US Dollar Rally Continues, May Consolidate Above Recent Lows Next Week

The US dollar rebound continued on Friday as the White House announced a $17.4 billion bailout for GM and Chrysler. The move will leave the firms with $13.4 billion to be paid out in December and January, while the last $4 billion must be approved by Congress since it would come as part of the second installment of TARP. While official steps haven’t been made to release the additional $350 billion, Treasury Secretary Henry Paulson urged Congress to do so on Friday afternoon. A description of the plan shows that GM and Chrysler must use the money to become financially viable, and if they end up near bankruptcy later on, additional taxpayer financing will not be provided.

Looking ahead to next week, or two weeks for that matter, the big question is: what sort of price action will we see? With major holidays looming on December 25 and January 1, leaving many of the world’s financial markets closed, trading volumes will fall dramatically. Thin markets have a tendency to result in either very choppy or very quiet price action. Given the volatility seen in recent days, I think there’s a greater risk that these sorts of trends will continue, but they may ultimately leave the US dollar consolidating above its recent lows within wide ranges. Data wise, the final round of US GDP readings for the third quarter is not expected to show any revisions upon release at 8:30 ET on December 23. Indeed, annualized GDP is forecasted to go unchanged at -0.5 percent, while personal consumption is expected to hold at -3.7 percent. 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. Meanwhile, economic releases due out at 8:30 ET on December 24 are likely to be broadly disappointing and add to indications that the US recession only worsened during Q4. Indeed, personal spending in the US is forecasted to have fallen negative for the fifth straight month in November at a rate of -0.7 percent, while durable goods orders are expected to have dropped 3.0 percent, marking the fourth straight month that demand has either stagnated or declined.

Japanese Yen: Bank of Japan Cuts Rates, Intervention Risks Linger

The Japanese yen held strong on Friday, despite the fact the Bank of Japan unexpectedly cut rates by 20bps to 0.10 percent and increased monthly purchases of government bonds to 1.4 trillion yen from 1.2 trillion yen, which should effectively drive down yields. While BOJ Governor Masaaki Shirakawa has said that the bank isn’t planning on increasing the amount of government debt purchases any further, it is clear that they are very concerned about prospects for growth and the financial markets. One of the biggest questions going forward though, is if Japan will intervene in the currency markets. Given the rally in the yen over the past few months, Japanese exporters have felt the brunt of the impact, and the government has become increasingly concerned. In fact, they’ve started to use verbal intervention, as Finance Minister Shoichi Nakagawa said on Thursday that he has “the means” to temper the appreciation of the yen. Japan has a long history of successfully intervening in the markets, as they hold the second largest amount of foreign currency reserves in the world (China holds the most). As a result, it will be important to watch for verbal intervention, or perhaps even a physical one, at the start of next week. Traders shouldn’t necessarily take this as a sign that they should sell yen, but should certainly beware of the potential for choppy price action if they are already holding positions.

Euro, British Pound Slump as Markets Price in January Rate Cuts by ECB, BOE

The euro and British pound both retreated further on Friday, though the former was much weaker against the US dollar as it tumbled 2.3 percent while the pound slipped 0.63 percent. Furthermore, EUR/GBP continued to fall from yesterday’s record high of 0.9542, as the forex markets have generally shifted to retrace the extreme moves witnessed earlier in the week. Looking ahead to the next week, there is very little in the way of key economic data from the Euro-zone and UK, so there is a possibility that we’ll simply see pairs like EUR/USD and GBP/USD consolidate below their recent highs. However, bearish pressures may linger as Credit Suisse overnight index swaps are pricing in at least a 50bp cut by the ECB and at least a 25bp reduction by the BOE in January.

Canadian Dollar Edges Lower Despite Surprisingly Strong Canadian Inflation Figures

The Canadian dollar ended the day lower versus the greenback, but fared a bit better than currencies like the euro as Canadian inflation figures proved to be surprisingly strong. Headline CPI fell less than expected to an annual rate of 2.0 percent from 2.6 percent, but the shocking factor was that core CPI, which excludes energy and other volatile items, actually jumped to a 17-month high of 2.4 percent from 1.7 percent. The rise was due primarily to surge in food prices, and overall, the news will make it difficult for the Bank of Canada to continue slashing interest rates.

Terri Belkas is a Currency Strategist at FXCM.