US Dollar, Japanese Yen Rally on Russian Credit Downgrade, Mounting US Job Losses

US stock markets initially opened higher this morning, but investors were unable to shake off the news that Fitch downgraded Russia’s credit rating to triple-B, just two rungs above junk grade, while deeply disappointing earnings from Time Warner and Kraft Foods helped lead the DJIA down 1.51 percent by the end of the day while flight-to-quality and deleveraging sent the US dollar and Japanese yen higher. US economic data was mixed as ISM non-manufacturing, a gauge of business conditions in the retail, services, and finance sectors, rose slightly to 42.9 in January from a revised 40.1. However, this marks the fourth straight month that the index held below 50, signaling a consistent contraction in activity. Furthermore, a breakdown of the index shows that new orders continued to fall, albeit at a slower pace, while the employment component slipped very slightly to 34.4, boding ill for Friday’s US employment reports. There were additional indications that job losses climbed, as layoffs rose 222.4 percent rise in January from a year earlier amidst heavy layoffs in the retail, industrial, computer, and pharmaceutical sectors, according to an index published by Challenger, Gray, & Christmas. Meanwhile, ADP’s private payrolls estimate fell for the twelfth straight month in January by 522,000, suggesting that the Labor Department’s release of US non-farm payrolls could indeed reflect national job losses of another half million or more.

British Pound: Bank of England Rate Decision May Be Market-Mover of the Day

The already-volatile British pound is bound to face additional volatility this week as both Credit Suisse overnight index swaps and a Bloomberg News poll reflect expectations that the Bank of England will cut rates by another 50 basis points at 7:00 ET on Thursday to a new record low of 1 percent. This is indeed within the realm of possibilities since the UK has tipped into recession and the BOE, and UK government, anticipate that things will only get worse. In fact, Bank of England Monetary Policy Committee Member David Blanchflower, who is easily the most outspoken and dovish member on the Committee, issued very dovish comments on January 29, saying 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 quite timely comment when you consider that Chancellor of the Exchequer Alistair Darling gave the BOE permission on the same day to buy 50 billion pounds worth of bond and commercial paper in order to alleviate tight credit conditions. Overall, this leaves the odds in favor of year another rate cut by the BOE on February 5, but the reaction of the British pound may depend on what sort of bias is reflected in the Monetary Policy Committee’s subsequent statement, as suggestions that they will leave rates unchanged next month could lead the currency to rally. On the flip side, a greater-than-expected rate cut or indications that they may eventually bring the Bank Rate to zero could weigh heavily on the British pound, especially against the euro.

Euro: European Central Bank Unlikely to Cut Rates, but Watch Trichet’s Comments

The decline in Euro-zone CPI estimates well below the European Central Bank’s 2.0 percent target, steady gains in unemployment, and increasingly pessimistic consumer and business confidence all indicate that the central bank will cut rates again. However, evidence suggests that the ECB will wait until March 5, and this is exactly what a Bloomberg News poll of economists is forecasting as well. Indeed, after the ECB cut rates to a record low of 2.00 percent on January 15, Mr. Trichet said that the next "important" meeting would be in March when they release new projections for growth and inflation, suggesting they have no plans to adjust interest rates in February. However, he refused to call 2 percent the lower limit for interest rates, leaving the door open to further reductions in coming months. As a result, the 7:45 ET announcement may not garner as much attention as ECB President Jean-Claude Trichet’s post-meeting press conference at 8:30 ET. Mr. Trichet is one of the most opinionated central bank chiefs around, and suggestions that the ECB will continue to cut rates have the potential to lead the euro far lower. On the other hand, if the ECB signals that they may leave rates unchanged during their next meeting, the currency could actually rally.

Commodity Dollars Struggle to Hold on to Gains, Canadian Dollar Faces Ivey PMI on Thursday

The commodity currencies saw a volatile day of trading but ultimately ended the day down against the US dollar as risk appetite remains weak.. Data released last night showed that Australian Retail Sales jumped 3.8 percent in December, the most in over 8 years as holiday shopping helped boost spending at department stores.

Looking ahead though, the Canadian dollar could come under pressure as Ivey PMI will likely continue to show a further contraction in business activity as the nation grapples with a recession in the US and ever-declining commodity prices. The index is forecasted to hold below 50 for the third straight month in January at 40.0, up from 39.1. If this reading proves to be disappointing, the Canadian dollar could pull back and push USD/CAD up above 1.2350. On the other hand, a surprising rise in PMI above 50, which would signal a resurgence in business activity, could lead the Loonie to jump.

Terri Belkas is a Currency Strategist at FXCM.