confidence rose to 108.0 in May from a revised 106.4 in April. The Chicago PMI index rose strongly to 61.7 in May from 52.9 the previous month.

GDP growth for the first quarter was revised down to 0.6% from the 1.3% original estimate. A weaker trade performance and a drop in inventories triggered the downward revision while consumer spending held firm.

The ADP report registered an increase of 97,000 for May while jobless claims were little changed at 310,000 in the latest week which suggests the labour market is holding firm, although not strengthening.

Minutes from the May FOMC meeting reiterated that the main risk remained inflation. The Fed was expecting growth to improve despite the negative impact from the housing sector while the labour market remained tight. US bond yields were near  the highest level for the year with 10-year yields at around 4.90%.

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The ECB remains firmly on track for an interest rate increase at the June council meeting and is also still talking tough over future policy. There has, however, been some evidence of a slowdown in the economy and speculation over a pause in tightening will increase if there is a batch of poor data. There will also be stresses in the property sector. The ECB is likely to offer less guidance on future policy which will increase uncertainty and potential Euro volatility.   

The Euro struggled to find clear direction over the week. Sentiment remained firm, but with gains being met with bouts of profit taking against the low-yield currencies.

The German employment data was weaker than expected with the unemployment rate edging higher to 9.2% in May from 9.1% together with a small 3,000 increase in unemployment. The Euro-zone retail PMI indices also fell sharply for May which will raise some doubts over consumer spending trends, although overall confidence levels remained firm. German and national consumer inflation rates held steady at 1.9% in May.

ECB officials continued to take a tough stance with Garganas, for example, stating that there could be a rise in rates beyond the expected June increase.

Yen

The Bank of Japan is still looking for an opportunity to tighten monetary policy again as soon as an interest rate increase can be justified. There will be political constraints ahead of the July Upper-House elections with a potential rate hike in August. The yen will remain vulnerable on renewed interest in carry trades, but the underlying capital flows will offer support to the currency. There will continue to be the risk of a rapid yen correction stronger.      
                    
The Japanese yen strengthened significantly at times, but was unable to sustain the advances as there was fresh interest in high-yield currencies. The yen performance remained correlated with global stock market trends with lows near 122.0 against the dollar.

The Japanese unemployment rate fell to 3.8% in the latest month from 4.0% and the household spending data was firm with a 1.1% annual increase. The industrial data was, however, weaker than expected with a 0.1% decline over the month as exports to the US slowed.

The latest capital account data recorded a net surplus in the latest week with inflows at their strongest level for the month. There was still evidence of retail investment in overseas securities.

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Markets will continue to look for further Bank of England interest rate increases, especially as there are still significant inflation concerns. There are, however, already signs of a slowdown in growth and there is the risk of a more substantial deterioration in the economy over the next few months as property-sector stresses intensify. In these circumstances, the UK currency is still at risk of sharp losses with volatility increased by carry trade activity.   
 
Sterling weakened to lows beyond 0.68 against the Euro before finding some support. Sterling traded within a 1.97 - 1.99 against the dollar as carry trade activity continued to have a significant impact on the UK currency.

The housing data recorded a slowdown in mortgage approvals to 107,000 in the latest week from 113,000 the previous month, the lowest reading of the year.

The latest data also recorded a slowdown in consumer lending for April as new credit card borrowing dropped to the lowest level for 10 years. The CBI reported a slowdown in retail sales growth for May, but consumer confidence recovered.

Swiss franc

The National Bank will increase interest rates in June and there will also be speculation over a 0.5% increase, although a 0.25% increase looks more likely. The Swiss fundamentals will also remain strong with robust growth. The franc will remain vulnerable on sustained interest in high-yield currencies, although the underlying flows are likely to be more favourable for the Swiss currency which will limit the scope for franc losses. Sharp gains are realistic if there is a rapid unwinding of carry trades.   
 
The Swiss franc was able to recover some ground against the Euro during the week, although gains were still attracting selling interest. The franc found solid support weaker than 1.23 against the dollar.

The Swiss economic data remained firm with a rise in the UBS consumption index for April.

The export performance remained strong despite a narrowing of the trade surplus over the month to CHF0.63bn from CHF0.85bn.

Swiss consumer prices rose 0.2% in May with the annual inflation rate steady at 0.5%. Swiss officials continued to warn over franc weakness during the weak, but there was no evidence of intervention.

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The Australian dollar found support below the 0.82 level against the US currency and rallied strongly to levels around 0.8300 as interest in carry trades increased again. The Australian dollar strengthened to a 15-year high against the yen.

The retail sales data was weaker than expected with a 0.1% increase for April, although annual growth was still 6.2%. There were firm readings for consumer credit with annual growth above 14.0%.

The trade deficit widened slightly to AUD0.96bn for April, but this did not have a significant impact.

The Australian dollar gained support from a recovery in risk appetite as Chinese stock market falls failed to de-rail global markets.

Overall, the Australian dollar will struggle to secure further short-term gains.

Canadian dollar

The Canadian dollar continued to advance during the week and strengthened to a 30-year high against the US currency beyond the 1.07 level.

The Canadian central bank left interest rates unchanged at 4.25% following the latest council meeting. The bank, however, warned that inflation risks had increased while there was also evidence of excess demand in the economy. The comments suggested that there would be an interest rate increase in July.

The current account position remained strong with a CAD6.4bn first-quarter surplus.

March monthly GDP slowed to a 0.3% increase from 0.4% in February, but the first-quarter performance was strong with growth at a four-year peak.

The Canadian dollar should remain strong in the short-term, but with a short-term period of consolidation realistic after recent rapid gains.

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The Indian rupee again strengthened to nine-year highs against the dollar before a temporary retreat as volatility increased. Underlying sentiment was strong with further underlying capital inflows and expectations of further inflows pushed the rupee to 40.55 against the US dollar on Friday.

The rupee was unsettled by stock market volatility with a sharp drop as the Chinese market fell sharply, although confidence recovered quickly. The rupee was also undermined by month-end dollar demand from oil importers.

Overnight interest rates fell sharply to 1.0% at one stage which undermined the rupee. The Commerce Minister warned that rupee rise was a cause for concern.

The rupee remains vulnerable to a limited correction weaker, although heavy falls are unlikely unless there is a big drop in regional stock markets.

Hong Kong dollar

The Hong Kong dollar volatility rose sharply during the week with a recovery from 30-year lows to a four-month high. The currency was unable to sustain the gains and weaken back to 7.8135 on Friday.

The Hong Kong dollar strengthened sharply to around 7.8010 in mid week following rumours of an imminent increase in prime rates. Long dollar trades were also liquidated as arbitrage risks became extended beyond 7.8250.

A rise in US yields eroded support for the Hong Kong dollar and there was fresh US dollar buying which pushed the local currency back to 7.8135 on Friday. Given the arbitrage selling, the Hong Kong dollar will find it difficult to strengthen through 7.80 unless there are hints over a change in currency policy.

Chinese yuan

The Chinese yuan has continued to strengthen gradually over the past week. The mid-point was set at 7.644 against the dollar on Thursday before settling close to 7.65.

The currency was undermined briefly by a sharp fall in stock prices after stamp duty was increased to 0.3% from 0.1%. The Chinese market fell around 6.5% before steadying.

There were rumours that the authorities would impose a capital gains tax which also unsettled the market. Central bank governor Wu stated that the pace of yuan gains could accelerate if economic reforms were a success.

Underlying pressure for yuan gains will persist. There will still be official caution over allowing a rapid advance with slow gains realistic in the short-term.