US Dollar, Japanese Yen End Friday Mixed - Risk Appetite to Improve Next Week?

The US dollar and Japanese yen ended Friday mixed across the majors, as early morning rallies were following by steep declines during the afternoon. This is very much in line with what we’ve seen in the stock markets, as DJIA and S&P 500 futures were down over 2 percent before the US open, but subsequently recovered over the course of the day, with the former ending the day down a slight 0.56 percent and the latter up 0.54 percent. From a technical perspective, declines in the US dollar and Japanese yen from key resistance levels suggest the currencies could be due for deeper retracements, but it’s also worth keeping in mind that US news due to be released next week has the potential to impact risk sentiment.

On Wednesday the Federal Open Market Committee (FOMC) is widely expected to leave the fed funds target range at 0.0 percent - 0.25 percent and this should remain the case throughout much of the year. In fact, the FOMC said in December that their focus going forward will shift to supporting “the functioning of financial markets” and the stimulation of the economy “through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.” Thus, the only important part of this meeting will be to watch the FOMC’s subsequent monetary policy statement to see if they announce any new efforts meant to improve credit conditions. On Friday at 08:30 ET, the advanced reading of Q4 GDP for the US is forecasted to contract for the second straight quarter at a rate of -5.4 percent, which would mark the worst decline since Q1 1982. The National Bureau of Economic Research (NBER) has already declared that the US has been in recession since December 2007, but a plunge in GDP in line with expectations will only suggest that the contraction in growth will continue to be worse than previously expected. The Federal Reserve really has no room to make monetary policy more accommodative, so traders should watch for the impact of this report on equities, as a surge in risk aversion may only lead the US dollar higher despite the disappointing fundamental scenario.

Euro Recovery Seems Increasingly Possible, Euro-zone CPI Expected to Fall to Nearly 10-Year Next Week

The euro has been consolidating within a falling wedge formation, with support now looming at 1.2750. This is lower than the levels noted in previous day as support comes in the form of a falling trendline. With falling wedge formations typically signaling bullish reversals, the latest consolidation may warrant the consideration of buying EUR/USD. The one major piece of event risk for the euro next week comes on January 30, as Eurostat estimates for Euro-zone CPI are projected to show at 5:00 ET that inflation growth eased to a nearly 10-year low of 1.4 percent in January from 1.6 percent. Given European Central Bank President (ECB) Jean-Claude Trichet’s more bearish stance on economic growth and the bank’s total of 225 basis points worth of rate cuts since October, a weaker-than-expected CPI reading could exacerbate the market’s speculation that the central bank will cut rates again on February 5, and weigh on the euro. On the other hand, if CPI does not fall further, the currency could gain as the markets assume the central bank will leave rates unchanged next month and wait until March to make monetary policy more accommodative.

British Pound Ends Day Lower as UK Economy Contracts by Most Since 1980

The British pound plummeted toward support at the psychologically important 1.35 level this morning, before rebounding 300 points, as UK figures reflected the sharpest economic contraction since 1980. Indeed, Q4 GDP was worse-than-expected at -1.5 percent, marking the second straight quarter of contraction. 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. The data raises the odds that 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, especially in light of the latest downgrades of Spanish, Portuguese, and Greek debt.

Canadian Dollar Jumps Despite CPI Slump, Commodity Dollar Outlook Hinges Upon NZ, Australian Data Next Week

The Canadian dollar surged nearly 2 percent against the greenback and Japanese yen on Friday as the currency managed turned up from key support. The move ran counter to the initial impact of Canadian CPI, as the headline index fell 0.7 percent during December, bringing the annual rate down to a 2-year low of 1.2 percent. The decline was a bit more than forecasted, but given the Bank of Canada’s forecast for negative CPI readings for 2 quarters this year, it seems like this reading could have actually reflected far sharper declines. Meanwhile, the Australian dollar and New Zealand dollar have shown signs of stabilizing, but event risk next week could shake the high-yielding currencies up.

On January 27, the release of Australia's headline consumer price index is forecasted have shown a 0.4 percent drop during the fourth quarter, bringing the annual rate down to 3.6 percent from 5.0 percent. The quarterly contraction would be the first in two years and the sharpest drop in eleven years, and may also add to speculation that the Reserve Bank of Australia (RBA) will cut rates aggressively during their next meeting on February 2. As it stands, a Bloomberg News poll of economists is forecasting a 50 basis point reduction to 3.75 percent, while Credit Suisse overnight index swaps are close to forecasting a 100 basis point reduction to 3.25 percent, and this sentiment could weigh on the Australian dollar. However, if inflation pressures prove to be stronger than anticipated, the currency could actually rise.

On January 19, data showed that New Zealand's consumer price index fell during Q4 for the first time in two years and by the most in ten years at a rate of 0.5 percent, bringing the annual rate down to 3.4 percent from 5.1 percent. While the annual rate is still above the Reserve Bank of New Zealand’s 1 percent - 3 percent target band, the news added to speculation that the RBNZ will cut rates aggressively on January 28. As it stands, both a Bloomberg News poll of economists and Credit Suisse overnight index swaps are forecasted a 100 basis point reduction to 4.00 percent, and this sentiment could weigh on the New Zealand dollar. However, if the RBNZ suggests in their policy statement that they may refrain from cutting rates any further, the currency could actually rally.

Terri Belkas is a Currency Strategist at FXCM.