US Dollar, Japanese Yen Surge as Geithner’s Lack of Clear Policy Actions Stoke Risk Aversion

The US dollar and Japanese yen rocketed higher on Tuesday due to a jump in risk aversion, a threat that has continued to linger in the markets for months. The driver? Comments by Treasury Secretary Tim Geithner and Federal Reserve Chairman Ben Bernanke failed to suggest that a quick fix for the woes in the credit market was in the works. The reality of the situation is that there is no silver bullet to reverse the damage done to the financial markets, and instead, it will take a significant amount of time to even begin to see a semblance of true stability. Indeed, Mr. Geithner's speech provided more of a broad outline for policy actions, rather than clear cut plans.

The first goal was to enact regulations in which banking institutions would have to go through comprehensive stress tests and would subsequently receive capital if needed with a facility that uses funds from the Treasury as a “bridge to private capital.” The second goal was to establish a Public-Private Investment Fund, which would target toxic assets and provide a mechanism for valuing them. The third goal was to expand the Federal Reserve’s Term Asset Backed Securities Loan Facility (TALF) in order to create the Consumer and Business Lending Initiative, which should lower borrowing costs and improve access to small business lending, student loans, consumer and auto finance, and commercial mortgages. Finally, Mr. Geithner said that President Obama’s economic team will formulate and announce a comprehensive plan to address the housing crisis over the next few weeks. Meanwhile, Mr. Bernanke's speech focused primarily on the Federal Reserve’s efforts to improve transparency of their various lending facilities, but there was little in the way of new information announced.

Looking ahead, a series of speeches and testimony are scheduled for Wednesday starting with Federal Open Market Committee (FOMC) Governor Elizabeth Duke at 9:50 ET, who will speak in New York on stabilizing the housing market. At 10:00 ET, Treasury Secretary Timothy Geithner will testify on TARP in front of the Senate Budget Panel. At 13:00 ET, Chicago Fed President Charles Evans will speak on the US economic outlook. For the most part, comments by these individuals should be innocuous for price action in the forex markets. However, any sort of biased commentary or extreme opinions on the outlook for the economy has the potential to impact risk sentiment and thus forex carry trades, with improved risk appetite likely to weigh on the US dollar and Japanese yen while benefiting high-yielding currencies like the Australian dollar and New Zealand dollar.

British Pound Tumbles Ahead of Bank of England’s Quarterly Inflation Report

The British pound fell hard on Tuesday, as did all “risky” assets, following the market’s disappointment in speeches by Treasury Secertary Geithner and Federal Reserve Chairman Ben Bernanke spurred flight to quality. Meanwhile, the British pound may encounter additional bearish pressure on Wednesday as jobless claims in the UK are anticipated to rise for the twelfth consecutive month in January, adding to evidence that the combination of a slowing global economy, sharp declines in domestic consumption, and the continuous collapse of the UK housing sector are bound to make the UK economic contraction extend for a lengthy amount of time. Indeed, the jobless claims change is anticipated to rise by 88K, the largest single-month gain since 1991, and while this could impact the British pound upon release at 4:30 ET, the announcement of the Bank of England’s Quarterly Inflation Report at 5:30 ET may be more important. The BOE’s latest policy statement suggests that the Monetary Policy Committee may opt to leave rates unchanged at 1 percent going forward, but if the report shows that this isn’t the case, the British pound could sell-off.

Euro Slides But Holds Within Defined Trading Ranges as EU Signals Coordinated Plans for Banks

The Euro initially started the European and US trading sessions on a strong note as European Union finance ministers agreed that they should coordinate efforts to clear toxic assets off of their bank’s balance sheets. However, the euro subsequently reversed course as a pick up in risk aversion led nearly every major currency to fall against the US dollar and Japanese yen. Focusing on the EU’s plans, the European Central Bank released a statement noting that finance ministers wished to maintain level playing field and wanted to avoid an influx of protectionist measures. EU Monetary Affairs Commissioner Joaquin Almunia also said that they intend to publish, perhaps by the end of the month, “a clear framework for the evaluation of the assets, for the list of assets eligible for these schemes, for the conditionality of those banks who will get support, for purchases of impaired assets and for restructuring when needed.”

Ultimately, EUR/USD remains within relatively well-defined trading ranges on a short-term and medium-term basis despite the fact that Tuesday’s price action reflected high volatility. This leaves breakout potential open, so it will be increasingly important to keep an eye on risk trends as well as key technical levels, such as support at 1.27 and resistance at 1.32.

Terri Belkas is a Currency Strategist at FXCM.