Weekly Forex Currency Review 05-04-2007

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Overall strategy

US growth trends will continue to be monitored very closely given fears over an underlying slowdown. The dollar should be able to avoid further heavy losses unless there is evidence of further destabilisation in the housing sector. High-yield currencies could remain strong initially, but with the risk of a sharp corrective retreat within the next few weeks. The monthly payroll report could trigger high currency volatility this Friday.

Key events for the forthcoming week

Dollar

There will be further concerns over the US growth outlook with the latest survey evidence not offering any significant reassurance. The housing sector will remain an important focus given fears that mortgage difficulties will undermine the wider economy. The Fed will be very reluctant to cut interest rates while inflation concerns persist and only a limited revision to interest rate expectations would revive the dollar. Overall confidence is likely to remain fragile, but the US currency has discounted a considerable amount of bad news which should help limit further heavy near-term losses eve with a possible move to 1.35.

The dollar was unable to make significant headway during the week as underlying currency sentiment remained weak.

The ISM index for the manufacturing sector remained subdued with a reading of 50.9 in March from 52.3 the previous month while the reading for the services sector also weakened to a 12-month low of 52.4, although the unadjusted data was stronger over the month. Factory orders secured a weak 1.0% monthly recovery.

The prices index, however, recorded a significant increase over the month in both surveys which maintained inflation concerns

The ADP employment report registered a 106,000 increase in employment for March which maintained expectations of steady employment growth in the monthly payroll report while reported job cuts also fell over the month.

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The Euro will continue be supported by confidence in the economic outlook in view of recent data releases.  There will also be further expectations that the ECB will sanction at least one more interest rate increase. There will, however, be the risk of protests against currency strength from European officials while the French presidential elections could have a negative impact during April. Nevertheless, the Euro should remain firm over the next few weeks. 

The Euro has remained firm over the past week with renewed gains against the Swiss franc and Japanese yen while holding for against the dollar.

The Euro-zone PMI indices for the services sector and the manufacturing sectors were little changed in March and continued to suggest steady Euro-zone growth.

There was a sharp 3.9% increase in factory orders and a 0.9% increase in production which reinforced confidence over the German economy.

ECB officials continued to take a tough stance on interest rates during the month with further warnings that they would act to control inflation if required with markets still expecting an increase in rates during the second quarter.

Yen 

The domestic economic fundamentals will remain solid and there is evidence that the Bank of Japan will take a tougher stance on policy, especially with rising land prices. Overall yields will remain low and the yen will be vulnerable to selling pressure while the global interest in high-yield investments continues. The Japanese currency will remain vulnerable initially, but with the potential for a sharp recovery within the next few weeks. 
                    
The yen came under renewed selling pressure during the week with the Japanese currency weakening to 119.0 against the dollar and near 159.0 against the Euro.

The headline Japanese Tankan index fell to 23 in the March quarter from 25 previously. The other components were also generally slightly weaker, although capital investment plans held firm.

There was renewed interest in carry trades during the week with risk aversion levels falling. According to one measure, investors were more confident than at any time in the past 18 months which helped trigger capital outflows from Japan.

The Bank of Japan continued to suggest that it raise interest rates only slowly and there was evidence of a renewed capital outflows at the start of the new fiscal year.

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The UK economic fundamentals will remain firm in the short-term which will support Sterling with expectations of a may increase in rates. The UK currency will also gain support if there is sustained interest in high-yield currencies. There are, however, important underlying risks associated with the economy and currency, with particular concerns surrounding the housing sector. Markets will be looking to target the 2.00 level against the dollar, but Sterling is likely to be vulnerable over the next few weeks as a whole.

Sterling pushed to a 2-month high above 1.98 against the dollar before retreating to 1.97 with the UK currency unable to break 0.6750 against the Euro.

The Bank of England left interest rates unchanged at 5.25% following the latest MPC meeting and this decision pushed Sterling slightly weaker before a recovery.

The CIPS index for the manufacturing sector held firm at 54.4 although this was lower than the 55.4 recorded the previous month. The services-sector index strengthened slightly in March while the inflation readings remained firm with the prices component at a 7-month high

The UK currency gained support from a renewed interest in carry trades over the week with expectations of higher interest rates increasing Sterling’s attractiveness.

Swiss franc

The Swiss economy will remain robust with the National Bank continuing to interest rate increases gradually. Levels of global risk aversion will remain very important and the renewed enthusiasm for high-yield currencies will tend to weaken the Swiss currency in the short-term. Nevertheless, there are substantial underlying risks and the franc is liable to regain ground over the next few weeks.  
 
The Swiss franc weakened against the Euro and was also unable to hold levels stronger than 1.21 against the dollar with a move back to 1.22.

Consumer prices rose 0.1% in March with the annual inflation rate at 0.2%. There was no additional pressure on the Swiss National Bank to tighten monetary policy. The PMI index remained strong for March with a reading 62.0 for the month

The Swiss currency was undermined by the renewed interest in global carry trades with the franc targeted as a funding currency.

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The Australian dollar strengthened to highs near 0.82 ahead of the interest rate decision and, despite a temporary retreat, the currency regained ground with a further challenge on the 0.82 level on Thursday.

The Reserve Bank left interest rates on hold at 6.25% at the latest monthly meeting. The futures markets priced in the chances of a rate increase at around 50% for the May meeting as confidence over the economy was sustained.

The trade deficit was little changed at AUD0.84bn in February compared with expectations of a deterioration with imports and exports both firm over the month.

The Australian dollar secured support from gains in commodity prices during the week as copper and gold prices strengthened.

Sentiment will remain strong in the short-term, but only a limited shift in risk tolerances could lead to sharp Australian dollar losses.

Canadian dollar

The Canadian dollar strengthened to 1.15 against the US currency and despite weakening back to 1.1590, the Canadian dollar strengthened again on Thursday.

Domestically, there was a sharp drop in building permits over the month, but weather conditions trigger erratic figures during the winter months. There was a strong 54,700 increase in employment for February which supported confidence over the economy.

The Canadian dollar drew support from high oil prices over the first half of the week, but there was a reduction in energy prices later in the week as Iran tensions eased and this, temporarily, pushed the Canadian currency weaker.

Overall, confidence in the domestic economy should support the Canadian dollar.

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The Indian rupee has remained strong with the currency moving to near an 8-year high against the US dollar. The rupee peaked at 42.85 before weakening to 43.15 on Thursday as importer demand increased.

The rupee gains were trigger initially by a tighter central bank policy with the Reserve Bank increasing lending rates by 0.5% to 7.75% at the end of last week.

The bank also tightened reserve requirements which increased domestic interest rates and also forced commercial banks to curb dollar holdings.

Levels of risk aversion declined over the week and this helped trigger further capital inflows to local capital markets.

There were suspicions of central bank intervention to curb rupee gains, but there was no evidence that the bank was defending specific levels.

Hong Kong dollar

The Hong Kong dollar was unable to secure renewed gains beyond the 7.81 level against the US currency and weakened to lows around 7.8160.

There was evidence of increased corporate US dollar demand which undermined the local currency. There was also US dollar demand ahead of the Easter holidays with banks taking advantage of higher US interest rates.

The Hong Kong dollar is liable to recover slightly next week after the holiday period, but strong gains are unlikely.