Weekly Forex Currency Review 31-08-2007

Overall strategy

Fears over a forced selling of assets will remain an important market feature as credit stresses persist and these concerns are likely to prevent a sustained recovery in high-yield currencies, although the main feature is likely to be continued volatility. The dollar will find it difficult to make strong headway given underlying fears over the US economy.    

Key events for the forthcoming week

Dollar

Concerns over US economic trends will continue in the short-term with persistent fears that mortgage-related difficulties will undermine the wider economy and push the economy towards recession. There will also be further pressure for a Federal Reserve interest rate cut. Direct measures to ease mortgage defaults would support confidence and ease pressure for lower borrowing costs while the dollar will also be supported by the fact that a series of interest rate cuts are already priced in. The Fed will be reluctant to cut rates and the US currency will still secure some degree of defensive demand as risk aversion remains high. Strong dollar gains look unlikely at this stage.
      
The dollar has had a mixed tone over the past week with a generally softer tone against the European currencies with lows around 1.3680 against the Euro, although losses have been contained, while the US currency has gained against the yen.

A generally stronger trend in global stock markets curbed defensive dollar demand, but credit and inter-bank lending markets remained tight.

Following higher than expected new home sales last week, existing home sales for July remained little changed at an annual rate of 5.75mn, the lowest level since late 2002. The latest evidence also suggested that prices have drifted lower.

There were further fears that mortgage-related stresses would undermine the wider economy. US consumer confidence fell sharply to an 11-month low in August as unease over the labour market increased. Jobless claims also rose to 334,000 in the latest week which suggested layoffs were increasing.

Minutes from the Federal Reserve August 7th FOMC meeting stated that the Fed was concerned over the credit trends and would take appropriate action if required.

Following the Fed comments, there was further speculation over a near-term cut in interest rates with markets looking for further guidance from Fed Chairman Bernanke.

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The ECB decision will be an important short-term influence and there will be further political pressure for rates to be left on hold this month. Any decision to increase rates would be likely to support the Euro with a close decision realistic next week. The Euro will be subjected to further selling pressure if there are renewed banking-sector difficulties. The overall fundamentals should remain firm which will limit Euro selling pressure. Volatility will remain high as cross trading remain important.            

The Euro fluctuated wildly against the yen during the week and secured a generally firmer tone with a move back to 159.0 on Friday.

The German IFO index weakened in August to 105.8 from 106.4 the previous month, although the figure was still high in historic terms while money supply growth remained strong.

There was a reduced 15,000 decline in German unemployment for August while consumer confidence weakened and retail sales growth was subdued.

ECB President Trichet stated that his comments on strong vigilance on prices were made before the latest market turbulence. The comments, along with similar comments from bank officials, increased speculation that the ECB would decide against a September rate increase.

The German government called for the ECB to hold rates steady at the meeting and there was further political pressure for unchanged rates from the French government.

Yen

The Bank of Japan will look to increase rates when there is an opportunity, but market turbulence and low inflation will continue to deter a near-term increase. If market conditions stabilise, there will be a further temptation to sell the Japanese currency and capital outflows will persist. Overall risk aversion is, however, likely to remain higher and underlying yen selling is likely to remain at lower levels as liquidity remains tighter. Volatility levels should remain higher in the short-term with the yen still finding it difficult to make strong headway.               
                    
The yen tested levels beyond 114.0 against the dollar during the week, but failed to hold the gains as trading conditions remained very volatile with losses to 116.20. Japanese currency moves were dominated by global risk conditions.

There was evidence of Japanese yen selling below when the dollar weakened with investment trusts looking to allocate funds overseas before the end of August.

There was a sharp July decline in retail sales with a 2.2% annual decline. Unemployment fell to a 9-year low while core consumer prices fell 0.1% in the year to July.

The latest weekly capital account data recorded a firm surplus, but there was no evidence of strong capital repatriation back to Japan.

The yen was strengthened by reports that Singapore-based DBS Bank had bigger than expected sub-prime related losses.

There was a reshuffle of the cabinet with speculation that new Cabinet Secretary Yosano will be less opposed to a Bank of Japan interest rate increase.

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There will be expectations of an underlying slowdown in growth. There will also be the risk of a more substantial deterioration in economic conditions given high debt levels, especially if financial-market instability continues. The Bank of England will not consider a short-term cut in interest rates and yield levels will provide Sterling support if global risk conditions stabilise. Nevertheless, the net risks suggest that the currency is liable to weaken as the fundamentals deteriorate.             
 
Sterling struggled to find direction against the dollar during the week as a whole with a 1.9960 - 2.0190 range in choppy market conditions. The UK currency was little changed against the Euro for the week as a whole.

Mortgage approvals held broadly stable over the month while there was evidence of a gradual underlying slowdown in personal lending. The CBI retail survey was slightly weaker for August.

The Bank of England was tapped for emergency funding on Wednesday which reinforced speculation that a UK bank was facing credit difficulties. The Bank of England refrained from making any comments on interest rate policy.

The Nationwide Bank reported that house prices rose 0.6% for August with a 9.6% annual increase, although there was an unadjusted monthly drop in prices.

Swiss franc

The September National Bank interest rate decision is likely to be close, but the lower inflation rate will curb market speculation over an increase and failure to tighten again would tend to undermine the franc. Nevertheless, the overall tightening of financial conditions should provide important currency support with a repayment of franc-denominated loans. The short-term trends will tend to remain dominated by levels of risk aversion and the Swiss franc will gain support if there is a renewed increase in credit stresses.  
 
The franc fluctuated around the 1.20 level against the dollar for much of the week as movement against the Euro continued to dampen moves against the US currency. The franc edged lower against the Euro as global stock markets were generally stronger and also drifted weaker against the dollar on Friday.

The Swiss KOF index fell slightly to 2.06 in August from a downwardly-revised 2.09 the previous month, although this was still high in historic terms. Similarly, the monthly consumption indicator edged lower over the week

Consumer prices fell 0.1% in August with the annual inflation rate falling to 0.4% from 0.7% which dampened expectations of a near-term interest rate increase.

The franc was again strongly influenced by global risk aversion during the week. The Swiss currency gained support when risk aversion increased, but volatility levels remained high.

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The Australian dollar hit resistance above the 0.83 level against the US dollar as underlying risk aversion curbed demand for the local currency. The currency resisted losses below the 0.80 level and confidence gradually improved over the second half of the week.

The current account deficit increased to AUD16bn for the second quarter from a revised AUD15.6bn previously. The data failed to have a significant impact as the July trade deficit narrowed.

There was a stronger than expected 0.9% retail sales increase for August, but Australian dollar moves were still dominated by international risk tolerance levels.

Given the underlying tightening of credit, the Australian dollar is likely to face difficulties in extending the recovery against the US currency, although choppy trading conditions will persist.

Canadian dollar

Despite volatile moves, the Canadian dollar held little changed within a 1.05 -1.0650 range against the US currency during the week.

The currency tended to lose ground when risk aversion increased as carry trades were scaled back while stronger global stock markets supported the currency. The Canadian current account position remained comfortable for the second quarter at CAD8.4bn while the producer prices data had little impact.

Merger activity provided further support to the currency with a proposed USD1.1bn US Steel bid for Stelco and rumours of further bid activity.

Overall, the US dollar is likely to find support below the 1.05 level against the Canadian currency, but there is only limited scope for US currency gains.

Indian rupee

The rupee has been unable to make any significant headway as credit fears persisted and weakened to near 41.20 on Thursday. Losses were still generally contained with a move to 41.05 on Friday.

There was limited buying of Indian stocks during the week and stock market gains supported the rupee on Friday, but there was still caution as credit fears persisted.

The Indian currency was hampered late in the week by month-end dollar demand from oil importers. GDP growth rose 9.3% in the year to the second quarter which supported confidence in the economy.

Political fears remained an important background focus with continuing fears over opposition to a nuclear agreement with the US.

The underlying credit tightening is likely to weaken the rupee with volatility remaining relatively high, although currency losses should be measured.

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The Hong Kong dollar had a firmer tone and strengthened to 7-month highs against the dollar during the week with gains to near 7.7965 on Friday.

The currency was supported by reduced arbitrage activity as continuing global credit fears resulted in an unwinding of short Hong Kong dollar positions.

Local inter-bank rates were also firm which provided support to the local currency while the stock market was firmer.

The Hong Kong dollar will struggle to sustain gains much beyond the 7.80 level against the US currency even if short-term volatility levels remain higher.

Chinese yuan

The Chinese currency strengthened during the week and there was an increase in volatility. The yuan jumped stronger late on Thursday with a move to 7.54 as state banks sold the dollar aggressively.

There was speculation that the authorities would discourage yuan gains to help protect the export sector given doubts over global growth trends. There were no major domestic market influences with global trends dominant.

The yuan weakened slightly to 7.5460 on Friday, but markets were resisting central bank guidance  to push the yuan weaker.

The net trend is still likely to be for a stronger Chinese yuan. Volatility levels are liable to remain high, especially if there are further market battles with the central bank over the yuan's level.