Weekly Forex Currency Review 28-03-2008

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Overall strategy: Financial market conditions will continue to be watched very closely in the short-term. The Federal Reserve actions has eased market fears to some extent, although conditions will remain very testing in the short-term. Confidence surrounding the US economy and dollar will remain very weak, although there is the possibility that sentiment is close to a significant short-term turning point.                    

Key events for the forthcoming week

Dollar:

Confidence in the US economy will remain very weak with further fears over a prolonged downturn triggered by a sustained decline in house prices. There will also be concerns over the financial sector and pressure for the Federal Reserve to cut interest rates further. The Fed has, however, managed to stabilise market conditions which will lessen fears.  The US attitude towards the dollar will be an increasing focus with a much more decisive approach required to secure a rebound in sentiment towards the currency. Pressure for official dollar support will increase and this should help curb selling pressure. Any sign of improvement in the housing sector could also trigger an important shift in confidence. 
      
The dollar strengthened to highs near 1.5350 against the Euro over the Easter holiday period, but the US currency was unable to hold the gains and weakened sharply to lows beyond 1.5850 before stabilising. The US currency held above the trade-weighted lows seen after the Bear Stearns collapse.

US existing home sales increased 2.9% over the month to an annual rate of 5.03mn while new home sales were also stronger than expected even though the selling rate was still a 13-year low. There was a drop in inventories, but the prices data was weak. The Case-Shiller index also recorded a 10.7% decline in house prices in the year to January which may help trigger buying support in the market.

Consumer confidence remained at depressed levels with the headline rate at a 5-year low while the expectations component fell to the lowest level for 35 years.

The durable goods orders data was also weaker than expected with a 1.7% drop in orders while core orders fell 2.6% over the month while there was a recovery in the Richmond Fed manufacturing index. The fourth-quarter GDP estimate was left unrevised at 0.6% while jobless claims edged lower to 366,000 in the latest week.

The first Federal Reserve TAPS auction took place to strengthen market liquidity and market fears eased slightly as bids for funds were lower than expected. There were still serious underlying stresses in the markets.

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The robust ECB stance on inflation and interest rates will provide further near-term Euro support, especially in view of the favourable German data over the past week. There are still substantial financial-market and banking-related risks within the Euro-zone and confidence could erode rapidly, especially if there are increased internal divisions over economic policy. Economies outside Germany are also liable to deteriorate. The Euro should retain a firm stance in the near term, but should be close to a cyclical peak.       
       
After a bout of profit taking, the Euro secured renewed gains against the major currencies over the week with a solid performance against the low-yield currencies.

The German IFO index strengthened to 104.7 in March from 104.1 the previous month, contrary to market expectations of a decline.

The ECB continued to take a tough stance on policy with President Trichet continuing to concentrate on the inflation risks. In particular, there is a strong determination to minimise the risk of secondary pressures from the high level of energy prices.

Markets responded by moving to lessen expectations for interest rate cuts later this year with futures markets cutting the chance of any rate cut to around 50%. There were further stresses within the money markets and the ECB added additional liquidity to help ease the tensions.

There were reports of European irritation over the US Administration's dollar policy, but comments in public by European officials were still relatively restrained. French president Sarkozy was more vocal in the opposition to Euro strength.

Yen:  

There is the probability of a further slowdown in the Japanese economy in the short-term and the Bank of Japan is likely to keep interest rates on hold. Yen moves will still tend to be dominated by global financial markets and the degrees of risk aversion. Any sustained easing of fears will curb immediate demand for the Japanese currency. There will also be nervousness over Finance Ministry action to stem further yen gains. Given the underlying stresses, a substantial weakening of the yen remains unlikely in the short-term.
                    
The dollar has traded in wide ranges against the yen over the week with support on dips to below the 98.50 level while there was tough resistance towards the 101.0 level. The yen suffered net losses against the Euro.

The Finance Ministry and Bank of Japan continued to warn over the risk of a deterioration in the domestic economy. Business confidence was also weaker in the latest monthly survey. The labour-market data was also weaker with unemployment rising to 3.9% from 3.8% while core inflation rose to 1.0% for March from 0.8%.

The trade account returned to a JPY870bn surplus for February after a January deficit. Overall exports rose despite a further downturn in shipments to the US as shipments to Asia and Europe were strong.

There was further friction over the appointment of a new Bank of Japan governor while there were increased policy disputes over the issue of taxation.

Although the Finance Ministry stated that the currency markets would continue to be monitored very closely, there was no evidence of actual intervention.

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The most recent evidence suggests that the economy held relatively firm during the first quarter. There will, however, be strong pressures on consumer spending, especially with conditions still tightening in the credit and mortgage markets. In this environment, the Bank of England will continue to cut interest rates with a cut by May at the latest. Overall Sterling confidence will remain weak, but a substantial amount of bad news has been priced in and the export sector is strengthening. Overall, the UK currency should be able to avoid further heavy short-term selling pressure even if there are further medium-term losses.         
 
Sterling was unable to sustain gains beyond the 0.78 level against the Euro during the week and weakened back to test record lows around 0.7910. The UK currency endured a high degree of volatility against the dollar with a high near 2.02 before a retreat back to below the 2.00 level.

The net housing-sector evidence remained generally weak. The Rightmove organisation reported an increase in asking prices of 0.8% for March with an annual increase of 5.0%. The Nationwide Bank, however, recorded a 0.6% drop in prices for March with the annual increase at a 12-year low of 1.1% There was a small increase in mortgage approvals for February, although there was still a sharp annual decline.

There was an upward revision to the fourth-quarter business investment estimate while consumer confidence was also weak which illustrated the concentration of  pressures on the consumer sector.

The Bank of England warned over the inflation outlook in testimony to the Treasury Select Committee, but was also downbeat over growth prospects. Bank Governor King stated that the bank was more willing to consider a cut in interest rates.

Bank of England chief economist Bean also stated that it was expecting a further decline in Sterling which undermined confidence in the currency.
 
Swiss franc:

There will be some unease over the Swiss banks and the economy is likely to slow, but the franc trends are still likely to be dominated by the trends in global financial markets. Short-term demand for the franc is liable to slightly weaker as the degree of fear in markets eases slightly following the Fed action with a correction weaker. Given the underlying stresses, there is unlikely to be substantial selling pressure on the franc in the short-term.    
 
The Swiss franc fluctuated around parity against the dollar during the week with the US currency hitting selling pressure above the 1.02 level before a retreat back to 0.9950. The franc weakened against the Euro, although losses were contained.

The Swiss currency moves were again influenced to a significant extent by the degree of stresses in financial markets and levels of risk aversion. There was further speculation over additional debt write-downs at investment bank Credit-Suisse.

There were no major domestic developments but the National Bank injected additional liquidity into the money markets to alleviate liquidity pressures. National Bank member Jordan stated that interest rates were at an appropriate level while the franc was not at excessively strong levels against the Euro in historic terms.

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The Australian currency found support below the 0.90 level against the US currency and pushed back to highs around 0.9250, although moves remained cautious.

There were no significant domestic developments over the week with the Reserve Bank Governor Stevens not making any significant comments on monetary policy.

The Australian dollar continued to draw some support from the strength of commodity prices over the week, although market conditions were again volatile.

The Australian currency will gain if risk aversion eases, but the net risks suggest that progress will be limited, especially with a slowdown in the domestic economy.

Canadian dollar:

The Canadian dollar continued to have a weak tone against the US currency during the week, although it was able to resist heavy losses.

There was a firm report for retail sales with a 1.5% monthly increase for January while there was a also a robust increase in underlying sales. There was still a lack of confidence in underlying economic trends amid the sharp US slowdown.

The Canadian dollar was underpinned by a recovery in oil prices from levels below the US$100 per barrel level while wider commodity prices were firm.

Economic vulnerabilities will tend to weaken the Canadian dollar with expectations of lower interest rates. The currency losses should be measured while oil prices remain at elevated levels as volatile trading conditions persisted.

Indian rupee:

Although market conditions remained volatile, the rupee resisted renewed selling pressure during the week and settled stronger at close to 40.10 against the dollar

The rupee was supported by a cautious improvement in risk appetite over the week and evidence of net capital inflows after outflows for the first quarter as a whole.

Yield support also remained intact, although the rupee was undermined by the high oil prices as importers increased dollar buying ahead of the month end.

There is the potential for a further tentative rupee recovery given the easing of market fears and improved yield support, but strong rupee gains remain unlikely given the underlying stresses.

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The Hong Kong dollar was unable to maintain a position close to 7.77 against the US dollar and retreated to around 7.78 during the week.

Export growth was slower with a 7.6% increase in the year to February the slowest for four months as shipments to the US were lower.

The Hong Kong dollar drew support from further strong gains by the Chinese yuan over the week amid further speculation that the Hong Kong peg could be broken in the medium term.

The Hong Kong currency should avoid significant selling pressure in the short-term. There will be further speculation over a revaluation or a abandonment of the currency peg within the next few months.

Chinese yuan:

The Chinese yuan continued to gain strongly over the week with a push to highs near 7.01 against the US currency with a succession of daily post-float highs for the currency. The central bank appeared keen to guide the yuan stronger over the week.

With evidence of some strains in the domestic economy there was some increase in pressure for inflationary pressure to be contained through an appreciation of the exchange rate rather than through a further increase in interest rates.

There was further speculation that the authorities would sanction a one-off yuan revaluation within the next few weeks.  

The yuan will remain strong in the short-term with further gains realistic during the second quarter. There is still a strong probability that gains will slow and possibly reverse during the second half of 2008.

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New York, February 26, 2008  dbFX, the leading retail online  currency trading platform from Deutsche Bank, experienced the highest  volumes of trading during January 2008 since its launch in June 2006.

Nearly half of all retail trades executed during January over dbFX  were Euro / USD transactions, compared to an average of 15% in the three months prior to the market turmoil that began in August 2007. The surge in Euro / USD trading peaked on January 16th when 70% of  daily trading was between this currency pair.

Immediately after the FED's first interest rate cut of 75 base points on January 22nd , the U.S. dollar lost ground against the Euro as the Euro / USD currency pair accounted for 40% of trading on the following day, and nearly 50% on January 24th. As a result of the FED's cut, the next day's trading of the Japanese  yen was down against the world's other major currencies, most notably against the Euro where volumes were slashed by half to just 8% of daily trading volumes.

Trading of the Japanese yen against the U.S. dollar continued to decline and accounted for less than 10% of  January's total volume on dbFX, down nearly half against the previous  month's figures. dbFX has 34 currency pairs available to investors on  its platform.

Commenting on January's volumes, Betsy Waters, Director and head of dbFX Americas said, "Tumbling equity prices prompted investors to look  for asset classes where they could make money, and FX presented such  an opportunity. In January, we saw a 'flight to quality' in currency  trading."

Launched in 2006, dbFX is available in multiple languages and accessible in over 70 countries around the world. Deutsche Bank was  ranked the No.1 Foreign Exchange Bank in 2007 by Euromoney magazine  for the third year running. The platform can be accessed here