Weekly Forex Currency Review 14-03-2008

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Overall strategy: Conditions within the US economy and financial markets will remain very important market influences in the short-term. Any intensification of credit-market related fear would result in further gains for the Japanese yen and Swiss franc. The central banks will remain under very close scrutiny with pressure to boost market confidence while there will also be increased risk of more active measures to promote dollar stability.  In this environment, market volatility is liable to increase.                   

Key events for the forthcoming week

Dollar:

Confidence in the US will remain at a very low ebb in the short-term with expectations that the economy is already in recession and vulnerable to a protracted downturn. The Federal Reserve is likely to sanction a further significant cut in interest rates next week which will reinforce the lack of yield support. There will also be a risk that longer-term confidence in the dollar will be lost due to doubts over the Fed's credibility and economy. Given the extent of pessimism, any tentative evidence of an improvement in conditions could result in a rapid reversal in sentiment. Nevertheless, the dollar will struggle to secure more than limited near-term relief unless there is aggressive intervention.
      
The dollar remained under pressure throughout the week as confidence remained at depressed levels. The US currency weakened to a succession of fresh record lows against the Euro while the trade-weighted index also weakened steadily.

Sentiment towards the economy remained weak following the employment report at the end of last week. This recorded a decline in non-farm payrolls of 63,000 for February which was the weakest figure for close to five years.

US retail sales fell by 0.6% in February while there was a 0.2% drop in core sales over the month, although the January estimate was revised up slightly. Initial jobless claims were little changed in the latest week at 353,000 while continuing claims continued to edge higher.

The Federal Reserve announced fresh measures to ease persistent tensions in the money markets and help alleviate credit risks. The Fed will supply additional liquidity and allow a wider range of collateral to increase liquid funds available to brokers.

Overall confidence in the financial sector remained weak as a prominent hedge fund failed to meet margin calls and faced a seizure of assets. Markets continued to discount a Federal Reserve rate cut of at least 0.75% next week.

The US trade deficit was little changed at US $58.2bn in January with rising exports helping to produce a further narrowing of the underlying deficit.

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The ECB will continue with a tough stance on inflation in the short-term. The firm approach will support the Euro if there is evidence of continued growth in the Euro-zone economy. The recent data has offered someencouragement, although there is still a very high risk of divergence within the individual economies. Speculation over withdrawals from the Euro area are a threat while a substantial overall slowdown is also likely. There will be greater protests against Euro strength even if actual intervention is rejected as a policy option.              

The Euro has remained strong over the past week, although there have been notable spells of weakness against the Yen and Swiss franc when risk aversion increased.

The German ZEW index recovered to -32 in March from -39.5 the previous month which eased fears over the economy and the main institutes were confident that solid growth would be achievable this year. The overall data tone was mixed with gains for production offset by a drop in business confidence across the Euro-zone as a whole.

There was a widening of internal credit spreads with some speculation that countries such as Italy could decide to leave the Euro area if economic conditions continued to deteriorate. Weak Spanish data also fuelled divergence fears within the markets.

Euro Group head Juncker stated that ministers very vigilant over currency moves while ECB President Trichet noted with extreme attention the US strong dollar policy. He also stated that he is now pre-occupied with excessive forex movements, although the verbal intervention was still contained.

Yen:  

The domestic trends will not provide any significant yen support and the Bank of Japan has warned over deteriorating conditions. External risk factors will tend to dominate in the short-term and the yen will gain underlying support from fears over the US and global economy. Capital repatriation will also be a significant near-term risk factor ahead of the fiscal year-end. The Japanese Finance Ministry will be uneasy over rapid yen gains and there will also be caution given the potential for intervention below the 100 level.         

The Japanese yen continued to strengthen rapidly against the dollar and tested levels beyond the 100 level for the first time since 1995 as US confidence deteriorated.

Fourth-quarter GDP growth was confirmed at 0.9% for the fourth quarter of 2007 despite the downward adjustment to capital spending. There was also a much larger than expected increase in Japanese machinery orders for January. The Bank of Japan still downgraded its assessment of the economic outlook

There were further political tensions surrounding the nomination of a new Bank of Japan governor with the government's nominee Muto vetoed by the Opposition-controlled Upper House of Parliament.

The Finance Ministry stated that currency market movements were being watched very closely and that excessive moves were not good for growth, although there was no evidence of intervention when the dollar dipped to the 100.0 level.

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There will be persistent fears over the housing sector and the outlook for consumer spending, especially as credit tightening is liable to continue. The most recent data has offered some degree of support and the Bank of England will also be very cautious over cutting interest rate aggressively given that there are still important inflation fears. The central bank stance will provide Sterling support if the economy does not deteriorate rapidly. If consumer spending appears to be weakening sharply, then Sterling will be more vulnerable to aggressive selling pressure and the overall risk profile will remain high.          

Sterling advanced strongly against the dollar with a fresh 2008 high close to 2.04. The UK currency was resilient against the Euro for much of the week before testing record lows later in the week as the Euro advanced strongly.

There was a further strong monthly increase in input producer prices with an annual increase of close to 20% which was a 19-year high as raw-material costs jumped higher. The increase in core output prices was more subdued with a 0.2% monthly advance and an annual increase of  3.5%.

The latest RICS house-price data recorded a drop in the February index to -64.1% from -54.7% previously and this was the weakest survey since 1990 which reinforced speculation over a very sharp deterioration. The latest BRC retail sales monitor also recorded a slowdown in annual growth to 1.5% from 2.6% the previous month.

The UK industrial production data was subdued, but there was a 0.4% increase in manufacturing production for January. The visible trade deficit was little changed in January at GBP7.5bn which did not have a significant impact.

Swiss franc:

The National Bank's quarterly statement suggests that the bank will look to maintain near-term stability on interest rates, especially given the inflation concerns. The stance should provide some franc support given previous expectations that there could be a shift towards lower interest rates. Degrees of risk aversion are still liable to dominate sentiment for now and underlying fears over the global economy will provide important franc support. Nevertheless, the Swiss currency should be close to a near-term peak unless there is a further serious deterioration in financial-market conditions.     

The Swiss currency secured net gains against the Euro despite weakening sharply following the Federal Reserve move to boost liquidity. The franc pushed to record high beyond 1.0050 against the dollar.

The franc moves were again influenced strongly by the degrees of risk aversion and the Swiss currency drew support from greater fears surrounding the financial sector.

The National Bank left interest rates on hold at 2.75% following the latest quarterly meeting. The bank cut its GDP growth forecast slightly while the 2008 inflation estimate was increased slightly to 2.0% from 1.7%.

The ZEW expectations index weakened further to -71.7 in March from -55.6 the previous month which suggested the possibility of a sharper slowdown.

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Australian dollar volatility increased over the week due in part to large swings in wider asset markets . The Australian currency secured net gains against the US dollar to around 0.9450, although there were losses on the crosses.

Domestically, there was a decline in consumer confidence to the lowest level since 1993 which increased speculation over a slowdown in domestic demand. Markets were less confident that there would be a further increase in interest rates by the Reserve Bank of Australia.

The Australian currency was underpinned at times by the strength of commodity prices, but it was also unsettled when risk aversion remained strong.

The overall global risk profile will make it difficult for the Australian currency to extend gains even with the strong support from wide interest rate differentials.

Canadian dollar:

The Canadian dollar secured net gains against the US dollar with a move to highs around 0.98 during Thursday, although there was a retreat on the crosses.

The trade surplus increased to CAD3.3bn in January from CAD2.3bn the previous month with the gains led by higher export prices as volumes fell. There was a rebound in housing starts for January, although confidence in the economy remained fragile.

The Canadian dollar drew further short-term support from the strength of oil prices which pushed to record highs over the week while gold was at a record high.

Oil prices will continue to provide short-term support to the Canadian dollar. The Canadian economy will, however, find it difficult to de-couple from the US downturn which will make it difficult for the currency to make much headway.

Indian rupee:

The rupee dipped to fresh six-month lows against the US currency during the week with a low around 40.60. High oil prices undermined the rupee during the week

The decline in local stock market prices was again the main catalyst for selling pressure with the Indian market dipping sharply to a six-month low on Thursday.

The rupee staged a cautious recovery to 40.45 late in the week and there was evidence of exporter selling of dollars which helped support the local currency.

Elevated levels of risk aversion will remain the principal short-term rupee threat and further losses are realistic, although heavy selling should still be resisted.

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The Hong Kong dollar again tested levels around the 7.78 level against the US dollar during the week, matching the highest levels seen for March.

Inter-bank rates were generally lower during the week due to the timing of IPO offerings which was a slight negative factor for the currency.

The Hong Kong dollar was unsettled at times by weakness in the Hang Seng index, but there was support from speculation that the Chinese central bank could sanction a one-off yuan revaluation while general dollar weakness also offered support.

The Hong Kong currency maintain a generally firm stance in the short-term, although a Chinese and HKMA policy shift will be required to secure sizeable gains.

Chinese yuan:

The Chinese yuan strengthened against the US dollar over the week and challenged fresh record highs since the 2005 currency float. The central bank encouraged a firm currency and the yuan strengthened to highs around 7.09 on Friday.

The NDF market also indicated a faster pace of yuan appreciation as wider confidence in the US dollar weakened.

The yuan was supported by comments from a director of the State Administration for Foreign Exchange (SAFE) who stated that that a combination of policy measures would be used to control inflation.

The inflation fears were increased by a higher reading for wholesale prices while the consumer inflation rate rose to an 11-year high of 8.3% for February.

The trade account was weaker with the surplus for February falling to US$8.2bn from US$23.8bn the previous year, although this was probably due to seasonal factors.

Given inflation fears, the Chinese currency should retain strong tone in the short-term. Fears over a deterioration in the Chinese economy will tend to limit the scope for gains. A one-off revaluation is possible, although steady gains are more likely.

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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