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Weekly Update

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America's currency extended its rally from the prior week

Tue, Aug 19 2008, 06:53 GMT
by Union Bank of California Team

Union Bank of California

USD -- America’s currency extended its rally from the prior week, buoyed mostly by the stalwart rise in the University of Michigan US Consumer Confidence Survey. The Index reflected improvement for the second consecutive month in August, rising to a 4-month high (61.7 vs. 61.2 prior). Looking at a breakdown of the report, the pull-back in oil prices since mid-July appears to have had a huge impact, as the most noticeable change in the Index was the drop in 1-year inflation expectations to 4.8% from 5.1%. Likewise, with inflation expectations easing, consumers are feeling a bit better about the economic outlook, as that index rose to a 5-month high (56.8 vs. 53.5 prior). Nevertheless, with job losses in the US mounting, credit conditions remaining tight, and food and energy prices still relatively high, the index gauging sentiment on current economic conditions slumped (69.3 vs. 73.1 prior).
This suggests that the average US consumer is not necessarily ready to head to stores and shop again just because oil futures are down, and as a result, significant downside risks to growth remain. More tellingly, Credit Suisse’s Overnight Index Swaps moved sharply last Friday to price-in 38-bps worth of hikes by the Federal Reserve over the next 12 months, down from 71-bps on Thursday. Meanwhile, currency positioning as measured by FXCM SSI, technically signals that traders are growing less bearish on the greenback. Since SSI is a contrarian indicator, however, the shift suggests that the USD could be in for losses soon, and that combined with the change in US interest rate expectations, the coming weeks could finally see a significant pullback in the US dollar.

EUR -- The euro continues to moderate as markets reassess the outlook for the USD. The single currency fell to lows of 1.4657 as oil prices dropped and Eurozone growth showed continued signs of a slowdown. The E-15 GDP contracted -0.2% in Q2’08, registering a meager +1.5% gain over the previous year. Slackening growth and easing energy prices helped moderate inflation, which also fell -0.2% in July, although the annual rate remains persistently high at 4%. Reflecting the slowdown, industrial production registered zero growth in July, falling -0.5 from the previous year. With a stalling in Eurozone growth underway, markets are scaling back the outlook for euro strength, which will keep the dollar supported in the near term.

JPY -- Last week, the yen briefly benefited from talk of more financial woes in the US. Concern of a global slowdown and global rate cut talks also prompted investors to unwind “carry trades” and sell higher-yielding assets financed in Japan, thereby boosting the yen.
However, the yen quickly gave back the gains after news that its own economy shrank an annualized 2.4% during Q2’08 after expanding a revised 3.2% in Q1’08. A bearish outlook on Japan’s economy may signal further losses in the currency down the road. Japan currently holds the lowest short-term interest rate target of any major world central bank at 0.5%. Japan’s currency will likely remain supported by a reduced global appetite for risk, and the continued liquidation of “carry trades”.

GBP -- The BoE has been burdened by a rapidly deteriorating growth outlook and soaring price pressures. While high and rising inflation has put the Central Bank on hold, it is expected to resume its easing cycle once it has been confirmed that inflation rates are falling. Accordingly, market participants expect that the BoE will continue to lower rates in the beginning of 2009, taking the base rate down to 4% by the end of the year. The pound has fallen almost 7% over the past month against the USD, and to boot was the worst-performing G10 currency last week. The minutes of the latest BoE policy meeting released this Wednesday will be a particularly important as confirmation of the MPC’s apparent shift to a policy easing bias could potentially cause the sterling to lose its luster.

CAD -- The loonie was flat versus the greenback on Monday as higher commodity prices were not enough to trigger a sustained rally, given the slate of key data due out later this week. Overnight, crude oil rose to more than $115 a barrel and gold topped $800 an ounce, but later turned lower giving a boost to the USD. This week's data should offer clues as to what the BoC will do at its remaining 2008 interest-rate decisions.

MXN -- The peso climbed higher as Banco de Mexico raised its key lending rate—now standing at 8.25%— for the third straight month in an attempt to halt inflation, which is running at its fastest pace in three years. Mexico’s Central Bank comments indicate that it is unlikely they will raise interest rates again for the year topping the interest rate differential between the U.S. and Mexico at 6.25%.

CNY -- China’s yuan was little changed on speculation that the Central Bank will halt yuan appreciation to sustain economic growth as global demand weakens. China will “fine-tune” monetary policy to strike a balance between supporting growth and fighting inflation, according to the PBoC's Q2’08 report published last Friday. The Chinese currency is at 6.8710, nearly unchanged from Friday’s close. The yuan fell to seven-week lows earlier last week to 6.8808.

Last Week’s Currency Highs and Lows and Forecast

U.S. Economic Indicators

Published on  Tue, Aug 19 2008, 06:56 GMT