Weekly Forex Currency Review 16-03-2007

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Overall strategy

Levels of risk aversion will remain an important market influence in the short-term and any renewed slide in global stock markets would encourage a fresh defensive flow of funds into the yen and Swiss franc. The dollar is unlikely to secure a strong recovery in the short-term, but should be able to avoid further heavy losses.       

Key events for the forthcoming week

Dollar

The US retail and industrial data was not strong enough to curb growth doubts and deter speculation that the Federal Reserve will cut interest rates within the next few months. There are likely to be further concerns that mortgage-sector difficulties will spread to other areas of the economy. Any contagion effect could trigger sharp dollar losses, but there is also scope for defensive flows back to US markets if global stock prices fall sharply. The dollar should be able to find some support in a 1.3320 -50 band, but is unlikely to make strong headway.  

The dollar was unable to maintain the firmer tone following the employment report at the end of last week and weakened to lows around 1.3320 against the Euro in early Europe on Friday as sentiment deteriorated due to concerns over the economy. 

Headline retail sales rose by 0.1% compared with expectations of a 0.3% increase while there was an underlying 0.1% retreat over the month as housing-related sales weakened significantly. There were further concerns that sub-prime mortgage difficulties would undermine consumer confidence and the wider economy.

The New York manufacturing index fell sharply to 1.9 in March from 16.0 the previous month. The headline Philadelphia Fed index was also weak, edging down to 0.2 from 0.6 in February, although the underlying components rose slightly.

The US current account deficit for the fourth quarter of 2006 fell to US$196bn from a revised US$229bn the previous quarter as lower oil prices cut the trade deficit. There was also an improvement in the income account. The latest TICS report recorded long-term capital flows of US$97.4bn for January compared with US$14.3bn the previous month while equity inflows recovered strongly.

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The firm ECB stance will continue to underpin the Euro in the short-term with some speculation that the bank will push interest rates above 4.0% to contain inflation. Much of the favourable news is priced in which will make it difficult for the Euro to secure strong gains, especially with positioning already biased towards the Euro. Nevertheless, the firm fundamentals should limit Euro losses.

The Euro suffered renewed losses against the yen and Swiss franc in the middle of the week, but the currency regained ground and was firm during the week as a whole on a trade-weighted basis. The Euro strengthened to a 3-month high against the dollar and a seven-month high against the UK currency.

The German ZEW index rose slightly to 5.8 in March from 2.9 the previous month while other Euro-zone data was limited, although there was a reported slight decline in industrial production which suggested a possible manufacturing slowdown.

ECB officials continued to take a firm stance on monetary policy during the week. Bundesbank head Weber, for example, stated that it was too early to give the all clear on inflation while other members warned that the bank may need to adopt a restrictive policy stance. Mersch also indicated that the central bank is assuming that interest rates will be increased to 4.0% in its forecasts.

Yen 

The short-term yen movements will regain strongly correlated with global stock market tends and levels of risk aversion. The yen will remain vulnerable on yield grounds and any sustained rally in global stocks would result in renewed yen selling on capital outflows. There are, however, major risks associated with tightening credit conditions and there is still the possibility of rapid yen gains beyond 115.0 on a destabilising unwinding of short trades.
                    
The yen strengthened to highs around 115.80 against the dollar before weakening back to near 118.0 in volatile trading. The yen regained late in the week as trading conditions remained choppy and dollar sentiment deteriorated.

Risk aversion levels remained a very important factor during the week and the yen’s movements were correlated strongly with global stock prices. A slide on Wall Street triggered yen gains, before a tentative US rally dampened yen buying interest.

There was little in the way of Japanese economic data during the week while the government left its economic assessment unchanged. Vice Finance Minister Watanabe took a generally optimistic view over the economy.

The latest capital account data recorded a second successive weekly withdrawal of funds from the Japanese market while Japanese investors were more willing to invest  overseas despite pressure for year-end capital repatriation.

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The Bank of England is likely to retain a tightening policy bias at the next two monthly meetings as inflation concerns persist. A further rate increase is, however, priced in and the UK economic outlook is likely to deteriorate. Sterling volatility is liable to remain higher in the short-term as position adjustment continues and with Sterling/yen volatility triggering erratic moves against the dollar and Euro. Overall, the UK currency is unlikely to make strong headway.

Sterling was volatile during the week and the currency was strongly influenced by the developments in carry trades. The UK currency was subjected to further sharp selling pressure against the yen before securing an equally strong recovery.

Sterling weakened to lows near 0.6870 against the Euro and also dipped to near 1.92 against the dollar before recovering back to 1.9420 as the US currency stumbled.

The latest data recorded a further small decline in unemployment with the claimant count dropping by a further 3,800 in February. The headline earnings growth rose to 4.2% from 4.0%, but the underlying increase was held to 3.6% from 3.8% previously.

The UK trade deficit was lower than expected with a decline in the January deficit to GBP6.2bn from GBP7.0bn the previous month as there was a decline in imports.

Swiss franc

The National Bank is likely to maintain a steady policy course and target a further interest rate increase at the June meeting. The Swiss fundamentals will remain firm which will offer important background support, although there will  be further volatility in short-term flows. The franc will remain closely correlated with global stock price movements and risk tolerances. Overall, the currency should be able to resist heavy losses and there is some risk of rapid gains on an escalation in market turbulence with a move to at least 1.20 against the dollar.
 
The Swiss currency gained support in mid week from a renewed sharp decline in global stock prices. There was a corrective franc decline, but the franc strengthened again on Friday and broke dollar support near the 1.21 level with a move to 1.2070.

Franc moves were correlated strongly with global stock price moves with the franc strengthening significantly when equity markets were subjected to selling pressure.

The National Bank increased interest rates to 0.25% to 2.25% following the latest policy meeting, the fifth successive increase. The bank stated that it would continue with policy normalization and take action if the inflation outlook changed. The markets took this to mean that the bank would increase rates again in June.

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The Australian dollar found support close to 0.78 against the US currency and recovered back to above 0.7925 on Friday, matching the levels seen in late February.

The Australian dollar was damaged briefly by global stock market declines, but the currency proved to be generally resilient as investor sentiment held firm.

The domestic data recorded an increase in February unemployment to 4.6% from 4.5% while there was a firm 22,000 increase for employment over the month. The currency was supported by yield considerations with markets pricing in a 50% chance of an interest rate increase over the next few months following fir comments from the Reserve Bank deputy Governor.

Canadian dollar

The Canadian dollar found support close to the 1.18 level against the US currency, but was unable to sustain gains through 1.17 as the currency struggled to find direction.

There was no major data releases from Canada with manufacturing shipments falling sharply by 2.1% in January after an equally large increase the previous month.

The Canadian dollar was undermined by fears that a weakening US economy would have a negative impact on the Canadian economy.

Energy prices were watched closely over the week, but failed to have a major currency impact. Overall, the Canadian dollar should be able to avoid significant losses from current levels, but with limited capital inflows.

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The Indian rupee has secured gains over the past week despite the renewed volatility in global markets with the rupee strengthening to near 44.15 against the US dollar.

The rupee was unsettled by stock market weakness on Wednesday and data recorded net investment outflows for March compared with inflows previously. There has, however, been evidence of direct investment inflows and the rupee proved more resilient in the face of Asian stock market weakness than it was in late February.

There was further speculation that the central bank would intervene to curb local currency gains and this trimmed the rupee’s advance late in the week.

Overall, there is likely to be tough rupee resistance close to 44.10 against the dollar.

Hong Kong dollar

The Hong Kong dollar remained trapped in narrow ranges over the past week. The currency was unsettled by a sharp drop in regional stock markets and temporarily weakened to lows around 7.8160.

The currency recovered, reassured in part by HKMA chief Yam’s comments that there had been no capital outflows from Hong Kong. Regional currency gains also offered some support to the Hong Kong dollar.

The fragile US currency also offered protection to the local currency which strengthened back to 7.8120. The Hong Kong dollar could challenge 7.81, but will struggle to secure strong gains given the existing yield spreads.