Weekly Forex Currency Review 30-03-2007

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Overall strategy

US growth trends will remain very important in the short-term, especially with the key ISM and employment data releases due over the next week. The dollar should find further support near 1.34 against the Euro, but will struggle to secure a significant recovery given a lack of confidence. High-yield currencies will find it difficult to extend recent gains.

Key events for the forthcoming week

Dollar

Recent data has not alleviated concerns over the US growth outlook, with further concerns over the housing and industrial sectors, and the data over the next week will be very important in determining near-term direction. Fed comments have stabilised interest rate expectations, but sentiment will remain fragile. The dollar will need a series of more impressive data to secure a durable recovery in confidence and significant recovery, especially with persistent structural fears.

The dollar was able to resist a further attack on 1.34 against the Euro over the past week, but was unable to secure significant gains with resistance close to 1.33.

The US data was generally weak for much of the week with new home sales falling to an annual rate of 0.85mn in February from a revised 0.88mn the previous month. Sales dropped to a 7-year low while inventories also rose to a 17-year high.

Headline durable goods orders rose 2.5% in February, but this followed a revised 9.3% decline for January. There was also a 0.1% decline in underlying orders, the fourth decline in the past five months. Fourth-quarter GDP growth, however, was revised up to 2.5% from 2.2% while jobless claims fell to 308,000 in the latest week.

Fed Chairman Bernanke took a generally optimistic view on the economic outlook and also stated that the Fed still had a tightening bias on policy. He also stated that the Fed wanted greater flexibility and markets were unconvinced with futures markets still indicating a 30% chance of a cut in interest rates by mid year.

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The Euro will continue to draw short-term support form the firm Euro-zone data while the ECB comments suggest that the bank will look to increase interest rates again in the second quarter. Protests against Euro strength and interest rate increases will tend to increase if growth outside Germany starts to falter. The political risk premium surrounding the French presidential election may also undermine the Euro slightly. Currency losses should be limited at this stage. 

The Euro remained generally firm over the week, regaining ground against the yen and Swiss franc after mid-week losses and holding firm against Sterling.

The German economic data remained robust with the IFO index for March rising to 107.7 from 107.0 the previous month. There was also a further 65,000 drop in unemployment for March while the provisional inflation rate rose to 1.9% from 1.8%.

The wider Euro-zone money supply growth recorded an annual increase of 10.0% for the month and this was a 17-year high for the annual growth rate.

ECB officials continued to take a tough policy stance and markets continued to price in a rise in a further increase in interest rates to at least 4.0% during 2007.

Yen 

The Tankan report next week will be an important indicator of underlying Japanese growth and the yen will be vulnerable if there is a weak report. Capital outflows from Japan will also tend to increase at the start of the new fiscal year. Underlying inflows are, however, still likely to be firmer, especially with the yen still under-valued. The yen will also gain support if there is a sustained increase in risk aversion with further support realistic near 118.0 against the dollar.
                    
The yen strengthen to highs beyond 116.50 against the dollar and 156 against the Euro, but failed to hold the gains as risk aversion eased slightly in choppy trading.

Retail sales fell 0.2% in the year to February, but household spending data was firm while industrial production fell 0.2% over the month.

The inflation data was subdued with core prices falling 0.1% in the year to February, the first drop for 10 months. Government officials took a more optimistic stance on underlying economic trends with the bank focussing on wider economic trends.

There was speculation over capital repatriation ahead of the fiscal year end, although the latest capital account data did not record strong inflows back to Japan.

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The growth data has remained firm at this stage which will support Sterling , especially while housing data holds firm. The Bank of England will also retain a tightening bias for policy. Nevertheless, with markets pricing in at least one further interest rate increase, Sterling will find it difficult to secure further buying and there are high medium-term currency risks associated with housing. Sterling is likely to hit further selling pressure above 1.97 against the dollar.

Sterling was unable to sustain levels above 1.97 against the dollar during the past few days and dipped to below 1.96 on Friday while edging weaker against the Euro.

Bank lending levels remained firm while there was a firm CBI retail spending survey for March. Housing surveys remained firm with the Nationwide Bank, for example, recording a 0.4% March increase in prices, although annual growth slowed to 9.3% from 9.6% .

The comments from Bank of England officials continued to indicate that the bank has a tightening bias, but the comments were mixed with the bank slightly less concerned over the level of wage settlements and uncertain over the economic outlook.

The current account deficit rose to a record GBP12.7bn in the fourth quarter of 2006 from GBP10.5bn previously which increased fears that Sterling is overvalued.

Swiss franc

The Swiss economy will remain strong in the short-term and the National Bank will continue with the policy of gradual interest rate increases. Levels of global risk aversion will remain very important and rising tensions would support the franc. Currency gains would be enhanced by the pressure for a repayment of franc-denominated loans, especially in Eastern Europe. In this environment, substantial franc losses are unlikely in the short-term. 
 
The Swiss franc pushed to high beyond 1.21 against the dollar before weakening back to 1.2180. Similarly, the franc was unable to sustain gains against the Euro.

The Swiss economic data remained firm with the KOF index rising to 1.90 in March from a revised 1.81 previously while the consumer spending indicator was also strong. Markets continued to expect a further interest rate increase in June.

The Swiss franc gained from an increase in risk aversion in the middle of the week, but the currency reversed these gains as global stock markets recovered ground.

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The Australian dollar resisted a decline through 0.80 against the US dollar, but was unable to strengthen above the 0.81 level.

There was little in the way of domestic economic data over the week and markets were still expecting a further interest rate increase during the second quarter of 2007.

The international influences were important with the Australian dollar unsettled by higher risk aversion during the middle of the week, but selling pressure was limited.

The Australian dollar will find it difficult to strengthen further against the US dollar even if interest rats are increased in April with volatility levels liable to increase.

Canadian dollar

The Canadian dollar found support close to 1.1620 as confidence remained firmer and strengthen to 1.1535 on Friday, challenging the strongest level for 2007 supported by speculation over an overseas bid for BCE.

The Canadian dollar was supported by higher oil prices during the week as prices temporarily spiked to US$68 p/b on an escalation in Middle East tensions.

There was further support from strong inflation data the previous week while Bank of Canada Governor Dodge stated that domestic demand appeared to be strengthening.

Political concerns eased over the week as separatist losses in Quebec elections reduced the potential for political tensions over the issue.

Overall, the Canadian dollar should retain a firm bias in the short-term while oil prices remain at elevated levels with support likely on retreats towards 1.1650.

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The Indian rupee continued to strengthen strongly in the early part of the week and strengthened to a high near 43.0 on Wednesday, an 18-year high for the currency.

The level of local interest rates were still elevated due to a liquidity crunch which encouraged further dollar selling. There was a sharp reversal on Thursday as an easing of liquidity and importer dollar demand undermined the Indian currency.

Underlying capital inflows were firm during the week which provided background currency support and limited retreats to 43.60 against the dollar, especially with reduced speculation over central bank intervention to curb rupee gains.

There is scope for further consolidation in the short-term, but regional pressures and capital inflows could provide support close to 44.0.

Hong Kong dollar

The Hong Kong dollar was unable to sustain gains beyond 7.81 against the US dollar, but losses were measured with a 7.81-7.8150 range again dominant.

Hong Kong Chief Executive Tsang stated that the Hong Kong dollar decline on a trade-weighted basis would support exports and there was no significant speculation that the Hong Kong dollar would strengthen with the Chinese yuan.

There was a decline in the February trade deficit while inflation fell to 0.8%. The fragile US dollar confidence supported the Hong Kong dollar, but this was offset by the rise in US Treasury yields.

Overall, the Hong Kong dollar is likely to remain trapped in relatively narrow ranges with further support realistic weaker than 7.8150.