US Dollar, Japanese Yen Remain Strong Ahead of US Q4 GDP Data

The US dollar started the New York trading session off on a weak note today, only to rebound with the Japanese yen following the release of broadly disappointing US economic data, which added to lingering risk aversion in the markets. Durable goods orders fell for the third month in a row at a rate of 2.6 percent in December, while the annual rate of growth shows that orders are down 19.7 percent from a year earlier. A breakdown of the index shows that demand for nondefense aircraft was down a whopping 43.6 percent, as Boeing orders slumped to 44 in Q4 from 148 in Q3. Meanwhile, non-defense capital goods orders excluding aircraft fell 2.8 percent, bringing the 3-month annualized rate to -32.5 percent. As a gauge of business investment over the next 6 months, this does not bode well for growth and job prospects going forward. Indeed, labor market conditions already remain abysmal, as continuing jobless claims climbed to 4776K during the week ending January 17, which is the highest level since record-keeping began in 1967. As it stands, a Bloomberg News poll shows that economists expect that the February release of non-farm payrolls will show another half million job losses and a rise in the unemployment rate to a more than 16-year high of 7.5 percent from 7.2 percent. Finally, new home sales for the month of December proved to be very disappointing, as they plunged 14.7 percent to 331K, the lowest since record-keeping began in 1963. There had been a bit of optimism about the prospects for this release given the surprise jump in existing home sales, but it appears that the 9.3 percent drop in median home prices to $206,500 hasn't been enough to spur an increase in demand.

Looking ahead to Friday, there’s potential for the US dollar and Japanese yen to gain further, as the 08:30 ET advanced reading of Q4 GDP for the US is forecasted to contract for the second straight quarter at a rate of -5.5 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 (and Japanese yen) higher despite the disappointing fundamental scenario.

Euro Pulls Back as Evidence Continues to Point Towards Further ECB Rate Cuts - Watch CPI on Friday

The euro came under significant pressure on Thursday, as the currency fell 1.5 percent versus the greenback and roughly 2 percent against the British pound and Japanese yen. Economic data certainly wasn’t working in the currency’s favor, as the German economy lost twice as many jobs as expected in January. Indeed, the net unemployment change rose for the second consecutive month by 56,000, which was the sharpest increase since March 2005, while the jobless rate rose slightly more than expected to 7.8 percent. Meanwhile, Bloomberg’s retail Purchasing Managers’ Index (PMI) actually rose to 44.0 in January, but with the index still below 50 and thus signaling a contraction in business activity for the eighth straight month, there was little optimism to be gleaned from the report. Finally, various measures of sentiment in the Euro-zone - including consumer, economic, industrial, and services – turned increasingly pessimistic in January as all of the indexes fell to the worst levels since record-keeping began in 1985.

All of Thursday’s news added to speculation that the European Central Bank will continue cutting interest rates, but Friday’s release of Eurostat’s estimate for Euro-zone CPI may go a long way to add to these expectations or negate them. The estimate is 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 ECB President 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. From a technical perspective, my bias for EUR/USD remains bullish in the near-term, though a break below 1.2861 would force me to reconsider.

British Pound Surges 2% vs. Euro Amidst Mixed Comments from Outspoken BOE Member Blanchflower

The British pound held up fairly well compared to many of the other majors, as the currency gained 2 percent against the euro and a slight 0.34 percent versus the US dollar. UK economic data released at 2:00 ET didn’t work in favor of the British pound, as Nationwide house prices fell for the fifteenth straight month in January, bringing the annual rate down to fresh record low of -16.6 percent. Meanwhile, Bank of England Monetary Policy Committee Member David Blanchflower, who is easily the most outspoken and dovish member on the Committee, issued conflicting comments for the UK’s national currency. From a bearish perspective, Mr. Blanchflower said that the UK economy may face a recession worse than that of the one in the 1980’s and that the Bank Rate needs to be cut “further and quickly.” Furthermore, he said that the MPC has considered their options in the case that the Bank Rate is cut to zero, which was a timely comment when you consider that Chancellor of the Exchquer Alistair Darling gave the BOE permission today to buy 50 billion pounds worth of bond and commercial paper in order to alleviate tight credit conditions. On the other hand, Mr. Blanchflower claimed that the British pound is undervalued and that he himself is bullish the currency. Given the outlook for further BOE rate cuts, these comments seem more like an attempt to prevent the currency from plummeting in response to the central bank’s dovish bias than anything else. Check out what the DailyFX analysts chose as their British pound trading picks.

Terri Belkas is a Currency Strategist at FXCM.