Weekly Forex Currency Review 20-07-2007

Overall strategy

The dollar will continue to be unsettled by mortgage-related difficulties, especially with the Federal Reserve expressing some concerns over the sector. Underlying growth is still holding firm which should provide dollar protection and the dollar will also gain support if the property-related sectors in the Euro-zone and UK start to show clear signs of deterioration. Strong interest in carry trades and high-yield currency gains may continue in the very short-term, but market volatilities are liable to increase.

Key events for the forthcoming week

Dollar

Mortgage-related concerns will persist in the short-term with  fears that sub-prime difficulties will undermine the wider economy. The second-quarter capital inflows data was firm, but there will be fears that tightening credit conditions will undermine inflows this quarter and undermine the currency. The overall US data has remained firm which will support confidence, especially if the labour-market data remains robust. Sentiment will remain very fragile in the short-term and the dollar will be at risk of record lows against the Euro, but a fragile recovery is realistic over the next few weeks.
      
The dollar has remained under pressure during the week with further concerns over the US economy. The US currency weakened to all-time lows against the Euro and 30-month lows on a trade-weighted basis before stabilising over the second half of the week.

Fed Chairman Bernanke still expected moderate growth in the economy and stated that inflation was still the pre-dominant concern. Bernanke also expressed concerns over the sub-prime sector with comments that the situation was likely to get worse before it gets better, although comments in his second testimony were slightly more positive with confidence that problems would be contained.

The US headline inflation indices were held down by lower energy prices over the month with a 0.2% monthly increase while there was a core CPI increase of 0.2% to give an annual 2.2% increase. Core producer prices rose 0.3% over the month.

The US industrial data was generally solid with a production increase of 0.5% for June, although the Philadelphia Fed survey weakened for July. Housing starts edged stronger over the month, but there was a 7.5% drop in building permits which maintained concerns over a prolonged downturn in the sector.

The latest capital flows data recorded strong inflows for May with long-term inflows at a very strong US$126.1bn from US$80.3bn the previous month. There were still concerns that the sub-prime difficulties and hedge fund losses would undermine inflows over the second half of 2007.

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The ECB will maintain a tight policy stance in the short-term and is still looking to increase interest rates again. The latest German data has shown some signs of a slowdown and the economies outside Germany are liable to weaken significantly given the important loss of competitiveness over the past 12 months. There will be a further discussion of exchange rate policy between the ECB and Euro-zone politicians. Although the ECB will forcibly resist any policy shift, pressure for measures to curb the Euro will increase if there are further gains.          

The Euro has remained generally robust over the past week with broad-based, although generally measured, gains against the major currencies. The Euro pushed to a record high around 1.3830 against the dollar.

The German ZEW index weakened to 10.4 in July from 20.3 the previous month which suggested a gradual slowdown in the German economy. There was little major evidence from other major Euro-zone economies.

Comments from ECB officials remained generally tough, although there was some evidence of unease over the extent of recent Euro gains.

The ECB forcefully rejected suggestions that it should look to manage the exchange rate or have a changed mandate, but the French government continued to express concern over the issue.

Yen 

Although the economy is struggling to make strong headway, the Bank of Japan is likely to decide on an August interest rate increase which will offer some yen protection. A wider trend for stronger Asian currencies will also tend to provide some yen support. There will still be interest in selling the Japanese currency on any significant rallies, especially from domestic retail investors. The yen's performance overall will remain correlated strongly with levels of global risk aversion and volatility levels are liable to increase.           
                    
The yen has been contained in relatively narrow ranges during the week with the Japanese currency finding support weaker than 122.30 against the dollar. There was still evidence of tough resistance towards the 121.50 level and the yen was close to record lows against the Euro.

There was little in the way of major Japanese data over the week with business confidence weakening slightly in the latest monthly survey.

The Bank of Japan minutes suggested that higher oil prices would strengthen the case for an August interest rate increase.

There was further evidence of retail yen selling interest during the week as carry trade interest persisted.

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Market expectations of further interest rate increases will persist in the short-term and the Bank of England will remain concerned over inflationary pressure. The economy has already shown signs of a slowdown and there is liable to be further deterioration in consumer-related areas as higher interest rates and falling disposable incomes prompt increased caution. The Bank of England has greater scope to assess the situation and delay a further rate increase which is liable to curb Sterling support and trigger at least a limited correction.         
 
Sterling pushed to fresh 26-year highs against the dollar with gains to above the 2.05 level while Sterling held firm against the Euro.

The consumer inflation rate fell to 2.4% in June from 2.5% the previous month, but the core rate rose to a 10-year high of 2.0% from 1.9%, while the RPI inflation rate rose to 4.4% from 4.3%

The headline earnings growth rate fell to 3.5% in May from 4.1% the previous month while the underlying rate also fell to 3.5% even though there was a further drop in the claimant count.

The Bank of England minutes recorded a 6-3 vote for an interest rate increase in July. The minutes overall suggested the bank may not push for a further early increase in rates.

Retail sales rose 0.2% in June with the annual increase falling to 3.4% while there was a slowdown in money supply growth and underlying lending growth.

Swiss franc

The domestic economy is continuing to perform well and growth as a whole is being supported by strong export growth. Although producer prices were subdued, the National Bank is likely to increase interest rates again by September and will consider an intra-meeting increase if inflation concerns intensify. This stance will underpin the currency, although the overall franc trend will be dependent on the levels of global risk aversion and stock market performance.
 
The Swiss franc again challenged levels below the 1.20 level against the dollar, but was unable to sustain the break with rallies against the Euro also encountering selling pressure

The Swiss franc gained when European stock markets fell, but the currency was unable to sustain the gains as New York gains inspired a global advance in prices.

The Swiss trade account remained strong with a CHF1.72bn surplus for June from CHF1.05bn the previous month as real exports rose 12.8% over the year.

Although the retail sales data was firm producer prices were unchanged for June with a 2.8% annual increase which dampened expectations of a near-term National Bank response.

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The Australian currency has continued to challenge 18-year highs against the dollar and has probed resistance levels above the 0.88 level late in the week.

The Australian dollar drew further support from the strength of commodity prices during the week with metals prices at a six-week high.

There was little in the way of economic data, but Reserve Bank Governor Stevens stated that he was not surprised over currency strength given the improvement in the terms of trade

The Australian currency will look to gain from expectations of firm growth and high commodity prices, but will be increasingly vulnerable to a correction given the recent strong gains.

Canadian dollar

The Canadian dollar has continued to find support on retreats against the US currency and briefly challenged the 1.04 level. The overall speculative positioning bias remains heavily against the Canadian dollar and US dollar rallies have been sold into given the positioning bias.

The inflation data was weaker than expected as consumer prices fell 0.2% in June while core prices were unchanged which held the annual increase to 2.5%. The Canadian dollar was again supported by the strength of oil prices during the week

There was little in the way of major releases on the economy, but manufacturing shipments fell for the second month running.

Canadian dollar sentiment is likely to remain strong in the short-term, although consolidation of recent gains is likely to be the dominant theme.

Indian rupee

The rupee has continued to test 9-year highs against the US dollar, underpinned by firm local sentiment and fragile US currency sentiment. The Indian currency was testing levels close to 40.30 on Friday.

The rupee has again been supported by strong capital inflows with international flows into the Indian stock market estimated at US$3.1bn during July. The stock market has pushed to a succession of record highs during the week.

There has been further evidence of central bank intervention to stem rupee gains. The rupee was also unsettled slightly by the very high level of oil prices.

The rupee will continue to gain short-term support from capital inflows and firm regional currencies. The central bank will deter appreciation and sentiment could still switch sharply within the next few weeks.

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The Hong Kong dollar has drifted weaker against the US currency during the week with lows just beyond the 7.82 level.

The Hong Kong currency has continued to be undermined by arbitrage activity during the week even though US Treasury bond yields drifted lower. Levels beyond the 7.82 level triggered profit taking on the US currency. Speculation over a further increase in Chinese interest rates offered some support to the local currency.

The Hong Kong dollar should find further support close to the 7.82 level against the US currency with some degree of support from a firm Chinese currency.

Chinese yuan

The Chinese yuan has continued to strengthen during the week with highs beyond 7.57 against the US currency and consolidation close to this level on Friday.

The Chinese economic data supported the Chinese currency during the week with GDP growth estimated at 11.9% in the year to the second quarter.

The annual inflation rate also increased sharply to 4.4% in June from 3.4% the previous month as food prices rose strongly.

The strong data increased speculation that the Chinese authorities would move to increase interest rates again in the near term. There have also been rumours that the Chinese government will sanction a 3.5% yuan revaluation in the short-term

The underlying trend should continue to be for a stronger Chinese yuan, especially if there is a further increase in interest rates, and a one-off revaluation remains a possibility.