US Dollar Could See Volatile Day on Wednesday Ahead of FOMC Rate Decision, Policy Statement

The US dollar ended Tuesday broadly mixed across the majors, as the currency consolidates its recent decline. Economic data from the US remained bleak, as the Conference Board's consumer confidence index fell to a new record low of 37.7 during the month of January from 38.6, missing expectations of a slight rise to 39.0. A breakdown of the report showed that sentiment on the present situation and on economic expectations both turned more pessimistic with an increasing number of consumers believing that business conditions were bad (versus good and normal). However, there was a bit of stabilization regarding outlooks for employment and income, as more consumers thought that prospects would remain the same in 6 months. That said, the majority of those surveyed (over 50 percent) said that employment was currently either "not so plentiful" or "hard to get," suggesting that the next round of non-farm payrolls (NFPs) should be disappointing, creating additional downside risks for consumption going forward.

Looking ahead to 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. The statement may have an impact on risk trends, and any news that is positive for the stock markets may be negative for the greenback, which has been trading solely as a safe-haven asset lately. Furthermore, the Committee is anticipated to issue news forecasts for GDP and CPI, which has the potential to shake up volatility.

Euro Gains on Strong German IFO Results, Reverses from Resistance at 1.33

The euro started the day off on a strong note following the release of better-than-expected German IFO results, which showed a rise in the expectations component to 79.4 in January from 76.8 while the measure gauging the business climate edged up to 83.0 from 82.6. Indeed, four rate cuts by the European Central Bank since October and the announcement of a 50 billion euro stimulus plan by German Chancellor Angela Merkel, which was approved today, have provided a few reasons to believe that there’s a light at the end of the tunnel. However, the current assessment index fell to a nearly 6-year low of 86.8 from 88.8, as economic conditions remain bleak and the financial markets are still relatively unstable. Shortly after the economic report, EUR/USD reversed from resistance at 1.33 to form a bearish gravestone doji on the hourly charts, and the pair ultimately ended the day down slightly. Looking ahead to Wednesday, rising trendline support at 1.3150 should be able to keep EUR/USD from falling lower, as there will be little in the way of event risk for the currency in the morning.

Japanese Yen Ends Tuesday Mixed as Risky Assets Consolidate Within Tight Ranges

The Japanese yen ended Tuesday mixed across the majors, gaining against the US dollar and euro while falling against the British pound. Currently, many risky assets, such as the Dow Jones Industrial Average, are trading within very tight ranges, leaving potential open for breakouts. One factor that helped to boost sentiment in Japan last night was the announcement of a plan to inject state money into ailing companies in exchange for equity stakes and will most likely be designed to target smaller and mid-size companies that employ some 70 percent of the country’s work force. Looking ahead, the Federal Reserve’s upcoming rate decision and policy statement could have a large impact on risk trends, so traders should beware the event risk on Wednesday afternoon.

Australian Dollar Could Gain Overnight on Australian CPI Figures, New Zealand Dollar Faces RBNZ Rate Decision

Australia's headline consumer price index is forecasted to have fallen 0.4 percent 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 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 closer to pricing in a 100 basis point reduction to 3.25 percent, and combined with a sharp drop in CPI, this sentiment could weigh on the Australian dollar. However, there is significant potential for these results to reflect resilient price pressures, as the producer price index for the same period showed that input cost growth rose to a record high of 6.4 percent (year-over-year). If this is indeed the case, the Australian dollar could rally sharply overnight.

Meanwhile, a decline in New Zealand's consumer price index during Q4 for the first time in two years and by the most in ten years has added to speculation that the Reserve Bank of New Zealand will cut interest rates on Wednesday at 15:00 ET, despite the fact the annual rate remains above the central bank’s 1-3 percent inflation target at 3.4 percent. 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 such a move 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.