Weekly Forex Currency Review 30-11-2007

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Overall strategy: Uncertainties over global growth and credit conditions are likely to be very important short-term market influences. There is still the potential for an unwinding of carry trades which should provide underlying support for low-yield currencies. Overall volatility levels are liable to remain higher, especially with tightening year-end liquidity.                    

Key events for the forthcoming week

Dollar:

The US data releases have had a consistently soft tone there will be further speculation over an other interest rate cut from the Federal Reserve, especially as officials have warned over credit-related stresses. The dollar will, however, gain some support on valuation grounds, especially with international funds looking to buy under-valued assets on a longer-term view. Global doubts will also provide some dollar protection while rate cuts will boost optimism that recession can be avoided. Expectations of reserve diversification will still severely limit dollar rally attempts.   
      
After dipping sharply to record lows beyond 1.4950 against the Euro at the end of last week, the dollar secured a generally corrective tone. There was a recovery back towards 1.4720 in choppy trading with the trade-weighted index also recovering.

The US housing data remained weak with October existing home sales dropping to an annual rate of 4.97mn from 5.03mn previously, the lowest rate since the current series began in 1999. Inventories also rose while prices fell and new home sales also remained at multi-year lows at 728,000 for the month. The Case-Shiller house-price index fell 4.9% in the year to September.

The durable goods orders was disappointing with a 0.4% drop in October while core sales fell 0.7%. Jobless claims also rose to 352,000 in the latest week which suggest that the labour market is starting to weaken, although weekly data will be volatile. Consumer confidence fell to a fresh two-year low while third-quarter GDP growth was revised up to 4.9% from 3.9%.

The Fed's Beige Book reported that activity was generally slowing while the housing sector remained depressed with core inflation steady to marginally lower.

Fed Vice Chairman Kohn expressed unease over the growth outlook and stated that the Fed could offset tight credit markets with a cut in interest rates. The remarks reinforced market expectations of a further interest rate cut in December, especially with Chairman Bernanke also warning over financial strains.

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The ECB will remain concerned over inflation, especially as November data has been higher than expected. In this environment, the bank will maintain a tough verbal attitude towards monetary policy. There is still little scope for an interest rate increase given that the growth outlook is deteriorating, possibly at a rapid pace as liquidity tightens. There will also be further protests against Euro strength which will curb aggressive buying and the currency remains vulnerable to a further corrective retreat.    

The Euro put in a mixed performance over the week, but generally had a slightly weaker tone except against the Swiss franc.

The German consumer inflation data recorded a further increase to 3.0% in November from 2.6% which was the highest rate since the end of 1994. The data reinforced ECB concerns over the inflation outlook.

ECB officials also warned over the growth outlook during the week and also expressed significantly increased uncertainty over short-term prospects. Money-market interest rates continued to increase with the bank providing extra liquidity.

The German IFO index broke the recent run with a small recovery for November although retail sales dipped sharply for October.

European officials continued to warn against rapid and brutal currency moves, although the protests against Euro strength were still relatively muted.

Yen:  

Short-term yen moves will remain dominated by levels of risk aversion in global markets and the Japanese currency will tend to weaken at times of global stock market rallies. The net trend is still likely to be a continuing shift into defensive assets and this is likely to be particularly important around the year-end period. The Finance Ministry will discourage disorderly markets, but appears relatively comfortable with some currency appreciation and sharp yen losses look unlikely.                     
                    
The Japanese yen strengthened to highs around 107.25 against the US dollar during the week, but then weakened back towards 110.0 in volatile trading.

Currency moves remained correlated strongly with degrees of risk aversion and the Japanese currency weakened as Wall Street staged a strong rally.

Finance Minister Nukaga stated that currency moves would be monitored closely, but protests against yen gains were relatively mild which suggested that there was no major opposition to yen gains.

Core consumer prices rose 0.1% in the year to October, the first increase for 10 months, but this did not have a significant impact on interest rate expectations.

The latest capital account data recorded a resumption of capital outflows, but there was still underlying caution. The latest IMM data recorded the highest net long speculative yen position for close to 3 years.

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There will be further unease over the UK economic trends with expectations of a significant growth slowdown. Given the underlying housing-sector vulnerability, there will also be the risk of a more serious deterioration. The Bank of England wants to delay an interest rate cut because of inflation fears, but there will be increasing pressure for a early reduction in rates. The UK currency will also remain correlated with carry-trade trends and the net risks still suggest underlying Sterling depreciation.                     
 
Sterling found support close to 0.72 against the Euro and corrected back towards 0.7125 before settling near 0.7150. Sterling peaked above 2.08 against the dollar while finding support below the 2.06 level.

The Nationwide Bank reported a 0.8% drop in house prices for November which was the weakest monthly figure for 12 years and the annual growth rate dropped to 6.9%, the lowest figure for the year. Mortgage approvals fell to 88,000 in October from 100,000 previously while consumer lending slowed to GBP8.8bn from GBP10.8bn.

The Bank of England expressed considerable uncertainty over the economic outlook with fears that growth would deteriorate while there would be short-term upward pressure on inflation with the overall outlook less benign.

MPC member Blanchflower again called for lower interest rates, but the other members continued to express uncertainty over the situation with Governor King expressing major doubts over the underlying trends. Futures markets slightly increased the chances of a December interest rate cut while Libor rates increased to the highest level since mid September.

Swiss franc:

The Swiss economic data has remained firm over the past week and suggests that any slowdown will be less serious than that seen in the Euro-zone. The National Bank December interest rate decision is still open and rates could be left unchanged which would undermine the Swiss currency's yield support, although the inflation data will increase the possibility of a further rate increase. Nevertheless, there is likely to be further underling demand for defensive assets which will provide important franc support.         
 
The Swiss currency strengthened to near 1.63 against the Euro before weakening back towards 1.65 as global stock markets rallied. The dollar also corrected strongly to 1.12 from lows record near 1.0950.

Swiss currency moves remained correlated strongly with levels of global risk aversion and an easing of immediate tensions undermined the franc in mid week

There was a solid reading for the UBS consumption index while the KOF leading index also rose remained above the 2.00 level for November while there was a 0.8% increase in third-quarter GDP.

Consumer prices rose 0.5% in November which pushed the annual inflation rate to 1.8%. National Bank Chairman Roth stated that interest rates would not be increased mechanically which cast doubt on a further rate hike at the December meeting.

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The Australian dollar was subjected to volatile trading during the week with lows around 0.8650 while there was a peak above the 0.89 level.

There was little in the way of economic data, but there was a reported drop in business investment for the third quarter while credit growth was firm.

There was relief that there was a decisive election result with Labour securing a convincing majority.

The Australian dollar was unsettled by a drop in commodity prices, especially for industrial metals prices. The currency was influenced strongly by levels of global risk aversion and rallied in tandem with a recovery in stock markets.

Australian dollar volatility is likely to remain high in the short-term and increased global growth doubts will make it difficult to extend gains.

Canadian dollar:

The Canadian dollar retreated to test levels around parity on two occasions over the week, but resisted a move through this level with a move back to 0.9950.

The Canadian dollar was again influenced strongly by levels of oil prices with the currency unable to sustain a brief spike after US-Canada pipeline closures. The currency was also influenced by levels of risk aversion.

There was a decline in industrial product prices for October as Canadian dollar strength continued to have an important impact. The third-quarter current account surplus fell to CAD1.0bn from a revised CAD6.3bn the previous quarter.

The Canadian dollar has the potential for further limited losses in the short-term, although there will be some significant degree of support close to parity.

Indian rupee:

The rupee had a generally softer tone over the week, although move were still relatively restrained. The Indian currency dipped to lows around 39.80 before stabilising around 39.70 as global stock markets rallied.

There were further modest outflows from the stock market with net outflows in November of around US$1.1bn which has restrained the local currency.

The rupee was also sapped by month-end dollar demand by oil importers, especially with oil prices still at elevated levels.

The Finance Minister expressed some concern over rupee strength, although the protests were relatively mild and third-quarter GDP growth was robust.

With tighter credit conditions and volatile markets, there is the risk of capital outflows and further rupee depreciation, although losses should be limited.    

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The Hong Kong dollar was confined to recent ranges with some net losses on arbitrage activity and the currency weakened to lows near 7.79 against the dollar.

The forthcoming IPO offerings boosting demand for the Hong Kong dollar and provided support to the local currency. Volatile stock markets caused significantly intra-day fluctuation for the Hong Kong currency.

HKMA chief Yam stated that Hong Kong would maintain the peg despite inflation pressures with the annual CPI increase of 3.2% the highest for nine years.

The Hong Kong dollar should be able to find near-term support stronger than the 7.80 central peg, especially with expectations of further US interest rate cuts.

Chinese yuan:

The Chinese yuan was subjected to choppy trading over the week, but there was a firmer tone with the biggest one-week rise for two years. The Chinese currency pushed to fresh post-revaluation highs near 7.38 against the US currency before consolidation around 7.3840 on Friday.

There were media reports that the Chinese cabinet had agreed in principle to let the currency strengthen faster, but were unsure how best to achieve this. Premier Wen also suggested that the yuan would be given greater flexibility in the market

There was further EU pressure for a stronger Chinese currency as senior European officials including ECB President Trichet visited China

The underlying trend is likely to be for further yuan appreciation with the central bank continuing to smooth volatility. A significant one-off revaluation remains a possible policy option for the Chinese authorities.