US Dollar Drops as Rise in Risk Appetite Saps Demand for Safe Havens

The US dollar, as usual, traded more in line with risk trends than anything else. At the start of the day, the currency was trading a bit stronger, but a rebound in risk appetite later in the day sent the greenback tumbling against nearly everything, excluding the Swiss franc. There was no data on hand, but comments by New York Fed President and US Treasury Secretary-designate Timothy Geithner garnered quite a bit of attention. During his confirmation hearing before the Senate Committee, Mr. Geithner primarily faced questions and criticism about his failure to pay all necessary taxes from 2001 - 2004 while working for the IMF. In his prepared remarks, he focused on the economy, which faces "extraordinary challenges," including a "severe recession…catastrophic loss of trust and confidence in our financial system. Unprecedented foreclosure rates, small businesses struggling to stay afloat, millions of Americans worried about losing their jobs and savings, growing job losses, a deep uncertainty about what tomorrow holds." Mr. Geithner went on to say that in “a crisis of this magnitude, the most prudent course is the most forceful course,” which he cited as being the American Recovery and Reinvestment Plan, President Barack Obama's stimulus plan. The $825 billion plan, which could be passed by Congress next month, includes $550 billion in targeted investments and $275 billion in tax cuts for individuals and businesses. There are no major US indicators scheduled to be released on Thursday making it all the more important to watch risk trends and signs of investor optimism will only weigh on the currency.

Euro Shows Signs of Bullish Reversal Despite S&P Downgrade of Portugal’s Credit Rating

We’ve been noting for the past few days that the euro has been consolidating within a falling wedge formation, with support looming just below at 1.2850/60 (this is slightly under the level noted yesterday due to the change in slope of the trendline). There has been no fundamental change regarding the economic scenario for the Euro-zone, as European Central Bank (ECB) President Jean-Claude Trichet suggested during their last meeting that additional rate cuts may be on the way, but just not in February. Meanwhile, Portugal became the third European nation to see their credit rating downgraded by S&P, following Spain on Monday and Greece last week, highlighting one of the major problems associated with monetary unions: monetary policy is not always going to suit the economies of all participants. Looking ahead to Thursday, the ECB’s Monthly Report is likely to highlight the bleak outlook for the Euro-zone economy and expectations for a decline in inflation pressures in the near-term. Given the broadly bearish expectations for the Euro-zone in general, the report has potential to weigh on the euro. However, since the ECB will not be issuing updated growth and inflation projections until March, the news may not be very market-moving. Overall, technical developments are proving to be more important at this juncture as the US dollar rally seems to be losing steam, and with falling wedge formations typically signaling bullish reversals, the latest consolidation may warrant considering buying EUR/USD.

Japanese Yen Increasingly Volatile Ahead of BOJ Rate Decision

The Japanese yen saw a surge in volatility on Wednesday, as the currency rocketed higher across the majors during the morning to touch record highs versus the British pound, 13-year highs against the US dollar and Canadian dollar, and 6-year highs versus the euro. However, the yen reversed course throughout the afternoon, and by the end of the day the yen was down nearly 2 percent against the New Zealand dollar and Australian dollar and slipped roughly 0.50 percent versus the euro and Canadian dollar. The move in the Japanese yen crosses corresponded with a 3.5 percent rally in the Dow Jones Industrial Average and a decline in the ultimate safe-haven asset: Treasuries.

Overnight, the Bank of Japan (BOJ) is forecasted to leave rates unchanged at the conclusion of their policy meeting, but with interest rates already at an ultra-low 0.10 percent, there isn't much room to make monetary policy more accommodative without going back to zero-interest rate policy (ZIRP) anyway. Thus, it will be important to gauge comments by BOJ Governor Masaaki Shirakawa and to look at the BOJ's Monthly Report on January 23 at 0:00 ET, but the outlook doesn't look good. Indeed, Japan's Cabinet Office issued an assessment of the economy during the month of January last night, and indicated that conditions were "worsening rapidly" as exports and industrial output plunge, corporate profits fall "substantially," business investment declines, the employment situation deteriorates "rapidly," and private consumption takes on a "weak tone." Mr. Shirakawa's comments on the economy ultimately may not have a huge impact on the Japanese yen, but it will be very important to look for comments regarding the currency, as the use of verbal intervention could push the yen even lower.

Swiss Franc Pulls Back as SNB’s Hildebrand Says ’I’ Word

Speaking of intervention, the Swiss franc tumbled across the majors as Swiss National Bank (SNB) Vice-Chairman Philipp Hildebrand brought up the “I” word during speech this afternoon, noting that the SNB could sell francs in the market to halt the currency’s gain, and in an “extreme case,” could even go so far as to fix the exchange rate. Furthermore, Mr. Hildebrand left the door open to quantitative easing, in line with what the ideas introduced by the Federal Reserve and Bank of England over the past month. Efforts to verbally boost the currency may help to quell speculative buying in the near-term, but if risk aversion drives carry trades lower once again, the SNB may be forced to attempt physical means.

British Pound Plunges as BOE Minutes Show Potential for Further Rate Cuts, Bounces From 1985 Lows

The British pound plummeted across the majors on Wednesday, reaching the lowest levels since 1985 against the US dollar and hitting record lows versus the Japanese yen. Economic data from the UK certainly didn’t help the currency, which has been trading more like a speculative carry trade than currencies with similarly low yields, like the Canadian dollar. UK jobless claims rose by a whopping 77.9K during December, leading the total number of job losses to reach 1.16 million and the claimant count rate to match the June 2000 high of 3.6 percent. Furthermore, the minutes from the Bank of England’s last meeting showed that the decision to cut rates by 50 basis points was on an 8-1 vote, as perennial Monetary Policy Committee member David Blanchflower - easily the most dovish on the Committee - called for a full 100 basis point reduction. Other members showed interest in a deeper rate cut as well, but refrained on fears it would seriously impact confidence. Nevertheless, the persistent fear amongst investors to borrow and lend leaves the odds in favor of further action by the BOE in coming months. There are no major indicators for the UK due to be released on Thursday, but given the sheer extent of the British pound’s recent declines and quick reversal from its multi-decade and record lows, the currency may be in store for further gains in the near term.

Terri Belkas is a Currency Strategist at FXCM.