Weekly Forex Currency Review 15-02-2008

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Overall strategy: There will be further debate over the relative prospects for the major economies. All are showing important vulnerabilities which will deter a decisive investor stance and tend to prevent sustained advances for the currencies. The Euro will be underpinned by a firm ECB stance in the very sort-term, but the deteriorating growth prospects are likely to prevent any firm buying support for the currency.                      

Key events for the forthcoming week

Dollar:

Although the most recent data releases have provided some slight reassurance over near-term economic trends, there will continue to be serious fears over recession conditions, especially as credit standards are still being tightened, with consumer spending under pressure. The Federal Reserve will look to maintain a supportive policy over the next few months and will be prepared to cut interest rates again even if it looks to avoid further emergency measures. The dollar will gain some protection from safe-haven demand as sentiment towards the global economy is likely to remain weaker with heavy selling pressure unlikely.    
      
The dollar was unable to secure further gains against the Euro and weakened back to lows just beyond the 1.4650 level. The US currency resisted heavy selling on a trade-weighted basis, although there was some depreciation over the week as a whole.

The headline retail sales report was stronger than expected with a 0.3% increase for January while there was also a 0.3% underlying increase, although there were still notable areas of weakness in the data.

Fed Chairman Bernanke continued to warn over the downside risks to the economy and stated that the Fed would take further action if needed. The Fed emphasised that it would look at the medium-term growth forecasts in determining policy.

There were some hopes of a bond insurer deal by investor Buffet which provided temporary relief, although the underlying credit fears increased over the week as municipal bond deals came under pressure.

The trade deficit fell to US$58.8bn in December from US$63.1bn the previous month as exports recovered and imports weakened. The 2007 deficit fell by over US$45bn from the previous year. Jobless claims were little changed at 348,000 in the latest week and are at a level which suggests weak growth in the economy.

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There will be continuing expectations of a sharp slowdown in the Euro-zone economy even though the most recent data has not backed the most pessimistic assessment of conditions. There will also be speculation that the ECB will move to cut interest rates during the second quarter. The central bank will look to hold firm in the sort-term, but the Euro will also be vulnerable on fears over renewed losses in credit-related instruments and banking fears. Overall, the Euro will struggle to make strong headway in the sort-term.           

The Euro recorded a mixed picture over the week with a general advance, notably against the dollar and yen, although there was some weakening against Sterling.

The German ZEW index was stronger than expected with  a small recovery to -39.5 in February from -41.6 the previous month. The industrial production data was weaker than expected with a 0.2% December decline which cut the annual increase to 1.3%.

There were fears over ratings downgrades for European CDO holdings while banking difficulties were an important background feature.

In a series of comments, ECB officials attempted to downplay expectations that the central bank would sanction a near-term cut in interest rates. Weber, for example, maintained his tough stance on inflation.

German GDP growth slowed to 0.3% for the fourth quarter from 0.7%  the previous quarter. Euro-zone growth also slowed to 0.4% for the quarter. The ECB downgraded its GDP growth forecasts in the latest monthly report while there was an increase in inflation estimates which maintained stagflation fears.

Yen:  

Although the fourth-quarter GDP data provided some relief, there will be further concerns over weakness in the domestic economy. The Bank of Japan will look to hold interest rates steady over the next few months. The yen will continue to gain some support from high underlying levels of risk aversion and capital repatriation will be an increasing threat over the next few weeks with evidence of speculative dollar selling. Although it will weaken significantly at times, the yen should be able to resist heavy selling pressure.      
                    
The yen found tough resistance on gains towards the 106.0 level against the dollar during the week and weakened to lows around 108.60. The yen also dipped to lows beyond 158 against the Euro.

The yen lost ground as risk aversion generally eased and the Japanese currency also retreated as volatility levels dipped to the lowest level of 2008.

Japanese GDP growth for the fourth quarter was stronger than expected with a 0.9% increase as business investment was strong. The GDP deflator remained negative for the quarter as prices fell again.

Wholesale prices rose to a 27-year high in the latest monthly survey while consumer confidence weakened to a four-year low according to the latest data. The current account remained in comfortable surplus for December at JPY1.7trn.

The Bank of Japan left interest rates on hold by 9-0 vote at the latest council meeting. The bank's outlook for the economy was broadly unchanged despite greater caution over the industrial sector. There were no major comments on exchange rates following the G7 meetings.

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There is still clear evidence that the economy is slowing and there will be fears that the downturn will accelerate if there is more substantial downward pressure on house prices. The most recent data has provided some degree of reassurance and there are still serious inflation concerns. In this environment, the Bank of England will want to maintain a cautious stance and avoid rapid cuts in interest rates. This stance will provide Sterling support if there is evidence of a controlled slowdown. The UK currency has scope to rally slightly further in the sort-term before encountering renewed selling pressure.      
 
Sterling found support weaker than 0.75 against the Euro during the week and tested resistance levels close to 0.74. Sterling had a firmer tone against the US dollar and strengthened to a high above 1.97.

There was a strong increase in producer prices for January. Input prices rose 2.6% to push the annual increase to near 20% while output prices rose 1.0% over the month
Headline consumer inflation rose to 2.2% from 2.1%, but this was below expectations and the core rate fell to 1.3% from 1.5%. Core retail prices rose 3.4% over the year.

Average earnings growth weakened slightly to 3.8% from 4.0% while there was a further decline in the claimant count according to the latest labour-market data. The housing data remained negative with the RICS index weakening to the lowest level since 1992 at -54.1% for January from -49.1% the previous month.

The Bank of England issued a tough warning over short-term inflation trends with the risk of a move to around 3.0% in the sort-term. The bank also warned that inflation would be above target on a two-year view if interest rates were cut in line with market expectations. In response, expectations of lower rates were downgraded slightly.

The bank also warned over growth prospects with two quarterly contractions in growth called a technical possibility.
 
Swiss franc:

There are likely to be further doubts over the Swiss economy as growth indicators have remained weaker over the past few weeks. The domestic influences will still tend to be of secondary importance in the sort-term with franc moves determined by degrees of risk aversion in global markets. The franc will be sold if there is a sustained improvement in risk appetite, but the currency is unlikely to be subjected to heavy selling pressure.   
 
The Swiss franc weakened against the Euro during the week and also dipped to lows near 1.11 against the dollar. The franc was able to regain ground later in the week as there were fresh doubts over credit conditions with the Euro blocked near 1.62.

The Swiss ZEW expectations index fell sharply for January which reinforced speculation over a slowdown on the economy.

The Swiss franc moves were again correlated strongly with the levels of risk aversion in the credit and equity markets.

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The Australian dollar tested levels near the 0.91 level against the US currency early in the week and, after a sharp correction, it regained the 0.90 level.

The Australian labour-market data was strong with employment rising by a further 26,800 in December while the unemployment rate fell to 4.1% from 4.3%.

There was weakness in the housing finance data while consumer confidence also weakened. Despite this weakness, markets continued to price in a further interest rate increase. The Reserve Bank continued to warn over inflationary pressure in its latest monetary bulletin, although it did not give a clear signal over rates.

The Australian dollar trends were still correlated with the movements in global stock markets and level of risk aversion.

Yield support will continue to battle for supremacy with international growth fears. The net risks suggest that the Australian dollar is unlikely to make much headway.

Canadian dollar:

The Canadian dollar continued to fluctuate around the parity level during the week as neither the US or local currency were able to sustain an advantage.

The trade surplus fell to CAD2.4bn for December from CAD3.8bn the previous month and this was the lowest figure for nine years as shipments to the US continued to fall. The Bank of Canada suggested that interest rates would be cut again.

The Canadian currency secured some net support from higher commodity prices over the week, although there were still big doubts over the global economy. Moves were influenced significantly by the degrees of risk aversion in the markets.

The Canadian dollar is liable to have a slightly weaker tone given the combination of domestic and international growth fears even if substantial losses are unlikely.

Indian rupee:

The rupee has had a slightly weaker tone, although movements have still been relatively contained with the currency around 39.60 against the dollar on Friday.

Movements in the rupee have again been influenced by shifts in the local stock market. Fears over capital outflows weakened the rupee at times, but the market rallied later in the week

There have been net capital inflows for the month as a whole which limited any selling pressure on the currency, although investors remained cautious.

The rupee was still gaining some support from the increased yield gap over US assets as money-market funds stayed in the local currency.

Fears over the global economy and a more cautious investment stance will continue to expose the rupee to selling pressure, although depreciation should be limited.

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The Hong Kong dollar has fluctuated around the 7.80 level against the US dollar during the current week and strengthened to just beyond this level on Friday.

Low inter-bank rates triggered arbitrage activity at times with the Hong Kong dollar weakening early in the week, but the US currency struggled to sustain gains.

Liquidity conditions gradually tightened later in the week with some demand for funds ahead of expected IPO offerings during March.

The Hong Kong currency should secure further support weaker than the 7.80 level against the US dollar, although movement is liable to be restrained.

Chinese yuan:

The yuan weakened sharply on Wednesday with the Chinese currency dipping to lows beyond 7.22 against the dollar. The currency was undermined briefly by the absence of exporters and regained ground quickly once trading volumes increased. The yuan pushed back strongly to a peak beyond 7.20 with highs beyond 7.18 on Friday.

The evidence still suggests that the central bank is looking to allow gradual currency gains to help contain inflationary pressure. In this context, the central bank set its reference rate sharply stronger on Friday.

The trade position remained strong with a US$19.5bn surplus for January while the IMF called for a faster pace of yuan appreciation.

The yuan is likely to strengthen in the sort-term, especially with the central bank  steering the currency stronger.  Fears over a sharp slowdown in the economy will curb firm buying and could trigger a sustained reversal against the dollar later in 2008.

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