by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar probed resistance levels below the 1.46 level in European trading on Friday, but the US currency was unable to sustain the gains and weakened back to 1.4660 later in New York trading as the Euro gained some traction against the yen.
The latest capital account data recorded net long-term inflows of US$26.4bn for September after a revised negative outflow of US$70.6bn for the previous month. Total capital flows were, however, negative for the second consecutive month. Although there were flows into US stocks and bonds, the data will reinforce a lack of confidence in the US currency.
The industrial production data was weaker than expected with a 0.5% output decline for October with falls registered across all major sectors. The capacity use rate also fell which will increase fears that the industrial sector is struggling even though the PMI surveys have suggested that production is still growing.
Fed officials took a generally firm stance on Friday with Governors Kroszner and Poole both downplaying the potential for further interest rate cuts unless there was further deterioration. Markets will remain unconvinced unless the data flow starts to show signs of improvement.
US Treasury Secretary Paulson has taken a firmer stance in comments over the past 24 hours by stating that the dollar will rebound to reflect strong long-term fundamentals. Comments at the weekend G20 summit will be watched closely and only a consistently strong approach from US officials will provide significant dollar support.
The yen strengthened to test levels below 110.0 against the dollar on Friday, but then weakened to briefly test levels above the 111.0 level in New York trade.
The yen is still gaining underlying support from a reduction in high-yield trades, especially with uncertainty over global credit trends. The rise in inter-bank rates has reinforced fears of a liquidity squeeze and is increasing the pressure for a reduction in carry trades. Any forced global liquidation could put the yen under strong upward pressure.
The Bank of Japan has taken a more cautious stance on the economy, warning over a potential negative impact from the US downturn, and this will reinforce expectations that the bank will not increase interest rates in the short term. The Finance Ministry is likely to oppose short-term yen gains much beyond the 110.0 level with volatility liable to remain high.
Sterling weakened to lows below 2.0350 against the dollar on Friday, but rallied back to 2.05 in US trade as a weaker dollar coincided with pressure for a corrective Sterling rally after heavy losses this week.
The renewed increase in inter-bank rates will fuel fears over further credit-related stresses and weaker lending within the UK. This factor, allied with the weaker sales data this week, will tend to undermine the Sterling directly and will also increase pressure for an early cut in interest rates by the Bank of England.
The franc remained strong against the Euro on Friday with gains to a peak near 1.6350 while the Swiss currency also tested 12-year highs near 1.1150 against the dollar.
The franc is still gaining underlying support from a reduction in carry trades with a move back into more defensive assets. The extent of carry-trade liquidation will remain a crucial short-term issue for the Swiss currency.
The Swiss data was firm with a 7.1% annual increase in retail sales for September. National Bank chairman Roth warned over the impact of further franc weakness if it had an impact on inflation.
The Swiss currency has, however, strengthened against the Euro and gained strongly against the dollar which should lessen immediate fears over currency weakness. There is likely to be a close call on rates at the December monetary meeting.
The Australian dollar dipped to lows around 0.8820 on local trading on Friday as Asian equity markets weakened. The currency pushed back to above 0.89 as European markets attempted to recover, although markets remained cautious.
There were no significant domestic releases with international trends remaining dominant. The Australian dollar has been unsettled by persistently high levels of risk aversion and a reduction in carry trades as credit fears have persisted.Investor caution is likely to remain high in the short term which will tend to undermine the Australian dollar and the impact will be magnified if metals prices come under renewed downward pressure.