US Dollar Gains Against Euro, Yen Despite Dismal Data, Slump Versus High Yielders

The US dollar has consistently been trading stronger than the euro, Swiss franc, and Japanese yen but has also remained weak versus the British pound and the commodity dollars. Much of this price action had to do with emerging signs of building risk appetite, such as the slow decline of the CBOE’s VIX volatility index below 40, despite the fact US economic data was broadly disappointing. Looking at the data on hand, the ISM non-manufacturing index - a gauge of business activity in the services sector - surprisingly rose to 40.6 in December from 37.3. A breakdown of the report shows that new orders, employment, and new export orders all edged higher. However, it is necessary to keep in mind that all of the index readings remained below 50, so they ultimately indicate that growth in the services sector is still contracting, just not as sharply.

Meanwhile, factory orders tumbled 4.6 percent during the month of November, marking the fourth consecutive month of negative readings. This is similar to what we saw in the ISM manufacturing index for December, and since that index is timelier, the record low results suggest that demand for manufactured goods is bound to fall further. In addition, pending home sales slumped 4.0 percent during November, as fewer individuals signed contracts to purchase homes. Demand for properties remains lackluster as the economy slows, job losses climb, and borrowing costs remain high despite aggressive rate cuts by the Federal Reserve. With supply levels still relatively high, the lack of demand indicates that prices have further to fall in 2009. Finally, the minutes from the Federal Open Market Committee’s December meeting didn’t reveal much in the way of new information, but simply confirmed some of the more dour outlooks amongst economists, as some Committee members thought that there was “a distinct possibility of a prolonged contraction.”

Looking ahead to the next 24 hours, the Challenger Job Cut index and the ADP Employment Change will both be released. While these are not typically market-moving reports, they will be worth watching as they may help to handicap the results of Friday's non-farm payrolls report. Challenger Job Cut are likely to show that companies laid off a greater number of workers in December from a year earlier, while the ADP Employment Change is forecasted to reflect the most job losses in the private sector since at least 2001. Such results would suggest that US non-farm payrolls may have indeed plunged another half-million or more during December alone.

Euro Plummets as Euro-zone CPI Falls to More Than 2-Year Low, Suggest ECB Will Cut Rates January 15

The euro fell sharply across the majors on Tuesday as Euro-zone CPI estimates plunged more than expected to a 2-year low of 1.6 percent in December from 2.1 percent. The severity of the decline was all the more important due to the index’s drop below the European Central Bank’s 2.0 percent inflation target, as we’ve already seen dovish comments by European Central Bank Vice President Lucas Papademos this week suggesting that the ECB may indeed cut rates on January 15. In light of this latest data, along with Mr. Papademos’s comments and ECB President Jean-Claude Trichet’s more bearish stance on economic growth, Credit Suisse overnight index swaps are moving ever closer to fully pricing in a 50bp cut to 2.00 percent. On Wednesday at 3:55 ET, the German unemployment change for the month of December is forecasted to rise by 10,000, which would mark the first increase in claims for jobless benefits since January 2006. This nominal change shouldn't impact the unemployment rate, which is anticipated to hold steady at 7.5 oercebt. Nevertheless, a rise in claims in line with or more than expected could trigger declines for the euro, which has already been under pressure as the markets bet the European Central Bank will cut rates next Thursday. However, it is worth noting that the impact of such releases tends to be very short-lived.

British Pound Rallies Despite Signs of Impending BOE Rate Cut on Thursday

The British pound continued to stage its rebound, and despite the fact UK interest rates are relatively low at 2.00 percent, the currency has been trading in a similar manner to that of more speculative carry trades like the Australian dollar and New Zealand dollar. However, UK economic data was broadly bearish as Nationwide home prices fell for the 14th straight month in December, bringing the annual rate down to -15.9 percent, which is the lowest in at least 17 years as record-keeping began in 1992. Meanwhile, the Purchasing Managers’ Index (PMI) for the UK services sector edged up to 40.2 in December from 40.1. There’s little optimism to be had in light of this release though, as the index has held below 50 - signaling a contracting in business activity - for 8 consecutive months. All of this leaves the odds in favor of a rate cut by the Bank of England on Thursday, and Bloomberg News is forecasting that the Bank of England will cut rates by 50 basis points. However, the reaction of the British pound may depend on what sort of bias is reflected in the Monetary Policy Committee’s subsequent statement, and as we saw with the December 4 rate cut by the BOE, the currency could actually rise following a rate cut.

Commodity Dollars Dominate as Risk Appetite Leads Carry Trades Higher

The Australian dollar, New Zealand dollar, and Canadian dollar have been some of the strongest of the major currencies we follow, as easing volatility and building risk appetite is helping to boost traditionally “risky” assets, including equities, commodities, and forex carry trades. Crude oil has received an added lift from persistent tensions in the Middle East, Russia’s cut in gas deliveries to Europe vis-à-vis Ukraine, and efforts by the US and China to take advantage of lower prices to stockpile reserves. There will be some event risk on hand for the Australian dollar overnight as retail sales in Australia are forecasted to have grown 0.1 percent during November, confirming that 2008 was a year of lackluster consumption for the economy. Any increases are likely to be solely the result of spending on food, as sales of apparel, household goods, and at restaurants have been consistently weak throughout the second half of the year. Regardless, a reading in line with or more than expectations could lead the Australian dollar to rise overnight, but if the index unexpectedly falls negative, the currency could tumble as the markets will shift to price in greater potential for a rate cut by the Reserve Bank of Australia during their next meeting in February.

Terri Belkas is a Currency Strategist at FXCM.