[B]The dollar will remain generally vulnerable in the short term given expectations of an aggressive Fed stance on interest rates, but heavy selling looks to be dangerous at current levels as global economic fears are liable to increase.
There will also be speculation over central bank action to limit Euro gains. There will be further near-term demand for the Swiss franc and Japanese yen, although a near-term peak for these currencies is realistic within the next few days.[/B]
[B]EUR[/B]
Confidence in the US economy will remain weak in the short term with fears that consumer spending will finally weaken significantly. Following recent comments on economic trends, there will also be strong expectations that the Federal Reserve will cut interest rates again by 0.50% at the end of January. With some speculation over a cut ahead of the meeting, the dollar will remain vulnerable on yield grounds.
There will still be fears over the Euro-zone outlook and there will also be increased opposition over the Euro’s level from European officials. The dollar will remain vulnerable in the short term and there is certainly the risk of a challenge on 1.50, but there is little immediate value in Euro buying above the 1.4950 level.
The dollar was trapped in narrower ranges on Friday with the US currency able to resist fresh lows following Thursday’s sharp decline in US trading. The dollar was unable to make a significant challenge on the 1.4750 level as the Euro failed on several occasions to break resistance levels above 1.4820. The Euro was still being supported by the firm ECB press conference on Thursday as yield spreads moved in the Euro’s favour. After initially holding steady on Monday, yield pressures pushed the dollar sharply weaker again to 1.4890 in early Europe. The dollar was also undermined by a Saudi state bank report that there should be a review of the existing riyal peg and a gradual move away from the US currency.
There was further speculation that the Federal Reserve would cut interest rates aggressively at the end of January and there were also some rumours that there would be an cut ahead of the planned meeting which maintained dollar vulnerability. Fed Governor Mishkin stated that the Fed must be prepared to act flexibly and that there were downside risk to employment and growth. He also stated that inflation expectations appeared well anchored.
There were several rumours and deals surrounding the US financial sector during Friday. Rumours of further losses at Citigroup unsettled the dollar, but this was countered to some extent by news that Countrywide Financial had been acquired by Bank of America. Tensions will persist ahead of a series of quarterly bank earnings reports this week. There will be further strong expectations of a 0.50% rate cut in January and some further speculation over a cut ahead of the Fed meeting if financial conditions deteriorate.
The US trade deficit rose to US$63.1bn in November from US$57.8bn previously as imports rose firmly over the month while exports rose slightly. Oil imports rose again over the month as prices continued to increase. The deficit for the first 11 months of 2007 was still below 2006 levels and the underlying shortfall is improving.
The Euro gained some support from a high wage settlement in the German rail sector which will reinforce ECB unease over inflation trends.
[B]GBP[/B]
Market sentiment towards the UK economy and currency will remain very weak in the short term and there will be strong expectations of an interest rate cut at February’s Bank of England meeting. The UK currency will also tend to come under selling pressure if there is a sustained increase in risk aversion and a move into more defensive currencies. Sterling is, however, over-sold after recent heavy losses and there will be some support on valuation grounds.
Overall, there is some scope for a correction against the Euro after very heavy losses over the past month. The 1.9650 level against the dollar will remain important for near-term sentiment and gains through this level are required to provide a much firmer base for the currency. There should be solid support close to 1.95 against the US dollar.
The UK currency remained generally on the defensive during Friday, although it did recover from its worst levels. Sterling found support below 1.95 against the dollar while the UK currency continued to register record lows against the Euro. Weak dollar sentiment allowed Sterling to regain the 1.96 level in early Europe on Monday. There was further selling pressure close to 1.9650 which helped weaken the UK currency further against the Euro.
Overall sentiment towards the UK economy and currency has remained weak with confidence further depressed by evidence of weaker property development. Nevertheless, Sterling remains over-sold on a technical view after heavy losses during 2008. This week’s growth and inflation data will be watched very closely for further evidence on the speed of deterioration. Unless the data is particularly robust, there will be strong expectations of an interest rate cut in February which will curb underlying Sterling demand.
UK producer prices rose 0.5% in December and there was a core monthly increase of 0.4% which will cause some Bank of England unease over inflation trends. These fears will intensify if there is a high CPI reading on Tuesday.
[B]JPY[/B]
The unease over global growth trends will continue to provide some defensive demand for the Japanese yen, especially if global stock markets are subjected to further heavy selling pressure. There will still be yen selling by domestic investors and there will also be concerns from Japanese officials that further yen gains would undermine the growth trends. Further yen gains could, therefore attract growing protests, especially with unease over Japanese economic trends. The dollar will be at risk of a serious test of support close to the 107.50 level in the short term before a significant correction stronger.
The dollar was unable to secure any significant recovery on Friday, remaining trapped just below 109.0 in US trade as Wall Street struggled. After initially holding firm on Monday, the yen strengthened towards the 108.40 level.
Tokyo markets were closed which dampened activity and also curbed yen selling in relation to retail investment overseas. Overall confidence in the global economy remains fragile and this will continue to fuel short-term demand for defensive currencies such as the Japanese yen. Comments on exchange rates by Japanese officials will be watched closely in the short term if the yen continues to strengthen as there will be fears over a negative impact on exports.
Demand for defensive currencies continued in European trading on Monday with a test of dollar support levels below the 108.0 level with the US currency weakening to lows near 107.60.
[B]CHF[/B]
The Swiss franc will continue to gain near-term support on grounds of risk aversion, especially with increased fears over the global economy. Swiss currency buying will also increase if there is a sustained fall in global stock markets.
Expectations of Federal Reserve action to support the US economy will tend to lessen Swiss currency demand to some extent with some potential optimism over carry trades developing over the next few days. The Euro should find near-term support close to 1.6250 against the franc. There is also little immediate value in franc buying against the dollar at levels below 1.09 even with the franc remaining generally strong.
The Swiss currency remained strong on Friday, fluctuating around 1.10 against the US currency. The franc also tested resistance levels below 1.63 against the Euro with gains to 1.6260 as risk aversion levels remained high.
Financial markets were unsettled by rumours of losses and difficult trading conditions. In an uncertain environment, there was further demand for defensive currencies which supported the franc.
Expectations of lower US interest rates should still provide some support to carry trades which will curb heavy Swiss currency buying, but risk concerns are liable to dominate in the very short term.