Weekly Forex Currency Review 23-03-2007

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Overall strategy

The degree of confidence in the US economy will remain important in the short-term with the dollar struggling to secure strong support without a more significant reversal in interest rate expectations, although heavy selling should be resisted with support close to 1.34 against the Euro. High-yield currencies could attract further short-term capital inflows, but will be vulnerable to a renewed correction from current levels.

Key events for the forthcoming week

Dollar

There will be further unease over US growth trends with fears that mortgage and housing difficulties will trigger a wider slowdown. The Fed statement this week reinforced market speculation over lower interest rates within the next few months. The Fed, however, still has inflation concerns and some reduced confidence over a near-term rate cut will provide some dollar protection unless forthcoming data is very weak. The dollar will remain vulnerable on longer-term reserve diversification risks and it will be difficult to secure a strong recovery.

The dollar struggled to make much headway during the week and fell to two-year lows around 1.3410 against the Euro before a tentative recovery back to 1.3310.

The Federal Reserve left interest rates on hold at 5.25% following the latest policy meeting. In the statement following the decision, the Fed dropped references to additional monetary tightening and, although the Fed still considered inflation to be the predominant risk, it switched to a more neutral policy. The Fed expected moderate growth in the economy and did not specifically mention the mortgage sector.

Markets initially considered this to indicate that the Fed had moved closer to a rate cut before mid year which put the dollar under pressure, although there was some reassessment of the situation later in the week.

Housing starts strengthened to an annual rate of 1.53mn in February from 1.39mn the previous month, but there was a drop in permits for the month. Elsewhere, jobless claims fell in the latest data to 318,000. the lowest level for six weeks.

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In the short-term, the Euro will continue to be supported by a firm ECB policy stance with speculation that there will be a further increase in rates. There will, however, be discomfort over the Euro’s level within the national governments. In this context, there are likely to be increased calls for interest rate increases to be suspended or for the Euro to be restrained and this will limit currency gains.

The Euro secured net gains over the week with advances against the dollar, yen and Swiss franc. There was no major economic data during the week with industrial orders edging lower for February after substantial gains the previous month.

ECB officials continued to take a firm stance on interest rates in public statements with Chairman Trichet also stating that policy was still accommodative.

There were, however, some concerns over the Euro and interest rates. The German Finance Minister warned that a further Euro rise could damage exports while the head of the IFO economic institute called for the ECB to stop raising interest rates.

Yen

The capital account trends will become less favourable on seasonal grounds from late March and this will lessen yen support. Renewed confidence in high-yield currencies will tend to weaken the Japanese currency in the short-term with defensive demand for the currencies at a lower level. Investor concerns could, however, return rapidly which would trigger renewed yen gains and volatility levels are likely to remain at higher levels with some yen support close to 118.0.
                    
The yen was unable to break through 116.25 against the dollar and weakened back towards 118.0. The yen also fell to 157.50 against the Euro before a Friday recovery.

The latest business confidence survey was weaker than expected which dampened expectations over the Tankan index which will be released in early April.

The trade account remained strong with a robust surplus for February. The latest capital account data showed reduced capital inflows, but there were still reservations over pushing funds overseas.

The Bank of Japan left interest rates at 0.5% at the latest meeting and comments from Bank governor Fukui suggested that rates would be left on hold in the short-term.

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The robust consumer spending data and rise in consumer inflation will maintain speculation that the Bank of England will increase interest rates again within the next two months. The Bank of England comments still suggest there is some caution and the markets are close to pricing in two further rate increases. Given these expectations, the UK currency will find it difficult to secure buying from current levels and evidence of a housing downturn would be damaging. 

Sterling was subjected to considerable volatility against the dollar and was unable to sustain gains above the 1.97 level. The UK currency was firm against the Euro and strengthened to a 3-week high on a trade-weighted basis.

The economic data had a generally firm tone over the week. As far as growth is concerned, there was a 1.4% increase in February retail sales following a revised 1.5% drop the previous month which increased annual growth to 4.9%.

Consumer inflation rose to an annual rate to 2.8% in February from 2.7% while the RPI rate rose to an annual rate of 4.6%, an 11-year high for the index.

Minutes from the March Bank of England meeting recorded an 8-1 vote for unchanged rates with the dissenting vote for a 0.25% cut in rates. The bank was also slightly less concerned over wage inflation in the economy.

The UK budget was broadly neutral in macro terms and failed to have a significant impact on the currency.

Swiss franc

The strong Swiss fundamentals will continue to provide important franc protection. Global investor sentiment will remain a crucial short-term factor and the franc will remain vulnerable if there is renewed increase in high-yield currency buying. There is, however, the risk of a disruptive forced repayment of franc-denominated loans which would be likely to strengthen the franc sharply. Overall, the currency should be able to resist heavy losses. 
 
The Swiss franc weakened back to near 1.62 against the Euro during the week and also failed to sustain gains beyond the 1.21 level against the dollar.

The Swiss economic data was generally strong with a healthy increase in industrial production. National Bank member Jordan sated that further interest rate increases were required, although he also stated that the need was now less pressing given that inflation forecasts are low.

There was a strong CHF1.39bn trade surplus for February as exports remained strong.

There was reduced demand for the franc on defensive grounds during the week as the rise in global stock markets triggered renewed enthusiasm for high-yield currencies.

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The Australian dollar retained a firmer tone throughout the week and strengthened to highs near 0.8090 against the US currency, an 11-year high for the currency, before drifting weaker towards 0.8055 on profit taking.

There were no major domestic economic releases over the week, but comments from Reserve Bank deputy Governor Edey offered support to the local currency.

The bank effectively retained a tightening bias and markets priced in around a 40% chance that interest rates would be increased at the April Reserve Bank meeting.

The Australian currency was also supported by reduced levels of risk aversion and a lack of confidence in the US dollar which trigger firm buying support.

Canadian dollar

The Canadian dollar found firm support close to the 1.18 level against the US currency and strengthened sharply to highs near 1.1540 in the middle of the week.

The Canadian inflation data was significantly stronger than expected with headline prices rising 0.7% for February. There was also a 0.5% increase in core prices for the month and the annual core rate rose to a 3-year high of 2.4%.

Retail sales edged down for January, but the underlying data was still firm following sharp gains the previous month.

The inflation data triggered reduced expectations that the Bank of Canada would be able to cut interest rates with some speculation that an increase could be required.

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The Indian rupee has had a consistently strong tone over the past week, gaining support from domestic and international factors. The rupee strengthened to an 18-month high around 43.45 before edging back to 43.70.

In the local money market there was a liquidity squeeze and this temporarily pushed rupee inter-bank rates to levels above 60% which triggered short-term dollar selling.

Global stock markets recovered and this encouraged a further flow of funds into the Indian market which supported the currency.

Regional currencies were also generally strong over the week which supported the currency. The rupee lost some ground late in the week as interest rates fell back and there was increased import demand for dollars.

The rupee will remain vulnerable to a correction back towards 44.0, especially with the threat of central bank intervention, but sharp losses should be avoided unless there is a big increase in risk aversion.

Hong Kong dollar

The Hong Kong dollar secured gains over the week, supported by a weaker US dollar trend, and temporarily strengthened to highs around 7.8080.

A recovery in the Hang Seng index helped trigger increased capital inflows while there was also evidence of corporate demand for the local currency.

The Federal Reserve statement pushed US yields lower and this helped support the currency, especially as there were gains for regional currencies.

The Hong Kong dollar retreated to 7.8110 on Friday as US dollar confidence stabilised. Given the lack of US dollar confidence firm Hong Kong dollar support is realistic close to 7.8150.