US Dollar Gains Despite Worst Housing Conditions in At Least 50 Years, Climb in Jobless Claims

We’ve been talking about the impact of risk aversion on the forex markets for months, and this trend continues to this day as low-yielding currencies remain the safe-havens of choice. Indeed, the US dollar ended Thursday up against higher-yielding currencies like the euro, British pound, Australian dollar, and New Zealand dollar, but slipped versus the Japanese yen, Swiss franc, and Canadian dollar. From a fundamental perspective, current conditions and the outlook for the US remains dismal. Despite broadly lower borrowing costs, MBA new mortgage applications fell 9.8 percent during the week ended January 16 while housing starts and building permits tumbled to the worst levels since the Commerce Department start keeping records almost 50 years ago. More specifically, housing starts were down 15.5 percent during the month of December and 45 percent from a year earlier to 550K, while new permits slumped 10.7 percent during the month and 50.6 percent from a year ago to 549K. Adding to the mix, initial and continuing jobless claims continued to climb toward the 1982 highs, a day after the New York Times reported that New York State’s unemployment insurance system is effectively insolvent and is issuing unemployment checks by borrowing from the federal government. According to New York’s labor commissioner M. Patricia Smith, claims are up 50 percent each week from a year ago. Assuming similar trends are occurring throughout the country, this does not bode well for the next release of non-farm payrolls in February.

The British pound remains under pressure, and looking ahead to Friday, the advanced reading of Q4 GDP for the UK is forecasted to contract for the second straight quarter at a rate of -1.2 percent, which would match the worst decline in 18 years. The UK has been hit particularly hard by the credit crunch, especially since the country became one of the biggest financial centers in the world. This has translated into a full-on collapse of the housing market, climbing job losses, and weak consumption. Furthermore, with growth slowing around the world, demand for British exports has declined as well, putting a large burden on manufacturers. Overall, a greater-than-expected decline could lead the British pound lower as the data would raise the odds the Bank of England will cut rates further in coming months and may also add to speculation of a possible downgrade of the UK’s AAA credit rating by Standard & Poor’s, given the latest downgrades of Spanish, Portuguese, and Greek debt. On the other hand, if GDP is a bit better than forecasts, the currency could surge, even if the index is still negative.

Euro Ends Day Lower as Industrial Orders Fall By Record - Buying Opportunity?

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. Though the currency ended the day down slightly against the greenback, EUR/USD has still managed to hold above that key support level despite dismal European released during the morning. Euro-zone industrial orders plummeted by a record 26.2 percent in November from a year earlier as the combination of waning domestic and foreign demand proves to be toxic for manufacturers. As we said yesterday, though, 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 the consideration of buying EUR/USD.

Japanese Yen Holds Near Record Highs, Verbal Intervention or Pick Up in Risk Appetite Could Trigger Reversals

The Japanese yen ended the day up across the majors as persistent risk aversion also weigh on the stock markets, with the Dow Jones Industrial Average slumping 1.28 percent. However, it is worth noting that the yen remained well below the record highs reached yesterday, suggesting that a top could be forming. Last night, the Bank of Japan (BOJ) left rates unchanged at 0.10 percent as expected, and their subsequent Statement on Monetary Policy didn’t reveal much in the way of new information. The statement noted the sharp slowdown in the economy and the dismal prospects for growth going forward as the BOJ expects to fall back into deflation this year. Meanwhile, we saw a bit of jawboning of the Japanese yen, as Vice Finance Minister for International Affairs Naoyuki Shinohara said that they were “closely monitoring movements in the currency market” while BOJ Governor Masaaki Shirakawa mentioned that the currency’s gains were negative for Japanese exporters and the economy in the short term. Nevertheless, there is still potential for Japanese officials to step up verbal intervention efforts or even physically currency intervention if the Japanese yen strengthens further.

Canadian Dollar: USD/CAD Could Break Below 1.25 If CPI Fails to Fall as Expected

The Canadian dollar initially plunged on news that Canadian retail sales plunged more than expected by 2.4 percent during November, the sharpest drop since January 1998, led primarily by a 7.1 percent drop in automotive sales. While there is little doubt that domestic demand is starting to falter, the bulk of the decline in automotive sales was due to a 14.9 drop in spending at gas stations, and when you consider the steady drop in gasoline prices in both Canada and the US during November, it is clear that since this index is not adjusted for inflation, the figures actually skew the picture a bit. Nevertheless, according to the Bank of Canada's Monetary Policy Report, the outlook for spending, and the economy in general, remains bleak. Going forward, the Bank expects GDP to fall by 1.2 percent in 2009, and then stage a recovery of 3.8 percent in 2010. According to the report, this is faster than the recoveries following the recessions of 1981-82 and 1990-92, and because the Bank has already cut rates aggressively and Canada maintains "greater fiscal flexibility and stronger corporate balance sheets" compared to the 1990's, the economy is in a far better position relative to the past and to other nations. This hint of optimism is part of the reason why the Canadian dollar was able to stage a rebound from this morning's lows.

Looking ahead to Friday, since the BOC has forecasted such sharp declines for inflation this year, the upcoming release of the Canadian Consumer Price Index (CPI) will be quite important. At 7:00 ET, CPI for December is anticipated to contract for the third straight month at a rate of 0.4 percent while the annualized pace is forecasted to tumble to a nearly 2-year low of 1.3 percent. Meanwhile, the Bank of Canada’s core CPI measure may actually hold steady at a 1.5 year high of 2.4 percent. Given the sharp drop in commodity prices since the summer and slowing in the Canadian economy, there is potential for weaker-than-expected readings and thus, the Canadian dollar could pull back further.

Terri Belkas is a Currency Strategist at FXCM.