Weekly Forex Currency Review 29-02-2008

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Overall strategy: US recession fears will dominate in the short-term with confidence continuing to deteriorate.  In this environment, there will be the risk of further selling pressure on the dollar and there will be an increased focus on G7 central banks to assess whether they will protest more forcefully against currency trends.  The US currency should still secure some protection from important underlying Euro-zone stresses.                  

Key events for the forthcoming week

Dollar:

Confidence in the US economy will remain depressed in the near term with continuing recession fears given that there has been improvement in data releases. Markets will also continue to expect further interest rate cuts from the Federal Reserve which will reinforce the dollar's lack of yield support. The dollar's outlook will depend crucially on the global economy as the currency will be more vulnerable to selling pressure if the international economy appears able to de-couple from the US trends. Overall, there are likely to be increased global fears which should alleviate heavy selling from current levels.      
      
The dollar came under heavy selling pressure during the week with the US currency hitting a succession of record lows beyond the 1.52 level against the Euro. The trade-weighted index also dipped to fresh all-time lows.

Consumer confidence continued to weaken in February with the headline figure at  a 4-year low of 75.0 while the expectations component fell to the lowest level since 1991. There was a sharp decline in durable goods orders after a sizeable increase the previous month. The Case-Shiller index recorded a decline in house prices of 9.1% in the year to December with an annual decline of 4.7%.

New and existing home sales were little changed for January while there was a further increase in inventories and prices fell over the year. Jobless claims increased to 373,000 in the latest week which continued to suggest a softer labour market, especially as the number of continuing claims rose further.

Producer prices rose 1.0% in January with an underlying increase of 0.4% for the month and inflation fears increased as the GDP deflator was also revised higher. Fears over weaker growth and higher inflation persisted.

Fed Chairman Bernanke continued to warn that the economy faced downside risks and that the Fed would take action as required. He warned that the economy was in a weaker condition than before the 2001 recession. Bernanke also stated that the overall inflation risks had risen over the past few weeks. Markets continued to price in a further 0.50% cut in interest rates at the March FOMC

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There will be slightly greater confidence in the Euro-zone in the short-term with expectations that the economy will be strong enough to allow a restrictive policy by the ECB. Nevertheless, the economic risks are still liable to increase and there will also be a greater risk that the individual economies will diverge more seriously within the next few months. There will also be additional concern over Euro strength with protests against further appreciation liable to increase.             

The Euro continued to gain ground against most major currencies over the week and the only principal losses were registered against the Swiss franc.

The headline German IFO index strengthened to 104.0 in February from 103.4 the previous month and compared with expectations of a monthly decline. The expectations component weakened over the month. There was also a 1.6% recovery in retail sales for January which supported confidence in the German economy.

Comments from ECB officials were generally firm with the bank suggesting that interest rate cuts would not be considered in the short-term. GDP growth forecasts for the area were downgraded while inflation forecasts were pushed higher.

There were warnings over the Euro's level from French Finance Ministry sources, while commissioner Almunia warned against excessive current movements. In general, however, the comments were relatively mild, especially in view of the Euro's strong gains over the week.

Yen:  

There will be concerns over a further weakening of the Japanese economy in the short-term, especially as the US slowdown will unsettle the export sector. The Bank of Japan is likely to keep monetary policy firmly on hold in the short-term. The yen will secure some important support if financial-sector fears increase and there is also likely to be increased seasonal repatriation of capital on seasonal grounds over the next few weeks. There is likely to be a sharp increase in rhetoric against yen gains if the currency advances to near the 100 level.        
                    
The yen was dominated to a large extent by dollar moves over the week. The Japanese currency strengthened to highs near 104.50 against the dollar , but weakened against the Euro over the week with lows beyond 161.0.

The industrial data remained generally weak with production falling by 2.0% in January following a 1.4% increase the previous month.

The retail data was more favourable with sales rising 1.5% in the year to January as energy prices boosted sales while unemployment held at 3.8% for the month. Core consumer prices rose 0.8% in the year to January as energy prices remained high

Bank of Japan member Mizuno voiced opposition to any reduction in interest rates to help support the economy and rate expectations were broadly steady.

There were no significant protests against yen gains by Finance Ministry officials even with the yen at a three-year high.

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The most recent data will increase the possibility of a gradual monetary easing by the Bank of England which would maintain UK yield support. Overall confidence in the economy will remain weak, however, with particular concerns over the financial sector which will undermine sentiment. The overall evidence also suggest that institutional inflows have deteriorated. Nevertheless, substantial economic deterioration has been priced in which should provide some Sterling protection and curb heavy selling from current levels.        
 
Sterling advanced against the dollar during the week with a peak close to 1.9950 against the US currency. Sterling lost ground sharply against the Euro, weakening to all-time lows around 0.7640.

Sterling was undermined by an underlying lack of confidence in the financial sector following some disappointing corporate results, although there were no significant debt write-downs from the major banking groups.

There was a small increase in BBA mortgage approvals for the January, although much of the increase reflected re-mortgaging activity rather than new borrowing. The Nationwide Bank reported a 0.5% decline in house prices for January.

GDP growth for the fourth quarter of 2007 was confirmed at 0.6%. There was a dip in exports and imports while inventories also increased which suggested that the underlying economy was slightly weaker.

Bank of England officials continued to warn over the risks of weaker short-term growth prospects and the threat of higher inflation. The overall impression was a reluctance to sanction an early cut in interest rates. There were rumours of an emergency MPC meeting, but these were strongly denied by the bank.

Swiss franc:

There is likely to be further unease over the Swiss economy in the short-term, although this is likely to remain a secondary consideration in the short-term. The Swiss currency will gain support from unease over the global financial sector, especially if credit fears increase again. The franc will struggle to extend gains given the rapid advance seen over the past two weeks, but substantial losses remain unlikely in current circumstances.   
 
The franc secured rapid gains against the dollar during the week with a peak at fresh record levels beyond 1.05 against the US currency. The franc also strengthened against the Euro as risk tolerances were lower.

The Swiss currency drew support from a lack of confidence in the global financial sector, even though net credit spreads eased over the week. Global stock markets avoided heavy selling pressure, but the franc retained a firm tone.

There were no major domestic data releases with the latest consumption index little changed while employment registered a solid increase for the fourth quarter of 2007.

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The Australian currency pushed consistently higher over the week with a fresh 24-year high near 0.95 against the US dollar as the US currency lost ground.

There were no major data releases with strong capital spending figures for the fourth quarter offset by a drop in building approvals.

The Australian dollar was supported by yield spreads, especially with further speculation that the Reserve Bank of Australia would increase interest rates again to 7.25% in the first week of March.

The commodity price trends were also supportive as industrial metals prices remained robust while gold challenged all-time highs.

Yield differentials will remain highly supportive in the short-term, although the overall risk profile should not be ignored, especially with the risk of profit taking.

Canadian dollar:

The Canadian dollar was on the defensive at the beginning of the week, but regained ground strongly over the second half of the week. As the US dollar crumbled, the Canadian currency pushed to a three-month high near 0.97 before retreating.

There were no significant data releases over the week to move the local currency.The Canadian dollar was supported by the strength of oil prices as crude probed record levels above the US$100 p/b level while wider commodity prices were strong.

Markets continued to expect an interest rate cut at the March central bank meeting which restrained the currency to some extent.

Commodity prices will offer short-term support, but the downside economic risks will make it difficult for the Canadian dollar to sustain gains from current levels.

Indian rupee:

The rupee briefly spiked lower through the 40.0 level against the US currency, but generally consolidated close to 39.90 during the week in cautious markets.

The rupee was undermined by increased dollar demand by oil importers reflecting both the high price level and the month-end demand for the US currency.

There was a lack of confidence in stock markets trends despite a three-day rally in the market with some concerns over capital outflows. The government's budget concentrated on inflation which provided some degree of rupee support.

The yield differential remained positive for the Indian currency as markets continued to speculate over further cuts in US interest rates.

A more cautious investment stance will tend to maintain rupee vulnerability while the improved yield spreads should still curb short-term losses.

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The Hong Kong currency has strengthened over the week as a whole with a peak at a three-month high around 7.78 against the US dollar.

There was additional Hong Kong currency demand associated with forthcoming IPO releases as China Railway Construction planned a US$2.3bn offering. In this context, inter-bank rates moved higher which boosted the currency, especially as US rates remained lower after the comments from Fed Chairman Bernanke.

The Hong Kong currency should retain a firm tone in the short-term as IPO-related demand for funds will be supportive and help push market interest rates higher.

Chinese yuan:

The yuan was held close to 7.14 against the US currency early in the week, but the currency then strengthened sharply. The yuan recorded the largest one-day gain since the 2005 float on Thursday and strengthened to 7.1050 on Friday.

The central bank was initially reluctant to let the currency appreciate, but was content to let the yuan strengthen over the second half

The central bank confirmed its commitment to a tight monetary policy to combat inflation which reinforced speculation over further yuan gains.

The authorities also promised to improve the yuan's exchange rate mechanism, although there were no details of any planned changes.

The Chinese is still likely to strengthen further in the short-term, especially with the central bank steering the currency stronger to help combat inflation. Fears over a sharp slowdown in the economy could unsettle the currency later in 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."

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