Fed Report Points to Further Rate Cuts, Dollar Accelerates Its Record-Breaking Declines
Since the dollar marked its unfavorable milestones late in the US session yesterday, traders around the world have jumped in to sell the battered currency. Now at record lows, bulls have quickly lost hope in a possible rebound from an overextended greenback. In fact, looking across the market, we have seen the influences of an unwanted dollar on otherwise sound technical formations among the majors. Momentum in EUR/USD pushed the pair through the closely watched 1.50 level and quickly surpassed 1.51 in the same session. Those currencies with high yields and hawkish central banks proved especially attractive to those wanting to short the dollar. NZD/USD rallied to a new multi-decade high of 0.82 while the Australian dollar broke to a new 23 year high. This follow-through momentum wasn’t found on sentiment alone, however; Fed Chairman Ben Bernanke’s semiannual testimony before the House Financial Services Committee certainly played its part. Few major changes were made in the central banker’s outlook for economic activity and Fed policy from last week’s minutes from the January 29-30 FOMC meeting; though his commentary did confirm the outlook for further policy easing. In his testimony, Bernanke said the policy group would be “carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.” In addition to his concern for growth, Bernanke had also recounted concern over inflation trends. While these worries have been present in the Fed’s commentary for some time, more media outlets and analysts have connected the dots and taken these forecasts to mean the economy will fall into a period of stagflation. Besides the Fed Chairman’s dour commentary, the market had further reason to sell dollars from two disappointing indicators. The Commerce Department reported a 5.2 percent drop in durable goods orders – the biggest such contraction in a year – predominately due to the drop in consumer sentiment and its expected effect on American’s spending habits. And, keeping the pressure on the housing market’s recession, new home sales dropped a greater-than-expected 2.8 percent to a 588,000-annual pace, now the weakest since 1995.

Euro, Backed by Strong Data, Blows Through 1.50 Against the Dollar
While the euro’s advance against the US dollar was generating a broad demand for the currency in most of its liquid pairings, the move also had its fundamental roots as well. Tuesday morning saw the release of a few indicators of economic import and fundamental influence. The January reading of M3 money supply growth cooled less than expected. An 11.5 percent pace of annual growth in the money supply is the second consecutive deceleration; yet this objective inflation reading is still near the 28-year high set back in November. More hawkish in its inflation support was the German import price index through the same month. Despite the deflationary influence of a record high euro, the inflation report hit a 16-month high 5.2 percent clip attributed largely to a sharp rise in energy prices. Elsewhere on the German docket, the GfK consumer sentiment survey followed the lead of the IFO business and ZEW investor confidence reports. Though still near a two-year low, the indicator fended off an expected downtick to hold at 4.5 for the third consecutive month. All of the hard data aside, the true market moving news for the day was actually commentary. ECB Member Axel Weber remarked in a speech that the market’s consensus expectation for a rate cut from the ECB was underestimating inflation trends. These comments were a clear signal for euro traders, which were holding back from bidding the euro on the forecast that the ECB will have to follow the Fed’s lead, to join the now aggressive rally.

Australian Dollar Joins Its New Zealand Counterpart at Multi-Decade Highs
The commodity bloc leveraged the day’s anti-dollar sentiment. Leveraging speculation of a follow up rate hike from the RBA at their next week, the Conference Board’s December leading economic index rose for a fifth consecutive month. The Canadian dollar added little distance to its 300-point rally against the greenback over the past two days as Fin Min Jim Flaherty projected the nation’s budget surplus would drop 77 percent in 2008 and shrink to decade low in 2009. Finally, the New Zealand dollar would perform actually drop against the US currency. Business confidence plunged to a 9-month low according to NBNZ with profit forecasts and hiring plans fading.

British Pound’s Rally Fades as Anti-Dollar Sentiment Takes Over
The tether between the UK and US economies seems to have kept the British pound from participating in a market-wide, anti-dollar rally. Indeed, while EURUSD shot another 150 points above yesterday’s close to new record highs, the pound-backed major produced an ugly reversal candle on a failed run to 2.00. Mirroring the sentiment in Fed Chairman Ben Bernanke’s discouraging speech on monetary policy across the pond, the first revision in the British fourth quarter GDP numbers printed a number of disappointing modifications. Though annual growth held a 2.9 percent pace, fixed capital investment dropped 0.5 percent, imports 1.2 percent and exports 0.5 percent.

Carry Trades Plunge as Risk Aversion Reigns
The economic docket was light for the low yielding Japanese yen and Swiss franc, through their aggressive advances would not have suggested a shortage of scheduled fundamentals. Instead of economic indicators, traders’ interest in these carry trade favorites came along with a broad pull back in risk appetite. Growing fears of an economic recession (or worse, stagflation) was a particularly ominous sign for the global economy. A similar sentiment was measured in equities and the increasingly speculative energy market.

Kathy Lien is the Chief Currency Strategist at FXCM.