Fed Considers a Contraction In GDP Likely
The dollar found little support from fundamentals Tuesday, but cross market currents helped to keep the currency elevated among the majors. Topping headlines for the day were unexpected highlights in the minutes from the Federal Reserve’s March 18th meeting. Few analysts and traders were expecting any substantial changes from the report; but there were more than a few notable remarks. The most dramatic change was made in reference to the outlook for growth. Considering the disappointing cut of data that has crossed the wires since the January meeting, it wasn’t surprising that the Fed’s forecast for the economy “weakened considerably.” However, what was startling was that “many” members considered a contraction in growth as “likely.” What’s more, the pessimists among the Board saw the risk for a “prolonged and severe” downturn. This clearly reflects a concern from the policy authority that the world’s largest economy is – at the least - heading for recession. And, while these comments were feeding bearish sentiment, the statement didn’t come without its silver lining. The two dissenters in last month’s 75bp rate cut (Fed Presidents Plosser and Fisher) voted for a less aggressive move, arguing that the previous 225bp of cumulative easing haven’t fed through the market and that the future risk to inflation in the medium term outweighs an economic cooling in the near term. Outside of the Fed’s influence, the greenback was jostled by mix fundamentals. Well before the open of the US session, the UAE central bank governor announced that he would not drop the dollar peg even as a number of countries in the region look to speed up the creation of a monetary union. Countering this promising news was the NAR’s pending home sales figure for February. Though it is a lagging indicator for the sector, the report’s worst reading since records began in 2001 is a potent reminder of the condition the housing market is in – not to mention it supports the Fed’s suggestion that there is “little indication” a bottom is forming.

British Pound Plunges as Housing Data Hints at a 50bp BoE Cut
The outlook for the Bank of England’s rate decision has gone to the doves; and the shift in sentiment has shown through price action. After a surprisingly sharp drop in housing prices from the HBOS indicator, GBPUSD proceeded to drop 250 points through the course of the day, slipping below major support seen around 1.9750 in the process. According to the data, housing inflation tumbled 2.5 percent through March, the sharpest monthly contraction since the UK’s last recession in 1992. What’s more, the 1.0 percent drop in prices through the first quarter from the same period a year before marks the worst pace the indicator in 12 years. This is a fully loaded piece of data. For the market, this data boosts speculation of a rate cut from the Bank of England on Thursday - with a number of traders entertaining the possibility that the MPC will cut by 50 basis points (though we see this as a very low likelihood). For the long-term, fundamental outlook, this data adds another facet to the concern that the UK housing market is looking a lot like its US counterpart a few years back. Looking ahead to the next 24 hours, we will monitor the Nationwide Consumer Confidence and industrial production numbers to see whether the data can add to rate speculation and maintain the pound’s recent volatility.

Risk Headlines Feeding the Buildup for a Yen Breakout
Risk trends were on the move again Tuesday morning. The highly visible credit crunch was fed by a number of reports today that both added to concerns that the crisis will deepen and conversely that conditions are improving. Suggesting things will only get worse before they get any better, the IMF produced its most in-depth report of the financial market crisis since it began last summer. In the report, the lender projected total losses from the sub-prime-borne crisis could cost financial institutions as much as $945 billion – well beyond the current level of writedowns already reported by the banking industry. Officials at the IMF suggested that the world’s banks should disclose all looming write downs and once again called for a coordinated effort by central banks to stamp out the credit crisis once and for all. On the other side of the coin, the Fed made another $50 billion injection through its auction facility and Washington Mutual was able to raise $7 billion in a market that is still very risk adverse. Despite these reports though, USDJPY was pushed even further into a technical wedge that begs for a breakout. Looking ahead, a BoJ rate decision is on tap; but considering the instability in the group’s ranks and the muddy Japanese fundamentals, there is little chance for a change in policy.

Euro: the Calm Before the Storm
The euro was little moved against most of its major counterparts Tuesday with no economic indicators available to produce fundamental waves. The lack of price action is fitting though considering the ECB rate decision is little more than 18 hours away. The market’s expectations for Trichet’s policy stance is best reflected in EURGBP, which reached a record high today. With the UK succumbing to the same growth and financial market problems as the US, it only further acts to highlight the appeal of the euro. The European Central Bank is expected to hold rates steady, and can do so with inflation elevated and growth still very strong.

Demand for Yield Saves New Zealand Dollar, Canadian Data Questionable
The commodity bloc was pushing higher against the greenback Tuesday. The Canadian currency was able to regain its footing thanks to a stronger than expected March housing starts report. Developers broke ground on 254,700 homes in Canada on an annual basis, a modest slip from February pace. However, we should remember permits data showed its worst trend since 1990. For the kiwi, demand for yield must be strong indeed. The NZIER business sentiment report for the first quarter dropped to a 33-year low as rate hikes slow the economy.

Kathy Lien is the Chief Currency Strategist at FXCM.