Weekly Forex Currency Review 05-10-2007

Overall strategy

The dollar's near-term direction will tend to be determined by the latest US employment data. The overall evidence suggests that the Euro is close to a near-term peak, especially with increased Euro-zone fears over the currency's level, but with the US dollar struggling to make any significant headway without evidence of the housing sector bottoming out.          

Key events for the forthcoming week

Dollar

The US economic conditions will continue to be watched very closely in the short-term.  Stronger than expected labour-market data could provide immediate relief, but confidence will remain very fragile with persistent fears over a wider economic downturn. Futures markets have already discounted a series of cuts which should provide some dollar protection, especially as the Fed is liable to take a more cautious stance. The amount of direct investment will also provide important dollar support as the underlying trade deficit continues to improve. The US currency will still find it difficult to secure a strong recovery given fears over global reserve diversification. 
      
The dollar weakened to fresh all-time lows at the end of last week and the overall tone this week has been one of consolidation with the dollar unable to strengthen back through 1.4070 against the Euro ahead of the payroll data.

The US ISM index for the manufacturing sector weakened to 52.0 from 52.9 previously while the services index dipped to 54.8 from 55.8. Within the services index, both the employment and prices components were stronger over the month.

The ADP data recorded a 58,000 September increase in private-sector employment from a downwardly-revised 27,000 the previous month. Jobless claims rose to 317,000 in the latest reporting week.

Housing data remained weak with pending home sales falling by a further 6.5% in August to give a 21.5% annual decline.

Estimates suggested that direct investment flows have increased to over US$250bn for the first three quarters of 2007.

There were no major comments from Fed officials on monetary policy during the week.

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The ECB stance will tend to limit short-term Euro support with the bank not signalling a near-term increase in interest rates. There will be further expectations of a slowdown in the Euro-zone economy while money-market stresses have persisted. The overall fundamentals will still be firm in relative terms which will provide important Euro backing.  There will be increased pressure on the G7 members to curb currency strength with increased verbal intervention from key officials which will tend to cap currency gains.            

The Euro has continued to have a generally firm tone in global markets despite being subjected to profit taking during the week. The Euro was supported by reports of aggressive central bank buying on Thursday.

The ECB left interest rates on hold at 4.0% following the latest council meeting.

In the statement following the decision, Trichet reinforced the commitment to curb inflationary pressure. The bank did not refer to the need for vigilance while the bank also declined to state that policy was accommodative, but rejected claims that policy was now neutral.

The ECB comments, overall, reinforced expectations that the bank would not increase interest rates in the near future.

The Euro-zone PMI confirmed an underlying slowdown in the economy with a notable deterioration in the German services-sector data.

The retail sales data was uninspiring with a 1.0% annual increase in the year to August.

Euro-zone officials expressed increased levels of concern over the Euro's strength against the dollar and effectively called for greater US backing for a strong US currency.

Yen

The Bank of Japan is likely to consider an interest rate increase during the fourth quarter, although the decision will remain open at this time. Overall yield support will remain weak and the yen will be vulnerable to capital flows overseas in search of higher yields. The net evidence, however, suggests that investors will continue to be more cautious, especially if Japanese interest rates are increased. Overall risk aversion levels, coupled with exporter selling, will make it difficult for the dollar to secure substantial gains against the yen, especially if G7 officials look to rebalance global exchange rates.                     
                    
The yen weakened to lows around 116.70 against the dollar as the Japanese currency was undermined by an increase in global risk tolerances. The yen found some support close to 165.0 against the Euro.

The Japanese Tankan index held steady at +23 in the third quarter while surveys on capital spending were generally firm.

The latest capital account data recorded a balanced position with a rise in outflows offset by fresh inward investment.

Bank of Japan member Iwata stated that policy should be adjusted gradually, but there was no commitment to an increase.

There was still some evidence of caution by Japanese institutions with some reduction in overseas bond holdings.

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The economy is still likely to slow as consumer and business spending provides less support. There are also very important downside risks to the housing sector as lending conditions tighten and mortgage interest rates increase. Although the Bank of England held interest rates unchanged at this month's meeting, there is likely to be a cut within the next few meetings which will lessen Sterling support. Overall, the UK currency is likely to weaken on yield grounds and there is a small risk that confidence will deteriorate rapidly which would trigger a more rapid decline.                 
 
Sterling found further support weaker than the 0.70 level against the Euro with gains back towards 0.6940. The UK currency remained volatile against the dollar with selling pressure above 2.04.

The Bank of England left interest rates unchanged at 5.75% following the latest MPC policy meeting. The central bank did not issue a statement following the decision.

The CIPS index for the manufacturing index fell to 55.1 in September from 56.3 the previous month. The services-sector index also fell to 56.7 from 57.6 which was the lowest reading for 12 months.

HBOS reported that house prices fell 0.6% in September, the first monthly decline for 2007 to give a 10.7% annual increase.

There was evidence that UK banks were borrowing in the Euro market to avoid higher UK interest rates.

Swiss franc

The ECB stance will provide some support to the Swiss franc and the impact will be magnified if there is increased speculation over a further National Bank interest rate increase at the December quarterly meeting.  The Swiss currency will tend to weaken if there is a sustained recovery in risk appetite. Underlying credit stresses will continue, however, and the National Bank will be uneasy over franc weakness in Europe even though reported inflation has remained under control. Overall, the franc should be able to resist significant losses.      
 
The Swiss franc weakened back towards multi-year lows against the Euro before securing some recovery over the second half of the week. The dollar was unable to sustain a break of resistance just above 1.18 against the franc.

The PMI index for Swiss economy fell significantly to 57.6 in September from 65.1 the previous month.

Consumer prices rose 0.1% for September with the annual inflation rate held to 0.7% compared with an expected 0.8%.

An improvement in risk tolerances tended to undermine the Swiss currency during the week as the US Dow Jones index strengthened to record highs.

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The Australian dollar tested 18-year highs above 0.89 against the US dollar and resisted pressure for more than a limited correction in choppy conditions.

The Reserve Bank left interest rates at 6.50% following the latest monthly policy meeting.

Retail sales growth was firm with a reported 0.7% for August after an upwardly-revised 0.8% increase in July.

Private credit growth, however, fell 1.7% in August to give a 0.1% year-on-year decline which raised some concerns over the housing sector.

The trade deficit widened to AUD1.61bn in August from AUD0.76bn the previous month

The Australian currency should remain firm in the very short-term on yield grounds, but remains vulnerable to at least a partial correction and the possibility of a more substantial retreat on growth doubts.

Canadian dollar

The Canadian dollar continued to test levels beyond parity against the US currency during the week and settled close to 0.9970 ahead of key employment data releases.

The Canadian PMI index weakened to 56.0 in September from 58.5 the previous month which raised some unease over growth trends.

Oil prices continued to have a significant impact on the currency with the underlying strength of prices still providing solid support.

The government announced the nomination of Carney as Bank of Canada governor to replace Dodge who is not serving another term.

The most likely trend is still likely to be for a gradual Canadian dollar correction weaker after rapid gains during September.

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The rupee has remained strong over the past week and tested fresh 9-year highs around 39.40 against the US currency on Friday.

There have been further capital flows into the local stock market with Indian markets supported by strong confidence in emerging markets in general.

The Indian central bank intervened during the week to restrain the rupee and also increased its intervention ceiling to INR2.0trn from 1.5trn.

Activity was dampened to some extent by the market holiday on Tuesday.

The rupee will aim to maintain a strong tone in the short-term, but gains from current levels are likely to be limited, especially with further central bank intervention. 

Hong Kong dollar

The Hong Kong dollar has remained strong over the past week with the local currency again testing levels beyond 7.76 against the dollar.

Local inter-bank interest rates remained high which supported the Hong Kong currency during the week.

The Hang Seng index reached record highs during the week which supported the currency, especially as market corrections were limited.

The PMI index weakened to a five-month low, but this failed to have a significant market impact.

The currency should remain firm in the short-term, although some further limited correction is realistic once reduced IPO demand helps lower money-market interest rates. There is still a small revaluation risk which would push the currency sharply stronger.

Chinese yuan

The Chinese markets were closed for a week-long holiday.