US Dollar, Japanese Yen Falter as Citigroup Rescue Boosts Demand for Carry Trades

The US dollar and Japanese yen – the biggest beneficiaries of flight-to-quality and deleveraging – both tumbled on news that the Treasury, Federal Reserve and Federal Deposit Insurance Corp. pledged up to $306 billion to shield Citigroup from losses related to toxic assets, though the firm must absorb the first $37 billion to $40 billion in losses, while also agreeing to inject an additional $20 billion in capital. The news suggests that the Treasury dropped provisions to buy troubled assets under the Troubled Asset Relief Program (TARP) on November 12 because it would simply be too expensive given the budget constraints approved by Congress. It will be interesting to see if other banks end up requiring similar aid, and if the US government will comply.

Looking ahead to Tuesday, in case the first round of US GDP readings for the third quarter weren’t bad enough for you, the second reading is anticipated to be revised even lower at 8:30 ET. Indeed, annualized GDP is forecasted to be altered to -0.5 percent from -0.3 percent, while personal consumption is expected to be corrected to -3.2 percent from -3.1 percent. However, it will likely take a surprisingly low result to illicit any sort of reaction from the markets, as traders are already well aware that economic conditions in the US remain dismal. Later in the morning at 10:00 ET, the Conference Board’s consumer confidence index is forecasted to hold near the record low of 38.0 reached just last month, though given the gloomy outlook for the economy, there may be downside risks. The key here will be to gauge the impact of the news on risk trends, as disappointing data could trigger flight-to-quality and thus, US dollar and Japanese yen buying. On the flip side, readings in line with expectations shouldn’t have a huge impact and could allow the surge in carry trades to continue.

Euro Breaks Out of Wedge Formation - Will German GDP Prevent a Push Toward 1.3050?

The euro finally broke out of a wedge formation on Monday thanks to a resurgence in risk appetite triggered by the US government’s announcement of a $306 billion rescue package for Citigroup. Indeed, the news ended up being more beneficial for European stocks than US shares, as the DAX ended the day up over 10 percent compared to a 4.93 percent gain in the Dow and a 6.47 percent rally in the S&P 500. The move went against the economic data released this morning, German business confidence fell to the lowest level in almost 16 years in November. Indeed, IFO’s business climate index dropped to 85.8 from 90.2 - the lowest since February 1993 – as the Euro-zone tips into recession and the credit crisis continues. Looking ahead to Tuesday, the final reading of third quarter German GDP is anticipated to confirm that Europe’s largest economy is experiencing its worst recession in at least 12 years. Indeed, the preliminary results showed that GDP fell 0.5 percent in the third quarter from the previous quarter, following a 0.4 percent contracting. The combination of restrictive monetary policy in the Euro-zone along with slowing growth in other regions has taken a toll on both domestic and foreign demand, which is particularly problematic for this export-dependent economy. If GDP happens to fall more than forecasted, the news could weigh on the euro as it would add to speculation that the European Central Bank will cut rates aggressively next week. However, if the data meets expectations, there may be little reaction in the forex markets and EUR/USD could continue to make its way toward the 50 percent fib of 1.3768 - 1.2328 at 1.3049.

British Pound Gains as UK Announces £20 Billion Fiscal Stimulus Plan, Downgrades Growth Forecasts

The British pound rose on Monday amidst broad US dollar weakness and the announcement of a fiscal stimulus plan for the UK. Chancellor of the Exchequer Alistair Darling said in his pre-budget report that the UK budget deficit will surge to £78 billion this year and to £118 billion in 2009-10 as the government cuts the Value Added Tax (VAT) to 15 percent from 17.5 percent, boosts state pensions and child benefits, extends employment support at a cost of £1.3 billion and provides a housing support package worth £1.8billion. This only covers a small portion of the government’s plans (check out the UK Treasury’s website for complete details), and in order to accommodate for some of these costs, Chancellor Darling said that after April 2011 those earning at least £150,000 a year would face an income tax of 45 percent. Meanwhile, Chancellor Darling also downgraded growth forecasts to 0.75 percent in 2008, between -0.75 and -1.25 percent in 2009, and between 1.5 to 2 percent in 2010. Looking ahead to the next 24 hours, the preliminary release of UK business investment is forecasted to fall negative for the third consecutive quarter during Q3 at a rate of -1.9 percent. However, this doesn’t tend to be a major market-mover, leaving US dollar trends and technicals the primary drivers of the forex markets.

Canadian Dollar Rallies on 9.3% Surge in Oil, Gains Could Accelerate on Canadian Retail Sales

The commodities dollars rocketed higher on increased demand for carry trades and a 9.3 percent rally in oil. Indeed, the Australian dollar and Canadian dollar both gained more than 3 percent versus the greenback, while the New Zealand dollar rose 2.3 percent. Focusing on the Canadian dollar, the currency could gain further on Tuesday as the September reading of Canadian retail sales are forecasted to have gained 0.4 percent in September, and excluding autos, retail sales are expected to have risen 0.2 percent. However, there is potential for a surprisingly strong reading given the solid employment numbers we’ve seen lately. In fact, the Canadian economy has added on workers for the past three months, and a record 106.9K in September alone. Furthermore, the September reading of Canadian wholesale sales surprisingly jumped 1.5 percent, and can sometimes serve as a good leading indicator for the headline retail sales report. As a result, this 8:30 ET release has the potential to lead the Canadian dollar higher, though a disappointing figure could weigh the Loonie down.

Terri Belkas is a Currency Strategist at FXCM.