US Dollar Stronger, Japanese Yen Mixed Ahead of Final Fiscal Stimulus Vote, G7 Meeting Feb 13-14

The US dollar surged across the majors, while the Japanese yen ended the day mixed as equities plunged throughout the day but staged a last minute rebound on reports that the US government would assist homeowners struggling with mortgages. The only thing clear right now is that there is serious indecision amongst market participants, and perhaps the biggest question mark in regards to investor sentiment is what will happens with the US fiscal stimulus bill, as the House and Senate could bring a final vote before the end of the week, which has potential to provide a big boost to risky assets and subsequently weigh on the US dollar and Japanese yen.

Data-wise, the picture looked mixed for the US on Thursday. Advance Retail Sales unexpectedly rose for the first time in seven months during January at a rate of 1.0 percent, and excluding autos, rose 0.9 percent. A breakdown shows increased spending on vehicles, electronics, food and beverages, gasoline stations, clothing stores, and internet retailers. The data suggests that aggressive discounting by retailers has helped to boost consumption, but it's also worth noting that retail sales remain down 9.0 percent from a year earlier as consumers cut back on their use of credit and the labor markets contract by the most since 1971. On the flip side, initial jobless claims for the week ending February 7 fell slightly to 623,000 from 631,000, but this is still near the highest since 1982. Likewise, continuing jobless claims for the week ending January 31 hit a fresh record high of 4,810,000 from 4,799,000, and on the housing front, the National Association of Realtors (NAR) said that median home prices fell a record 12 percent in Q4 from a year earlier.

Looking ahead, the University of Michigan’s consumer confidence survey for the month of February is forecasted to reflect the worst sentiment since 1980, as the index could dip to 60.2 from 61.2 in January. However, based on the latest release of US retail sales, there is potential for a bit of an improvement. If this is the case, the rise in the index could boost risk appetite, at least temporarily. Nevertheless, the greater risk for the forex markets rests in the hands of the status of the US fiscal stimulus. Another event to watch is the G7 meeting, which starts on Friday and goes on through Saturday, as they will reportedly discuss currencies. Hawkish comments about the Japanese yen could help drive the currency lower on speculation that the government will physically intervene, but it is worth noting that previous G7 meetings have yielded little in the way of market-moving news.

Euro to See Increased Volatility on Friday as Euro-zone Q4 GDP May Fall by Most on Record

The euro saw very choppy price action on Thursday, ending the day down against the US dollar but up against the rest of the majors, including the Japanese yen and British pound. Things could take a more broadly bearish turn for the currency on Friday though, as Euro-zone GDP will be released. In 2008, the release of Euro-zone CPI drew significant attention and sparked major volatility for the euro. However, indicators of growth have now become more important, as the European Central Bank has shifted its focus away from inflation and on to the global and regional economic slowdown. The advanced reading of Q4 GDP is forecasted to slump 1.3 percent from the previous quarter, marking the third consecutive period of contraction and the worst drop since record keeping began in 1995. Likewise, the annual measure is anticipated to fall negative for the first time ever. Such data would only raise the odds that the ECB will move to cut rates at their next meeting on March 5, which could trigger steep losses for the euro. On the other hand, better-than-expected results could provide a solid boost for the currency.

Ultimately, though, 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 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.

British Pound Remains Under Pressure as Markets Bet on BOE Rate Cuts

The British pound remained under pressure, along with other risky assets, following Wednesday’s news that Bank of England Governor Mervyn King said that the UK economy was in for a “deep recession” during opening remarks for his inflation report press conference regarding the UK economy. King was highly dovish, saying that "further easing in monetary policy may well be required.” Indeed, forecasts in the BOE’s Quarterly Inflation Report were based on market expectations for a drop in the Bank Rate to 0.75 percent by mid-year, with GDP projections showing growth remaining negative throughout 2009 followed by a rebound in 2010, while CPI is anticipated to fall well below the BOE's 2 percent target in the first half of 2009, though the outlook beyond that appears uncertain. However, the BOE’s dour outlook has led expectations to shift for the Monetary Policy Committee’s next rate decision on March 5, as some anticipate that they could slash rates to zero and signal a move to quantitative easing. There are no economic indicators for the UK due to be released through the end of the week, but traders should see continued volatility in GBP/USD, especially since the pair has been trading in line with risky assets like equities.

Terri Belkas is a Currency Strategist at FXCM.