Weekly Forex Currency Review 27-04-2007

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Overall strategy

Dollar confidence will remain fragile in the short-term with further speculation that weaker growth will trigger a third-quarter interest rate cut. A substantial US deterioration is now priced in which should curb further dollar selling. There is a renewed threat of market instability and higher volatility given complacency over global risk conditions.

Key events for the forthcoming week

There will be further concerns over the US growth outlook in the short-term with particular fears surrounding the housing sector as mortgage defaults rise. There will also be expectations of a third-quarter interest rate cut by the Federal Reserve and the existing yield structure will continue to limit the potential for dollar buying. If the wider economy can weather the housing difficulties over the next few weeks, then sentiment towards the dollar could improve.

The dollar's trade-weighted index fell to an all-time low during the week before a limited recovery. The US currency also dipped to near all-time lows against the Euro at 1.3665 before a correction back to 1.3590.

The US housing data remained weak for March with existing sales falling 8.2% to an annual rate of 6.12mn while new sales rose only slightly to 0.86mn from a downwardly-revised 0.84mn previously. Inventories fell, however, for new homes while overall prices held firm which offered some encouragement.

Consumer confidence weakened in April to 104.0 in April from 108.2 as fears over mortgage defaults and higher energy costs undermined sentiment.

There was a recovery in durable goods orders with a 3.4% monthly increase for March, but the regional Richmond Fed survey remained weak for April. Jobless claims fell by 20,000 to 321,000 in the latest week.

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Confidence in the Euro-zone economy will remain strong in the short-term and this will feed into optimism over the Euro with the ECB set to increase interest rates in June. There have been no major protests against Euro strength so far, but the risks of opposition will increase if the currency advances further. There will also be the risk of divergence within the Euro-zone economies which would increase economic and political stresses.

The Euro pushed to near a high against the yen during the week and also strengthened to a five-week high against Sterling as overall sentiment remained strong.

The Euro-zone economic data remained generally robust with the German IFO index rising to 108.6 in April from 107.7 previously, close to a record high for the index.

Consumer confidence indicators also remained firm in Germany and Belgium. There were no major protests against current Euro levels from European officials, although there were some concerns from within industry while Ministers did warn that further strong Euro gains would be damaging.

The Spanish stock market weakened during the week and caused some temporary losses on European bourses as a whole. The first round of the French presidential election did not have a significant impact.

Yen 

Nominal Japanese interest rates will remain low which will encourage a further outflow of funds from Japan in search of higher yields, especially with low inflation readings. Longer-term Japanese confidence is likely to remain firmer which will help underpin the currency. The Bank of Japan is also likely to increase interest rates again within the next 3 months. There is a growing threat that risk aversion will rise again which could trigger sharp capital repatriation and strengthen the currency with yen support near 120 against the dollar.   
                    
The yen weakened to record lows against the Euro beyond 162.50 and struggled to take advantage of dollar vulnerability, holding close to 119.50 on Friday.

Core consumer prices fell 0.3% in the year to March. There was a 0.6% drop in industrial production for the month while retail sales also fell over the year. The Bank of Japan left interest rates unchanged at 0.5% following the latest policy meeting, but remained committed to a gradual increase in rates.

Japanese sovereign rating was revised up to AA+ from AA by Standard & Poor's. The latest capital account data recorded a broadly balanced position with a recovery in inflows towards Japan.

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The economic data has remained firm and there is a strong probability that the Bank of England will increase interest rates again at the May meeting. The UK currency will look to gain further support on yield grounds in the short-term. The longer-term economic risks are continuing to increase with substantial risks associated with the housing sector while tightening has been discounted in current values. The UK economy is liable to deteriorate over the second half of 2007, possibly sharply, which would undermine the currency.
 
Sterling weakened to a 5-week low of 0.6830 against the Euro during the week and, after fluctuating around the 2.00 level against the dollar, dipped to lows below 1.99

The UK GDP data recorded 0.7% growth for the first quarter with annual growth of 2.8%. The ITEM economic forecasting group, however, warned that the economy was skating on thin ice with warnings against further aggressive monetary tightening.

The Monetary Policy Committee (MPC) members pledged a tough stance on inflation in parliamentary testimony with markets still looking for a May interest rate increase.

Merger-related activity was significant with a counter bid for ABN-Amro worth over US$95bn which triggered some speculation over capital outflows from the UK.

The latest house prices indicators remained firm with the Nationwide Bank reporting a 0.9% increase for April to give an annual increase of 10.2%.

Swiss franc

The Swiss currency will remain vulnerable to some selling pressure if there is further global interest in carry trades. The National Bank will, however, increase interest rates again in June and the Swiss fundamentals will remain strong. The currency will be in a position to gain strongly if there is a sustained increase in risk aversion. The central bank is also likely to protest against further currency weakness and significant franc losses look unlikely from current levels.
 
The Swiss currency temporarily strengthened to 1.6350 against the Euro before weakening back beyond the 1.64 level. The dollar found support at the 1.20 level against the franc over the week and recovered back to near 1.21.

The March trade surplus fell to CHF0.88bn from CHF1.38bn the previous month, but there was a strong performance from exports with annual growth of over 10%.

National Bank members Hildebrand and Roth both stated that the bank would increase interest rates if franc weakness jeopardised price stability.

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Australian dollar volatility increased over the week. The currency tested levels above the 0.8350 level before weakening to lows below 0.8250 in local trading on Friday.

The Australian consumer prices data was weaker than expected with prices rising 0.1% in the first quarter, cutting the annual inflation rate to 2.4% from 3.3%. The underlying rate fell to 2.7%, below the 3.0% Reserve Bank ceiling.

Markets moved to price out a Reserve Bank interest rate increase at the May meeting following the benign inflation data.

The level of industrial commodity prices provided support to the Australian dollar, but there was a drop in gold prices which had a negative impact. Bond redemptions started to increase during the week which hampered the currency.

Canadian dollar

The Canadian dollar secured further strong gains to highs around 1.1140 in mid week before a corrective retreat back to 1.12 on Thursday.

The Bank of Canada left interest rates on hold at 4.25% following the latest policy meeting. The central bank retained a slight tightening bias on policy, but also lowered the GDP growth forecasts slightly for the next 12 months.

The central bank was concerned that more subdued US growth would curb Canadian growth as well and suggested that interest rates would be left on hold for now.

Bank of Canada Governor Dodge announced that he would be leaving office.

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The Indian rupee remained strong over the week and strengthened to fresh 9-year highs of 40.60 against the dollar before a correction back to 41.05 on Friday. The rupee has strengthened by around 6.0% against the US currency during April as a whole as sentiment remained strong.

The central bank is concerned that intervention will increase inflationary pressure by pushing up liquidity and is curbing dollar buying. The bank did, however, encourage increased capital outflows by amending loan-repayment rules.

There was further evidence of robust capital flows during the week with overseas inflows amounting to around US$1.2bn for April.

The rupee should remain generally strong in the short-term, but with the potential for a further significant correction weaker following recent rapid gains.

Hong Kong dollar

The Hong Kong dollar weakened steadily during the week and depreciated to lows around 7.8215 against the US dollar on Friday, a 22-year low for the local currency.

The local currency was undermined by arbitrage activity during the week while a weaker stock market also unsettled the Hong Kong dollar to some extent.

The Hong Kong dollar was undermined by a drop in local money market rates as liquidity increased. There was also evidence that funds which had been raised through IPOs was being switched into overseas companies.

The Hong Kong dollar should be able to avoid further heavy losses, but will struggle to secure strong gains with tough short-term resistance close to 7.81.