US Dollar Tumbles as Data Suggests NFPs Will Plunge at Least 500K, Budget Deficit to Hit Record $1.2 Trillion

The US dollar ended Wednesday lower versus the euro, Japanese yen, Swiss franc, and British pound amidst news that the US budget deficit is set to spiral higher this year and as data signaled that Friday’s US non-farm payroll (NFP) report could be deeply disappointing. According to the nonpartisan Congressional Budget Office (CBO), President-elect Barack Obama will face a $1.2 trillion deficit in 2009, which may ultimately end up being much higher considering that this forecast doesn't even take into account the probable implementation of a massive fiscal stimulus plan. Indeed, there is speculation that the plan will add up to $775 billion over two years, with $300 billion devoted to tax cuts for individuals and businesses, and politicians are far more concerned with being remembered as the ones who saved the US economy from a second Great Depression, rather than being budget hawks. With the CBO also forecasting that the recession will extend "well into" 2009, echoing the sentiment of some Federal Open Market Committee members, and real GDP of only 1.5 percent in 2010, it's no wonder officials are striving to take drastic action soon.

Meanwhile, Challenger, Gray & Christmas reported that job cuts in the US rocketed 274.5 percent higher during December from a year earlier, the most since June 2001, led by the financial, chemical, retail, telecommunication and electronics sectors. Likewise, the ADP National Employment report showed the sharpest decline in private nonfarm employment since record keeping began in January 2001, with the index down by 693K in December. It is worth noting that the ADP report just underwent methodological changes in order to bring that numbers more in line with the ones issued by the government, so it will be interesting to see if this is indeed the case this week. Nevertheless, the data suggests that NFPs are bound to have fallen by another half million in the final month of the year, which could have dour consequences for the unemployment rate, which is forecasted to rise to a more than 15-year high of 7.0 percent from 6.7 percent.

Euro Bounces from Key Support Versus US Dollar, British Pound - May Prove Short-Lived

The euro bounced from support versus the US dollar and British pound on Wednesday, with EUR/USD continuing higher from yesterday’s test of 1.3311 while EUR/GBP drifted back above the psychologically important 0.90 mark following a late-morning drop to 0.8961. There was no fundamental drive behind the move, as economic data was broadly bearish. The German unemployment change rose for the first time in almost three years during December by 18,000, suggesting that consumption growth is likely to weaken substantially. Meanwhile, the Euro-zone producer price index plunged by 1.9 percent during the month of November, the sharpest decline since 1981, as lower commodity prices weigh on input costs. Given the decline in estimates for Euro-zone CPI below the European Central Bank’s 2.0 percent target to a more than 2-year low of 1.6 percent, it seems increasingly likely that the ECB will move to cut rates by 50 basis points to 2.00 percent on January 15.

British Pound Remains Strong 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 the strongest major currency in recent days as part of a correction of its massive declines through the second half of 2008. However, UK economic data was quite bearish as the British Retail Consortium’s Shop Price Index fell 2.0 percent during December, bringing the annual rate of growth down to 0.5 percent. Looking ahead to Thursday, the British pound should remain volatile as Bloomberg News is forecasting that the Bank of England will cut rates by 50 basis points at 7:00 ET on Thursday. This is indeed within the realm of possibilities since the UK has tipped into recession and the BOE, and UK government, anticipate that things will only get worse. In fact, the BOE’s latest Credit Conditions Survey for the fourth quarter indicated that they had worsened, with availability of loans down despite unexpectedly stable demand for mortgages. Furthermore, the survey said that spreads on secured lending to households and on corporate lending had widened, and that defaults on household and non-financial business loans had increased. Overall, this leaves the odds in favor of year another rate cut by the BOE on January 8, but the reaction of the British pound may depend on what sort of bias is reflected in the Monetary Policy Committee’s subsequent statement. My view? The British pound may only fall sharply if the BOE cuts rates more than expected, say by 100 basis points, but if the MPC only cuts rates by 25 – 50 basis points and suggests that they will leave rates unchanged next month, the currency could actually surge.

Australian, New Zealand, Canadian Dollars Reverse Course as Commodities Tumble

The Australian dollar, New Zealand dollar, and Canadian dollar reversed course on Wednesday as traditionally “risky” assets, including equities, commodities, and forex carry trades, fell across the board. In fact, crude oil plummeted approximately 12 percent as the US Energy Department reported that declining consumption led inventories of crude oil, gasoline and distillate fuel to rise last week. There will be some event risk on hand for the Canadian dollar on Thursday morning as the Ivey Purchasing Managers' Index (PMI) - a gauge of business activity - is forecasted to fall to the lowest level since record keeping began in 1999 during December from 40.2 in November. Any declines will suggest that the Canadian economy is the next to head for recession, though it has held up well relative to countries like the US as domestic demand holds strong. Index readings below 50 signal a deterioration in activity, and traders should keep an eye on the individual components of the index, particularly employment. Indeed, this component can sometimes serve as a good leading indicator for the release by Statistics Canada of the net employment change on Friday. Furthermore, Ivey PMI can be market-moving for the Canadian dollar, with disappointing figures likely to weigh on the currency.

Terri Belkas is a Currency Strategist at FXCM.