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Commentary for the week of 08/29/2008

The Australian dollar fell to an 11-month low versus the US dollar this week and ended down 2.6% continuing its stunning 13% fall versus the greenback since mid-July. Adding to pressure on the A$ this week were hardened expectations that the Reserve Bank of Australia will cut rates next Tuesday and lower commodity prices earlier in the week causing lots of stress on the carry trade - the A$ hit a 5-month low versus the yen this week. Briefly this week the A$ rebounded helped by a stronger-than-expected rise in capital expenditures in Q2. Private credit growth was weak as were home sales and construction spending.
In the coming week, the RBA meeting on Tuesday is widely expected to cut rates 25 basis points to 7.00%. This is discounted. However, the RBA will also issue a statement and any hint of more rate cuts ahead could weigh on the A$ we think. Otherwise the currency will remain tightly correlated with commodity prices and subject to more downside versus the yen as the carry trade remains vulnerable we reckon.

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The British pound fell 1.7% against the US dollar in the week and reached its lowest level versus the US currency in 2 years. Since mid-July the pound is down nearly 10% against the USD, a remarkable decline by any measure. Data on the housing sector were uniformly disappointing with home prices and home loan approvals falling in the latest month reported. The Confederation of British Industries retail sales index was the lowest recorded in the series 25 year history. One bright note on the UK economy came in the form of a rise in consumer confidence in August reflecting lower oil prices. Bank of England dove Blanchflower said large rate cuts are needed. However, most think the Bank of England will not cut rates until late this year due to elevate inflation and certainly not at next Thursday's Monetary Policy Committee meeting conclusion.
In the coming week the UK releases data on consumer credit, mortgage approvals, home prices and services PMI. Again the BOE is seen leaving rates on hold Thursday. In light of the steady decline in the pound, next week is shaping up to be more of the same barring a broader US dollar sell-off which no one is really anticipating we believe. Sterling is also falling victim to growing concerns that the UK economy is in a nosedive and could bring forward rate cutting from the Bank which leaves it vulnerable in the coming weeks we think.

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After posting gains versus the US dollar in the prior two weeks, the Canadian dollar ended this week down 1.6% versus the greenback behind lower oil prices early in the week and concerns over weakening Canadian growth. That said Canada's economy grew in Q2, albeit barely, after contracting in Q1 in data released this week suggesting no technical recession. However, the market is pricing in risk of rate cuts later this year. Canada also reported a wider current account surplus in Q2 helped by high energy prices. Producer prices rose modestly in July from June. Government officials downplayed the notion Canada's economy is in or at risk of slipping into a recession.
In the coming week Canada releases data on employment and the latest purchasing managers' index from Ivey Institute. But the highlight of the week is the bank of Canada rate announcement on Wednesday. While rates are seen on hold, the Bank's statement will be scoured for signs of any risk of easing down the road. In terms of the C$ next week, much will depend on energy prices, the US hurricane and broader US currency trends we think while keeping in mind that the C$ is still in a significant downtrend versus the greenback.

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The euro ended the week down 0.8% versus the US dollar reversing last week's gain. Perhaps the euro would have been even lower this week if not for a series of remarks from European Central Bank officials who questioned market expectations of ECB easing risks ahead. Several senior central bankers insisted that rates may still need to be raised to check inflation and inflation expectations ahead. Euro Zone flash inflation figures for August moderated to 3.8% annually from 4.0% in July, a record high. The index of economic sentiment fell to 88.8 in August from 89.5 in July. The unemployment rate in the Euro Zone was unchanged at 7.3% in July. The euro did fall on Tuesday's drop in Germany's IFO Institute corporate sentiment index to 94.8 in August from 97.5 in July highlighting downside risks to growth for the Euro Zone.
For the coming week, the Euro Zone publishes data on PMI (final numbers), producer prices, Q2 GDP revision and retail sales. However, the main event for the week will be Thursday's European Central Bank meeting and more precisely the monthly press conference and statement from ECB President Trichet as the risk of any change in rates is zero. Also in the week Germany reports data on retail sales, industrial orders and industrial production. Next week is setting up for a test of whether the euro has put in an important bottom against the US dollar, though much will depend on what happens to oil prices in light of hurricane Gustav heading for New Orleans we believe.

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The Japanese yen ended the week up 1.1% against the US dollar helped by a broad unwinding of the carry trade as high yielding currencies slumped against the USD and JPY. Japanese exporters were also thought to be buying yen ahead of month-end. However, there is evidence that Japan's retail forex traders were also buying yen to cover long currency exposure (NZD, AUD, GBP and EUR). Ironically the yen is the one currency that is rallying against the strong dollar at a time when Japanese economic data point to a recession. Data this week on Japan's economy were mixed. Industrial production rose in July from June but the consensus view is that this number will be down in August from July. Household spending fell in July from a year ago while retail sales rose about 2% from a year ago. Japan inflation hit a decade high in July at 2.4% year-over-year. The unemployment rate fell to 4.0% in July from 4.1% in June. By the end of the week the government reportedly will propose around a $100bln fiscal stimulus for the current fiscal year due to weak economic activity and soaring fuel prices.
In the coming week, Japan releases data on capital expenditures and capital flows in an otherwise dull week for economic news. BOJ Governor Shirakawa speaks next week at a time when rising inflation and contracting GDP leave little room for the Bank to either raise or cut the official rate from the relatively low 0.50%. In terms of the yen next week, look for more potential for the yen to move higher behind rising risk aversion, the potential for lower commodity prices to impact the A$ and NZ$ (negatively) and reduction in carry trades despite the weakening Japanese economic fundamentals.

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The Mexican peso slid 1.4% this week versus the US dollar helped by remarks from Bank of Mexico Governor Ortiz who declared inflation had likely peaked and as such market expectations of higher official rates retreated. But the currency is also suffering at the hands of a broadly higher USD. Mexico reported a wider deficit in Q2 tan Q1 as imports rose more than oil receipts from exports. Mexico retail sales rose 1.6% in July from June, though somewhat less than the 2.4% gain expected.
In the coming week Mexico releases data on the manufacturing sector and consumer confidence. Watch rate expectations in Mexico in light of the dovish remarks this week from Governor Ortiz. If rates have peaked as we suspect, the peso could face more downside pressure versus the US dollar once the dust settles from hurricane Gustav-oil next week we believe.

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The Swedish krona ended the week down 1.9% versus the US dollar aided by lower commodity prices and a broad strengthening in the greenback. However, growing concerns over a rapid slowing in European economic activity also weighed on the krona. Some doubt emerged over the scope for the Swedish central bank to hike more ahead as retail sales fell 0.5% in July from June. Sweden also reported an improvement in consumer confidence in August from July, but it was still a negative reading and the indexes of overall economic and manufacturing sentiment fell from July levels. Sweden reported a wider trade surplus for July from June. PPI rose 3.3% in July from a year ago, up from 3% in June.
Sweden's central bank meets next Thursday and is expected to leave rates on hold at 4.50% though there is a small risk of a quarter point hike. Sweden publishes data next week on PMI in an otherwise quiet week for economic statistics. As for the SEK, it looks like more downside risk for the currency assuming official rates are left on hold and the USD does not succumb to a Gustav-related spike in oil prices we think.

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Ending the week down 0.2%, the Swiss franc defied the broader trend lower in currencies versus the US dollar. The franc suffered only a modest loss versus the greenback despite the widely followed KOF Institute's economic indicator hitting a 5-year low for August in the week. Also in the week the Swiss national Bank said banks need better capitalization and liquidity buffers in light of the credit conditions plaguing the banking system. There is some evidence of investors covering franc-funded carry trades this week. Q2 payrolls hit a record level but the pace of improvement slowed.
In the coming week Switzerland reports data on PMI, CPI and GDP. The SNB is expected to leave rates on hold at its quarterly policy meeting later in September. For the franc, next week could shape up as another loser if oil prices can brush off hurricane Gustav and traders test this week's USD highs we think.

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Closing the week up 0.8%, the US dollar index extended the largest one-month rise in 12 years. For the month of August the USD index finished up 5.7%. Lower commodity prices early in the week coupled with an ongoing dive in the British pound and Australian dollar left the dollar broadly supported. US economic data on balance also surprised to the upside led by Q2 GDP which was revised to a 3.3% seasonally adjusted annualized rate from 1.9% in the advance report behind much higher exports than assumed at the time of the first release of the data. US durable goods orders for July posted a sizable gain as well and more importantly pointed to a jump in capital expenditures by firms. Core personal consumption and expenditures price index ticked higher adding to concerns over rising inflation and the need for the Fed to hike rates down the road. Existing home sales rose 3.1% in July from June. Home price data from the Office of Fair Housing Enterprise Oversight (government regulatory body overseeing Fannie Mae and Freddie Mac) and Case Shiller showed more declines for the latest month but there was some evidence in the reports to suggest that the pace of decline is slowing. Jobless claims for the latest week slipped but remain elevated. US consumer sentiment hit a 5-month high in August behind lower gasoline prices. Chicago PMI in August rose from July indicating a rebound in the region's manufacturing activity. Minutes of the August 05 FOMC meeting were published and confirmed concerns over inflation at the Fed remain elevated while most members see inflation slowing as growth moderates in the second half of 2008. As the week came to a close much attention was diverted to the Gulf of Mexico as hurricane Gustav was tracking for a hit on the Louisiana coast which could put US oil and natural gas supplies off-line for some time. US stocks muddled through the week with the DJIA ending down 0.7%.
Next Monday US markets are closed for Labor Day. Key economic releases next week include data on the manufacturing sector (PMI), construction spending, factory orders, car sales and employment (monthly jobs report plus ADP/MEA private payrolls data, productivity and jobless claims), The Fed issues its Beige Book ahead of the September FOMC meeting which will provide a snapshot of economic developments since the August 05 FOMC meeting. With the pace of the dollar rise decelerating in the last two weeks (USD index is up 0.1%), oil prices supported ahead of Hurricane Gustav, the scope for the dollar to rally much next week will again depend on what happens to oil and the lead weak currencies like the GBP and AUD which both hit new lows for the move down from the July highs versus the USD, as did the euro, this week we think. Clearly the risk for the dollar ahead is to the upside yet with the rally more or less having slowed in the last two weeks, any further USD gains will likely be modest next week we think short of another steep decline in oil - also a risk if the impact of Gustav proves less debilitating for US oil production. Meanwhile, the problems facing Fannie Mae and Freddie Mac persist and many think a government bailout is imminent, especially in light of data this week showing reduced demand for agency debt from central banks (China in particular).

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