British Pound Could Break 2.0 if Disaster Hits UK Mortgage Lenders
According to an article in the Times, Nationwide, the country’s second largest mortgage lender is planning to turn away business. We wonder why a mortgage lender would resort to this unless trouble was brewing in house. The Times argues that Nationwide is attempting to gain greater control over the amount that it lends and is doing so by increasing the rates on its tracker deals by more than 50bp. Efforts such as these are exactly why central banks including the UK and the US are struggling to contain the credit crisis. Despite interest rate cuts and liquidity injections, banks and mortgage lenders have reluctantly offered new loans while scrutiny has increased for potential borrowers, making it difficult for everyone. The liquidity crisis has hit the UK and US housing markets in more ways than one. If a mortgage lender announces major losses or even worse, is forced to fold shop, the British pound could easily break 2.0 and slip down to 1.9850. The news from Nationwide completely erased the British pound’s earlier gains which were driven by stronger economic data. The CBI retail sales survey rebounded this month, while fourth quarter total business investment beat expectations. More UK numbers are due for release tomorrow with Nationwide house prices, current account for the fourth quarter and the final Q4 GDP numbers due for release. Expect decent volatility in the British pound.

Dollar Lifted By Stronger GDP Numbers
The US dollar strengthened across the board following the stronger than expected final Q4 GDP report. Even though, the headline number remained unchanged, personal consumption was revised upwards while core PCE and the price index were revised downwards. This was good news for dollar bulls who have endured a weak of disappointing economic data. Jobless claims also pared back, but that does not alleviate our concerns about the labor market. Stronger spending and softer inflation reduces the need for a larger rate cut from the Federal Reserve, but this is Q4 data, which isn’t exactly reflective of current market conditions. Tomorrow’s personal income, personal spending and PCE deflator will be more telling. With negative job growth in January and February, the odds are certainly skewed towards dollar bearish data. The upward revision to GDP does not reduce the risk of a further slowdown in the US economy. The action will pick up next week with March non-farm payrolls due for release. Cutting interest rates alone will not be enough. If we have a third consecutive month of negative job growth, the Federal Reserve will be forced to look for alternative ways to stimulate growth.

Euro Slips, But Rally Far From Over
After rallying 400 pips in 2 days, the EURUSD was due for a correction. Aside from German consumer confidence which beat expectations, there was no major Eurozone data released today. ECB officials continue to remind us that inflation risks remain to the upside, but like the Federal Reserve and the Bank of England, they are becoming increasingly worried about the lack of liquidity in money markets. More Eurozone data will be released tomorrow including German import prices, retail PMI for the entire Eurozone and any revisions to French Q4 GDP. We continue to believe that the EUR/USD will not only test 1.60, but break it before the European Central Bank expresses any concern about the level of the currency. Meanwhile the SNB also joined the liquidity party by offering 3 month funds at 2.2 percent. Like the ECB, they are worried about money market rates which are under stress. Banks continue to hoard cash and buy only short term Treasuries. Switzerland will be releasing the KoF leading indicators report, which is expected to be strong following the improvement in the UBS Consumption index.

Australian, New Zealand and Canadian Dollars Lose Ground to the Greenback
New Zealand Finance Minister Cullen warned yesterday that the New Zealand economy faces serious challenges and is not immune to the global slowdown. Last night, RBA Governor Stevens said the exact opposite by indicating that their financial system should be able to weather the storm because Australian banks have very little direct exposures to US subprime problems. Interestingly enough, last night’s economic data suggests otherwise. New Zealand’s trade deficit turned into a surplus for the first time since the 2000 to 2001 recession last month while the current account deficit for the fourth quarter narrowed. Australia on the other hand reported a drop in leading indicators and job vacancies. New Zealand GDP is due for release this evening along with money supply. We expect GDP to be firm given the improvement in trade during the last 3 months of 2007.

USD/JPY: Vulnerable to More Losses
The Japanese Yen is weaker across the board, but that weakness may not last with tonight’s heavy economic calendar. Household spending, consumer prices and labor market data are due for release. We expect most of these numbers to be Yen positive because consumer confidence is off its lows while labor cash earnings have been strong. The stock market closed at the day’s low which suggests that carry trades could be vulnerable to more losses. On Monday, we published a report on why the USDJPY rally may be short-lived. Our primary argument was risk reversals which indicated that traders were paying a staggering premium for 3 month USDJPY puts. Since then, risk reversals have become even more extreme. The last time we saw risk reversals at these levels was in August, when USDJPY dropped close to 1000 points in less than a month.

Kathy Lien is the Chief Currency Strategist at FXCM.