Weekly Forex Currency Review 07-03-2008

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Overall strategy: A lack of confidence in the US economy will continue to be a very important short-term focus. Central banks will also be under close scrutiny to assess whether attempts will be made to stabilise the US currency. Risk aversion will tend to remain at elevated levels in the short-term which will underpin the defensive currencies such as the Japanese yen and Swiss franc as credit-related fears persist.                   

Key events for the forthcoming week

Dollar:

Confidence will remain depressed initially with further speculation that the economy is already in recession and fears will intensify if there is another drop in employment. From a longer-term perspective, there will also be fears that the Federal Reserve policy to cut interest rates aggressively will undermine longer-term confidence in the dollar. The global economic outlook will still be very important and the US currency will receive some important defensive support if there are increased fears over a global recession. If the US difficulties appear more isolated, then the dollar is likely to remain under selling pressure.
      
The dollar has remained under sustained pressure over the past week with fresh record lows against the Euro beyond the 1.54 level. The US currency also dipped to new lows on a trade-weighted basis as sentiment deteriorated sharply. The dollar was undermined in part by a further increase in oil prices as there was a switch into defensive and commodity currencies.

The US PMI index for the manufacturing sector fell to 48.3 in February from 50.7 previously, although there was some relief that the index did not fall further given recent very weak regional survey evidence. The PMI composite index for the non-manufacturing sector also recovered back to 49.3 in February from 44.3, although this still suggested net contraction in the sector and failed to revive confidence.

The ADP employment report recorded a drop in employment of 23,000 for February after a revised 119,000 increase the previous month which was the first decline in the survey's history. Jobless claims edged lower to 351,000 in the latest week, but continuing claims continued to increase.

Home foreclosures increased to a record level for the fourth quarter while the Fed's Beige Book reported generally slower activity. There were increased fears over credit conditions as a mortgage company missed a margin call.

Fed Governor Fisher warned over the potential inflation risks while other Fed members were concerned more with the downside growth risks. Fed Chairman Bernanke expressed serious concerns over the housing sector. Markets continued to price in interest rate cuts of at least 0.50% for the March 18 FOMC meeting.

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The ECB still appears determined to maintain a restrictive monetary policy in the short-term in order to defend against inflation risks. This stance will underpin the Euro provided that the Euro-zone economy does not deteriorate further. There are, however, serious threats to the economy and, crucially, there are very important risks surrounding a divergence of individual economies. Recession conditions within Spain and Italy would strongly increase internal stresses and also tend to undermine the Euro.             

The Euro has retained a firm tone with an advance against most major currencies over the past week. The Euro pushed to a record high against Sterling before a correction, while there were net losses against the Swiss franc.

The ECB left interest rates on hold at 4.00% at the latest council meeting. In the press conference, the ECB downgraded growth forecasts and increased the inflation estimates. The net emphasis, however, was tough on the inflation risks. Trichet stated that there were no calls for a rate cut or an increase and the remarks overall dampened expectations that the bank would sanction a near-term cut in interest rates.

There were protests against Euro strength within the Euro area with greater concern within industry. There were some warnings from within the ECB, but President Trichet did not make any reference to currencies in his Thursday press conference.

The Euro-zone PMI indices were solid, but continued to show significant divergence. The Spanish index at a six-year low while the Italian index also indicated recession conditions. There was a 0.1% decline in retail sales in the year to January while there was a decline in German factory orders, but the releases did not have a strong impact.

Yen:  

Confidence in the domestic economy will remain fragile and a downward revision to fourth-quarter GDP would further damage sentiment. Global risk conditions are liable to dominate in the short-term and underlying fears over credit-related risks will provide further short-term support to the currency. There will also be the potential for capital repatriation before the end of March. There are likely to be protests against currency strength if the yen weakens rapidly to beyond the 100 level.        
                    
The Japanese currency tested levels below 102.50 against the dollar during the week. The yen gained important support from increased risk aversion and the evidence of increased stresses within the financial sector were particularly important in providing support with a liquidation of carry trades during the week.

There was a sharp drop in reported fourth-quarter capital spending estimates which triggered fears over a significant downward revision to fourth-quarter GDP.

There was further uncertainty over the nomination of a candidate to replace Bank of Japan Governor Fukui who is due to leave office on March 18. Political friction over the bank's choice Muto unsettled the yen slightly.

The Bank of Japan left interest rates on hold at 0.50% following the latest policy meeting while there was a net downgrading of economic conditions.

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The most recent data will maintain the Bank of England's desire to cut interest rates only gradually in order to maintain a firm stance on inflation. The most recent data releases have suggested a controlled slowdown in the economy, but substantial risks will persist. If there is a serious deterioration in conditions, the Bank of England will find it very difficult to resist more aggressive cuts in interest rates. In this environment, the UK would be liable to weaken sharply, although substantial losses should be resisted in the near term.        
 
Sterling secured significant net gains against the dollar during the week with a move to above the 2.00 level for the first time in 2008. Sustained dollar weakness pushed Sterling to near 2.0150 on Friday. Sterling secured net losses against the Euro, although there was a recovery from record lows.

The PMI index for the manufacturing sector edged stronger in February to 51.3 from 50.7 the previous month. There was also a significant improvement in the services-sector index to 54.0 from 52.5 while business confidence was generally firm. The prices index in the surveys were strong.

In contrast, there was a further reported decline in consumer confidence for February while retail spending reports were generally subdued. The Halifax Bank also reported a further 0.3% decline in house prices for the month.

The Bank of England left interest rates on hold at 5.25% following the latest MPC meeting. The bank did not issue a statement with the decision and the vote breakdown will not be known until the minutes are released in two weeks time.
 
Swiss franc:

The near-term trends in the Swiss franc are likely to be dominated by degrees of risk aversion and the global credit conditions. The franc will gain further support if there is any intensification of stresses surrounding the credit markets, especially if there are a strong of hedge-fund collapses and a contraction of liquidity. If these pressures can be contained, the Swiss currency should be close to a near-term peak, especially after strong gains over the past few weeks.    
 
The Swiss currency strengthened to record levels against the dollar with a string of gains and a fresh high around the 1.02 level on Friday. The Swiss franc also strengthened to highs near 1.57 against the Euro.

Increased fears over the global financial sector provided important support to the Swiss currency over the week. Evidence of de-leveraging within the banking sector was also an important element in triggering franc gains as confidence in credit markets deteriorated further amid a series of missed margin calls.

The Swiss PMI index held relatively firm at just above the 60.0 level for February. The seasonally-adjusted unemployment rate fell to 2.5% in February from 2.6% the previous month, although international trends were dominant.

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The Australian dollar pushed to the 0.95 level against the US dollar over the week, but was then subjected to sustained profit taking with losses to near 0.92 in choppy trading. High commodity prices helped prevent more substantial currency losses with renewed gains on Friday as the US currency came under heavy pressure.

At the latest policy meeting, the Reserve Bank increased interest rates by 0.25% to 7.25%. In the statement with the decision, the bank stated that there has already been a substantial amount of tightening while there were signs of demand moderation.

The economic data was generally weaker than expected with retail sales static in February compared with expectations of a small increase while fourth-quarter GDP growth was held to 0.6%. The trade deficit rose to AUD2.7bn in January from AUD1.9bn the previous month as imports rose strongly while the fourth-quarter current account deficit widened.

Yield differentials will remain highly supportive, although the overall risk profile suggests a slightly weaker trend, especially with the risk of profit taking.

Canadian dollar:

The Canadian dollar strengthened to highs beyond 0.98 against the US currency, but was unable to extend gains even with the US currency under pressure. The Canadian currency also weakened significantly against the Euro during the week.

There was support from the strength of oil and commodity prices, but this positive influence was offset by domestic and regional economic fears.

The Bank of Canada sanctioned a 0.50% cut in interest rates to 3.50% and the bank also suggested that it would look to cut rates further during the second quarter. The bank pointed to downside economic risks due to the US downturn.

The GDP data was also weak with a sharp 0.7% monthly drop for December. Building permits also fell sharply over the month which sapped confidence in the domestic economy. There was also a decline in building permits for January

Commodity prices will offer short-term support, but the downside economic risks will make it difficult for the Canadian dollar to sustain gains much beyond current levels.

Indian rupee:

The rupee dipped sharply at the beginning of the week with a five-month around 40.40 against the US dollar. High oil prices remained a negative currency factor throughout the week

The Indian currency was undermined by a sharp decline in the local stock market which recorded a four-day cumulative loss of 8.0%. The resulting capital outflows created a dollar shortage and pushed the US currency stronger.

Central bank swap operations improved liquidity and helped the rupee stabilise around 40.30, but there were renewed losses on Friday as credit fears intensified with the rupee at a six-month low near 40.50.

Elevated levels of risk aversion will tend to undermine the rupee in the short-term, although losses should be measured given that confidence in the economy is still firm

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The Hong Kong dollar was unable to sustain gains through the 7.78 level against the US currency and dipped to lows near 7.79 later in the week.

The Hong Kong currency was undermined by a temporary decline in inter-bank interest rates as volatility associated with IPOs continued. Rates edged higher later in the week ahead of another batch of equity offerings which pushed the Hong Kong dollar slightly stronger, but weaker stock markets were a negative currency influence.

The Hong Kong currency should find support close to the 7.80 level against the US dollar as IPO-related demand for funds will be supportive.

Chinese yuan:

The Chinese yuan was little changed over the week as a whole close to 7.11 against the dollar, although there was substantial intra-day volatility. Comments from a central bank official that exchange rates should not be used to fight inflation dampened immediate speculation that faster yuan appreciation would be encouraged. There was also evidence that the bank was looking for a pause in gains.

The NDF markets, however, moved to price in additional yuan appreciation over the next few month as there was still market speculation that high inflation numbers next week would maintain pressure for a tighter monetary policy.

There was evidence of additional protest against currency strength from exporters even though the US currency was generally weak.

The Chinese currency should retain a bias for net gains in the short-term, especially with the central bank needing to combat inflation. Fears over a sharp slowdown in the economy are likely to slow yuan gains.

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

Launched in 2006, dbFX is available in multiple languages and accessible in over 70 countries around the world. Deutsche Bank was  ranked the No.1 Foreign Exchange Bank in 2007 by Euromoney magazine  for the third year running. The platform can be accessed here