Where to Park Your Dollars During a Recession
The leading story in the currency markets today is the US dollar and how it has fallen to a 2.5 year low against the Japanese Yen. However the 600 point intraday swing in the Dow has completely turned things around as risk appetite remains the predominant theme in the currency markets. Yes, the Federal Reserve is cutting interest rates, but what everyone is focusing on is whether the Federal Reserve’s rate cut will lead to similar moves by other central banks. If we are truly in a recession like many economists argue, then the dollar could actually strengthen. According to a study that we will publish later this week, over the past 30 years, there have been four recessions in the US economy. The dollar strengthened against the Euro (Deutschmark was used prior to the Euro’s inception) during three of them. The one time that the dollar lost value was 2001, which is also the most recent case of a recession. Of the seven major currencies, the safest one to park your dollars in is USD/CAD. The biggest drop in USD/CAD was during the 1980 recession and that only resulted in a 0.08 percent decline. US stocks staged a dramatic recovery today, providing evidence that the Federal Reserve’s emergency rate cut is working. However the 75bp of easing is only a start. Yesterday, we said that Fed Fund futures are pricing in another 50bp rate cut on January 30th. Now, they are toying with the idea of a back to back three quarters of a point drop. When stocks were down as much as 300 points, the futures were pricing in a greater chance of a 75 versus 50bp rate cut. With stocks closing up 300 points, there is a 92 percent chance that we will see 50 versus 75bp of easing. One way or the other, another big move is expected. The Fed has already made their down payment, now the markets want them to choke up the full amount. Existing home sales, the only potentially market moving number on the US calendar is due for release tomorrow. The housing market continues to be one of the most vulnerable sectors of the US economy. Therefore we do not expect the data to be dollar positive.

Will the Bank of Japan Intervene in the Japanese Yen?
Carry trades and the Dow are both trying to find a bottom and today’s move may be success in the making. All of the yen crosses staged dramatic intraday recovers, but will these gains last? We have mentioned on many occasions that carry trades thrive in 3 environments; low volatility, strong risk appetite and global tightening. Unfortunately the current market environment does not satisfy any of these qualifications, which is why we believe that even though carry trades may rebound further over the next 24 hours, they should continue to suffer over the medium term. As the yen continues to strengthen, particularly against the US dollar, many people are wondering whether the Bank of Japan will intervene in their currency. We believe that the uncle point for the BoJ in USD/JPY continues to move lower. It used to be 110, then it became 105 and now that level is probably at 100. Yesterday, Finance Minister Nukuga said specifically that the government is not thinking of large scale forex intervention. Today’s move also reduces the need for one.

Euro Helped by Hawkish Comments from Trichet
Earlier losses in the Euro today were contained by hawkish comments from Trichet. The central bank President reminded traders that even after the sharp moves in global stocks, they stand committed to fighting inflation. In fact, he stressed that because of the significant market turbulences, it is even more important for them to anchor inflation expectations to avoid “additional volatility.” Eurozone economic data also helped the currency rally. The monthly rise in Industrial orders doubled expectations and even though service sector activity slowed, growth in the manufacturing and composite PMI accelerated in the month of January. The German IFO report is due for release tomorrow. The global economic turmoil should lead to a more cautionary outlook by German businesses. Meanwhile the Swiss franc continues to rally against everything in sight as risk gets taken off the table.

Reserve Bank of New Zealand Leaves Rates Unchanged at 8.25 Percent
Unlike the Federal Reserve and the Bank of Canada, the Reserve Bank of New Zealand left interest rates unchanged at 8.25 and issued a relatively hawkish statement. Even though Bollard said that the uncertainty for interest rates has increased, inflation pressures remain persistent and the economy is expected to grow reasonably well. Stronger than expected consumer prices in Australia should also help to extend the currency’s gains. The Canadian dollar on the other hand is up for no reason other than a broad recovery in commodity currencies. Leading indicators dropped 0.1 percent last month, the first decline since 2001.

British Pound: February Rate Cut Not Forgone Conclusion
Despite stronger GDP growth in the fourth quarter and relatively hawkish minutes from the latest BoE rate decision, the British pound underperformed all of the major currencies. The GBP/USD, GBP/JPY, GBP/CHF and GBP/AUD all ended the US trading session lower while the Euro ended the day stronger against the pound. To the surprise of the markets, the BoE members voted 8 to 1 to leave rates unchanged at the beginning of the month. If the vote was tighter, then a February rate cut would be a near guarantee given the recent turmoil in the financial markets. Unfortunately the tightness of the vote means that the February rate cut is not a forgone conclusion. Therefore the combination of the stronger data and the hawkish minutes could lead to a further rally in the British pound.

Kathy Lien is the Chief Currency Strategist at FXCM.