Weekly Forex Currency Review 28-09-2007

Overall strategy

The dollar will remain vulnerable in the short-term as markets continue to anticipate further Federal Reserve interest rate cuts. Given the Euro-zone economic and amount of bad US news priced in, the dollar should be close to a near-term trough even though sentiment will remain depressed. High-yield currencies will struggle to extend near-term strong gains.        

Key events for the forthcoming week

There will be persistent fears surrounding the US housing sector and the risks to the wider economy with expectations of further Federal Reserve rate cuts. The wider employment market appears to have held firm and confidence over further aggressive interest rate cuts could fade, especially if the prices data is higher than expected, as the Fed will also have to address inflation issues. Given the extent of pessimism over the dollar, there is scope for some tentative recovery as expectations are adjusted. Underlying fears over reserve diversification will continue to stifle any significant rally attempts.
      
The dollar has remained under pressure during the past week with lows close to 1.42 against the Euro while the trade-weighted index has fallen to fresh 15-year lows.

US existing home sales weakened again in August with a decline in the annual rate to a five-year low of 5.50mn. New home sales also fell sharply by 8.3% over the month with rising inventories and falling prices undermining recovery prospects.

Consumer confidence also fell to a two-year low below the 100.0 level while durable goods orders fell sharply for August

The labour-market data was stronger with a headline drop in jobless claims to 298,000.  This was the lowest level since early May while the four-week moving average fell to a 7-week low.

The Saudi Arabian authorities stated that they would defend the existing peg arrangement against the US currency which eased immediate fears over regional dollar selling.

There was little in the way of comments from Federal Reserve officials during the week with markets looking for a further rate cut at the end of October.

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There will be further speculation over a significant slowdown in the Euro-zone economy and there will also be concerns over the housing sector. The ECB will want to maintain a firm policy stance, particularly given inflation concerns, but the bank will probably leave interest rates on hold in October and overall rate expectations are likely to be downgraded.  There is also the threat of more aggressive protests against Euro strength and further substantial gains could trigger co-ordinated G7 attempts to rebalance global exchange rates.             

The Euro remained generally robust over the week with the trade-weighted index strengthening to a record high.

The German IFO business confidence index weakened sharply again with a decline to 104.2 in September from 105.8 the previous month. Unemployment fell by 50,000 in September, but the situation was mixed as retail sales fell.

Provisionally, German consumer prices rose 0.2% in September to give an annual increase of 2.4% which increased Euro-zone inflation concerns.

There were further protests against Euro strength from French officials while there was also caution from Italian officials.

There were mixed comments from the ECB with officials voicing caution over the economic situation, but also stating that policy was still accommodative.

Yen 

The Tankan index will be important for yen sentiment and a stronger than expected figure would give the Bank of Japan scope to tighten policy.  Any hints over a rate hike would provide yen support, especially with markets not expecting an increase. The levels of global risk aversion will remain very important and a sustained recovery in risk appetite would continue to undermine the Japanese currency. There is, however, a growing threat of complacency over global risk conditions which should curb yen selling pressure.                    
                    
The yen was unable to strengthen through the 114.0 level against the dollar during the week even though US confidence remained depressed with a drop to lows around 115.80 while the yen weakened against the Euro.

Core consumer prices fell 0.1% in the year to August, in line with expectations. Bank of Japan's Suda stated that the bank should tighten in a pre-emptive and gradual manner, warning that the economy could overheat if rate increases are delayed.

There was a strong increase in industrial production with a 3.4% August increase while unemployment rose to 3.8% from 3.6%. The trade surplus was strong for August with an annual export increase of over 15%.

The yen moves remained correlated with stock market moves and levels of risk aversion. An overall improvement in risk tolerances tended to weaken the yen.

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There is likely to be an underlying slowdown in growth with the consumer sector under pressure while tighter credit conditions will have an important impact in undermining the housing sector. There has already been an adjustment in interest rate expectations which should limit selling pressure on the currency. The underlying risks still suggest that Sterling is likely to weaken further on a trade-weighted index over the next few weeks, especially given the risks of a more severe housing-sector deterioration.                
 
Sterling remained under pressure against the Euro during the week with 18-month lows around 0.7025 before some stabilisation. The UK currency held firm against the dollar in choppy conditions.

The house-price data was firm with the Nationwide Bank reporting a 07% increase in prices for September to give a 9.0% annual increase. There were, however, reports of a sharp drop in house sales over the past two weeks.

Bank of England MPC member Sentance stated that the tighter credit conditions could weaken growth while the headline inflation drop was encouraging.

The Bank of England stated that mortgage conditions had not deteriorated, but that there had been a tightening in corporate credit conditions. The bank's emergency credit facility was not used during the week as the first auction attracted no bids, butt he Northern Rock tapped the Bank of England facility.

The current account deficit fell to GBP9.1bn in the second quarter from a revised GBP10.6bn the previous quarter.

Swiss franc

The National Bank has again suggested that monetary policy is likely to remain on hold in the short-term which will curb franc demand. The KOF index held firm, however, which will maintain confidence in the Swiss currency. Although risk tolerances have improved during September, it is by no means certain that this confidence will be sustained and any reversal would provide important franc support. Overall, the currency should be able to resist further significant losses against the Euro with the dollar unable to secure more than a limited recovery.     
 
The franc weakened to lows beyond 1.66 against the Euro but the franc strengthened to the highest level against the dollar since 2005 at 1.1640 before settling around 1.17.

The Swiss KOF index rose slightly to 2.14 in September from an upwardly-revised 2.12 the previous month while the consumption index was weaker. Business confidence remained firm in the latest National Bank survey

The central again hinted that interest rates were now on hold, although it did express some unease over inflation trends.

The improvement in risk tolerances helped weaken short-term demand for the Swiss currency as low-yield currency demand diminished.

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The Australian dollar continued to strengthen over the week with gains to above 0.8820 against the US dollar which was close to the 18-year highs seen in July.

The currency secured support from an improvement in risk conditions which increased the flow of funds into high-yield currencies.

The Australian dollar was supported by the strength of commodity prices during the week, especially with the gold price making strong gains.

There was little in the way of domestic economic data during the week with Australian yield expectations remaining intact after a firm credit report.

The Australian currency should remain firm in the very short-term, but is vulnerable to at least a partial correction after recent rapid gains.

Canadian dollar

The Canadian dollar fluctuated around the parity level against the US currency during the week with the US dollar unable to secure a convincing recovery.

The Canadian currency was underpinned by persistent strength in oil prices during the week while wider commodity prices remained firm.

Bank of Canada Governor Dodge reported that some of the recent currency appreciation fell outside the bank's assumed range, but there was no suggestion of intervention to weaken the currency.

There was little in the way of domestic influences following the weaker than expected retail sales data at the end of last week

Overall, the Canadian fundamentals will remain strong in the short-term, but the US dollar should be able to secure at least a limited correction..

Indian rupee

The rupee has continued to take advantage of wider dollar vulnerability and strengthened to fresh 9-year highs around 39.65 against the US currency before a retreat to 39.80 on Friday as caution increased.

Capital inflows to the local stock market have remained strong with reported inflows of US$1.9bn over the past week

Finance Minister Chidambaram warned over the impact currency strength by stating that the rupee strength was problematic. The government has eased regulations on capital outflows to help ease upward pressure on the currency.

The rupee was still restrained by central bank intervention fears, although the central bank appeared relatively cautious over moving aggressively.

Rupee confidence should remain firm in the short-term on optimism over capital inflows and weak dollar confidence, but caution is still required at current levels.

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The Hong Kong dollar has remained strong with gains accelerating over the second half as the currency pushed to 16-month highs around 7.7570.

The Hong Kong currency was supported by a strong increase in inter-bank rates with one-week inter-bank rates rising to 6.30%. An easing of pressure on rates pushed the Hong Kong dollar slightly weaker to 7.76 on Friday.

Interest rates were supported by strong demand for funds ahead of the forthcoming IPO offerings.

The local stock market remained strong which supported the Hong Kong dollar while there was speculation that the currency peg would come under pressure.

The currency should remain firm in the short-term, although some correction is likely once IPO demand ease and money-market interest rates decline further. There is a small risk of a revaluation which would push the currency sharply stronger.

Chinese yuan

The yuan has been trapped within relatively narrow ranges over the past week with further tough resistance close to the 7.50 level against the US dollar.

The central bank has indicated that it is not keen to see the yuan strengthen beyond the 7.50 level and the markets have not pushed the central bank strongly.

There was particular caution ahead of the week-long market holiday from October 1st

There was also uncertainty and restraint ahead of the Communist Party's annual congress which is also due to be held in October.

Even if there is a further period of near-term stability, the net trend is still likely to be for a stronger Chinese yuan, especially with further pressure for a tighter monetary policy to ease inflation pressure.