US Dollar Ends Day Mixed, Japanese Yen Tumbles as Risk Appetite Surge on ‘Bad Bank’ Initiative

Risk appetite was strong on Wednesday, leading the S&P 500 to rally 3.36 percent higher and trigger sell-offs in Treasuries. This environment would normally be ripe for sharp US dollar declines, but we’re started to see the correlation between risk trends and the currency fall apart. Instead, the greenback ended the day up against the Japanese yen, New Zealand dollar, and euro while falling against the British pound, Australian dollar, and Canadian dollar. Focusing on the weak yen, today’s price action showed that the currency continues to move in lockstep with risk aversion, and today’s increase in investor confidence led the low-yielding yen to plunge 1.4 percent versus the euro and over 2 percent against the British pound and Australian dollar.

What was behind the surge in sentiment? Bad banks. Believe it or not, this is a good thing. According to reports, the Obama administration may be moving toward setting up a “bad bank” in conjunction with the Federal Deposit Insurance Corp. (FDIC), which would buy toxic assets off the books of financial institutions. This has the potential to go a long way to boost confidence in the financial system and thus, loosen up credit conditions, as there would be fewer concerns about counterparty risk. Though this isn’t a silver bullet for all the issues plaguing the financial markets, it is certainly a bit of good news. Meanwhile, the Federal Reserve left the fed funds rate target range unchanged at 0.0 percent - 0.25 percent, as expected, but with little in the way new information revealed in the Federal Open Market Committee’s policy statement, this announcement didn’t spark much price action. However, the FOMC did appear to be signaling potential for deflation to take hold of the US, as they said “inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.”

Looking ahead to Thursday, there will be a bevy of US economic indicators on hand. At 8:30 ET, durable goods orders are forecasted to fall negative for the third straight month in December at a rate of -2.0 percent. Given the extent of the recession plaguing the US, there is downside risk for this release as both consumer and business demand are relatively non-existent. At the same time, continuing jobless claims for the week ending January 17 are projected to climb to 4620K from 4607K, which is just a stone’s throw away from 4713K, the highest level since record keeping began in 1967. At 10:00 ET, new home sales are estimated to fall by 2.5 percent to a nearly 27-year low of 397K, but it will be very interesting to see if the index actually rises in light of Monday’s surprise increase in existing home sales.

New Zealand Dollar Down as RBNZ Slashes Rates More Than Expected

The Reserve Bank of New Zealand (RBNZ) cut their Overnight Cash Rate more than expected by 150 basis points to 3.50 percent, the lowest since the introduction of the mechanism in 1999. This marked the fifth straight meeting where the RBNZ slashed rates, and brings the cumulative total of cuts to a whopping 475 basis points since August 2008. Prior to the release, the markets had only been anticipating a 100 basis point cut, which is part of the reason why the New Zealand dollar fell sharply upon the announcement. Additional bearish pressures were waged on the currency as RBNZ Governor Bollard said that the market may be "correct' to price in further reductions to the OCR, though they likely won't be as aggressive in size. NZD/USD charts showed that the pair plummeted for a test of support at 0.5185/0.5200 before subsequently recovering a bit to end the day near 0.5250. For obvious reasons, this put my analyst pick from this morning in some danger, but with NZD/JPY still well above my noted stop levels, I still think there’s potential for the pair to climb higher in the near-term thanks to continued improvements in investor sentiment.

Euro Fails to Break Above Resistance at 1.33 Yet Again

The euro was not able to break above yesterday’s high or falling trendline resistance at 1.33 on Wednesday, and price action overnight may determine whether EUR/USD will break above the noted level, or if the pair is in for a deeper decline. The key level to watch is 1.3120, as a decline below this support level would be a bearish sign. There is some event risk for the euro on hand on Thursday morning, as the German unemployment change and Euro-zone consumer confidence will be release. The former is anticipated to show that the German economy lost jobs for the second month in a row during January while the latter is projected to drop to the lowest since record-keeping began in 1983, adding to evidence that growth in the region is slowing sharply. Such news could add to speculation that the European Central Bank will continue cutting interest rates, but nevertheless, my bias for EUR/USD remains bullish in the near-term.

Terri Belkas is a Currency Strategist at FXCM.