Weekly Forex Currency Review 08-06-2007

Overall strategy

Greater confidence in the US economy and the rise in Treasury bond yields will provide further short-term dollar support with slow gains realistic. There will still be tough resistance to strong gains given the threat of underlying diversification away from the US currency. There is the potential for a further short-term correction in carry trades as volatility levels continue to rise. 

Key events for the forthcoming week

Dollar

The dollar will continue to draw support from greater confidence over growth trends. US Treasury bond yields have also risen to significantly above the 5.0% level which will help underpin the US currency. There is the potential for stronger support if there is evidence that interest rate increases will be required. The dollar will still be hampered by unease over housing-sector trends, especially as higher yields will increase mortgage risks. Dollar rallies will also attract central bank selling as reserves are diversified away from the US currency.      

The dollar weakened to lows around 1.3550 against the Euro during the week, but regained ground with a move to 1.3400 in early Europe on Friday.

The US data had a generally firm tone following the strong ISM manufacturing report and 157,000 increase in non-farm payrolls reported at the end of last week.

The US ISM index for the services sector rose to 59.4 in May from 56.0 the previous month, the strongest figure for 13 months with solid readings for all the components including prices.

The firm data helped sustain greater confidence over the economy and 10-year yields pushed above the 5.0% level with a 10-month high for yields above 5.10%.

The comments from Federal Reserve Governors were generally in line with recent statements. Chairman Bernanke stated that housing would be a drag on the economy for longer than expected, but he was generally optimistic over the outlook.

Track the performance of your favoured currency against the top 20 global currencies. Click here.

The ECB will maintain a firm policy stance in the short-term and the central bank comments suggest that a further increase in rates is likely over the second half of 2007. Further interest rate increases have, however, already been priced in which will curb Euro buying. Euro-zone economies such as Spain are also vulnerable to significant stresses which could have an important negative impact on the Euro during the third quarter.    

The Euro secured firm gains in the middle of the week with record highs against the yen, but the currency suffered a significant correction following the ECB meeting. The Euro lost ground against the yen and Swiss franc.

The ECB increased interest rates to 4.00% from 3.75% following the latest council meeting, in line with market expectations.

In the press conference following the decision, ECB President Trichet stated that policy was still accommodative, but that previous rate increases were having an impact. Markets continues to price in further increases over the second half of 2007.

The PMI surveys for the services sector were little changed for May, but there was a weaker than expected reading for retail sales.

Yen 

The Bank of Japan is still looking for an opportunity to tighten monetary policy within the next two months. The rise in Japanese yields will provide protection, but will not be sufficient to trigger substantial yen buying on yield grounds. Higher global bond yields will, however, increase the general level of risk aversion and the threat of a sharp correction in carry trades will also be higher. Overall, the yen has scope for corrective gains with higher volatility levels.       
                    
The yen weakened to test levels beyond 122.0 against the dollar and record lows against the Euro, but the yen secured significant gains later in the week with a move to 162.0 against the Euro.

There was little in the way of major Japanese economic data during the week. Core machinery orders rose 2.2% in April, but this followed two monthly declines.

Japanese 2-year bond yields rose to above 1.0% during the week, the highest level for 10 years which helped support the yen.

The Japanese currency gained support from significant selling in global stock markets during the week as correlations with Wall Street movements remained high.

There were no major comments on Asian currencies from G8 officials.

Click here to perform accurate conversions on any major global currency.

The Bank of England will maintain a tightening bias in the short-term and there is scope for a further interest rate increase by August. Further increases have, however, already been priced in which will limit the potential for Sterling buying and the UK currency will be exposed to strong selling pressure if there is evidence of a sustained deterioration in the housing sector. Sterling will also be vulnerable if there is a sustained reduction in carry trades. The net risks suggest that Sterling is liable to weaken.    
 
Sterling pushed to highs around 1.9960 against the dollar before weakening sharply to 1.9750 after the Bank of England interest rate decision on Thursday with further losses to 1.97 on Friday. Sterling hit resistance close to 0.6770 against the Euro.

The Bank of England held interest rates at 5.50% following the latest MPC meeting and there was no statement following the decision.

The latest British Retail Consortium sales report recorded a slowdown in like-for-like sales growth to 1.8% from 2.5% while prices were subdued.

The CIPS index for the services sector was unchanged for May while the prices component was at the lowest level for 15 months. There was mixed survey evidence on earnings trends during the week.

Sterling was undermined over the second half of the week by a general reduction in carry trades.

Swiss franc

The National Bank will increase interest rates at next week's council meeting and there will be further speculation over a 0.50% increase. A 0.25% rate increase is the more likely outcome, but the bank is likely to increase rates again in September given the strong growth indicators which will support the franc. The Swiss currency will also tend to gain support if there is any sustained reduction in carry trades. Overall, there is scope for franc gains, especially given the potential for carry-trade unwinding.    
 
The Swiss currency advanced against the Euro during the week as a whole, although trading conditions were choppy. The franc strengthened to 1.2150 against the dollar before a retreat to 1.2270 as the US currency rallied.

The Swiss economic data remained firm with unemployment falling to a 20-year low of 2.7% in May from 2.9% the previous month.

National Bank warnings over inflation continued over the week and there was further speculation that there would be a 0.5% interest rate increase at next week's quarterly council meeting.

The Swiss currency drew some support from a general reduction in carry trades as trades funded through the franc were pared back.

Click here for an A to Z of Forex-related key words and phrases.

The Australian dollar strengthened to 17-year highs against the US currency with a peak close to 0.8480 before a retreat towards 0.84 as global stock markets weakened.

The Australian data was generally stronger than expected over the week. GDP rose by 1.6% in the first quarter of 2007 compared with expectations of a 1.0% increase.

The unemployment rate fell to a record low of 4.2% from 4.4% in April while there was a firm monthly increase in employment of close to 40,000.

The Reserve Bank of Australia left interest rates on hold at 6.25% following the latest central bank meeting, but markets were more confident that rates would increase again over the next three months.

The current account deficit for the first quarter was little changed at AUD15.4bn for the first quarter of 2007. Growth hopes and yield expectations will support the Australian dollar, but it looks very expensive at current levels.

Canadian dollar

The Canadian dollar strengthened to fresh 30-year highs against the US currency with gains to near 1.0550 before a retreat to 1.0650 late in the week

The Canadian PMI index rose to 62.9 in April from 60.9 which was below expectations, but still signalled firm growth.

Confidence in the economy remained strong during the week and the currency also drew support from the high level of oil prices.

The Canadian dollar should remain generally robust, but will remain vulnerable to at least a partial correction weaker.

Indian rupee

The rupee was unable to sustain the gains beyond 40.50 against the dollar seen at the end of last week and weakened to lows around 40.90 on Friday

The currency was unsettled to some extent by weakness in regional equity markets, although the overall impact was still measured as the rupee resisted heavy selling.

The trade minister again warned that the rising rupee was hurting exports and exports fell to US$10.6bn in April from US$12.5bn the previous month. There were further suspicions over central bank intervention  to restrain the rupee close to the 40.50 level.

The rupee remains vulnerable to a further correction weaker, although heavy falls should be resisted unless there is a severe drop in regional stock markets.

Get the latest Forex news articles here.

The Hong Kong dollar was trapped in relatively narrow ranges over the week

There was evidence of persistent arbitrage activity and Hong Kong dollar selling when the currency strengthened towards the 7.80 level. The local currency weakened to 7.8155 on Friday, although there was two-way activity.

Fluctuations in the domestic stock market cause some volatility in the local currency with the Hong Kong dollar weakening as stock prices fell.

Given arbitrage selling, the Hong Kong dollar will find it very difficult to strengthen through 7.80 unless there are suggestions of a change in the currency regime. Sharp drops in Hong Kong stocks would push the currency to beyond 7.82.

Chinese yuan

The yuan recorded its second largest one-day fall for 2 years on Thursday with a retreat to 7.655 from 7.636 and losses continues on Friday to 7.66. The yuan was hampered by a firmer US dollar trend.

The central bank was also keen to encourage a period of consolidation and correction after the faster pace of recent gains. The bank intervened to curb yuan gains.

The volatility in Chinese stock market prices caused some volatility, but the overall impact was measured.

Underlying pressure for yuan gains will persist and there is further scope for medium-term gains. Officials, however, will remain cautious over allowing strong currency gains with a firm US dollar also curbing near-term yuan gains.