US Dollar Mixed as Obama Announces Housing Program, Fed Releases Bleak Economic Outlook

The US dollar saw a mixed day of trading on Wednesday, gaining against the euro, Swiss franc, and Japanese yen while falling versus the commodity bloc. Based on broad losses for the Japanese yen, the moves signaled slight improvements in risk appetite. There was a flurry of economic releases, as well as news from President Obama and the Federal Reserve. First, US housing starts and building permits both fell by more than 50 percent in January from a year earlier to their lower levels ever, with record keeping having begun in 1955. At the same time, import prices fell negative for the sixth straight month in January while the annual rate hit a fresh record low of -12.5 percent, thanks to a stronger US dollar and lower commodity costs. Additionally, industrial production contracted for the third straight month at a rate of 1.8 percent while capacity utilization hit a nearly 26-year low of 72 percent, as manufacturers slashed output on the back of waning demand.

Meanwhile, President Obama announced a $275 billion program that will move to cut mortgage payments by matching reductions lenders make to interest payments to 31 percent of the borrower’s monthly income. The Treasury will also buy up to $200 billion of preferred stock in Fannie Mae and Freddie Mac, and detailed guidelines are due to be released on March 4. Finally, the Federal Open Market Committee's (FOMC) meeting minutes from January yielded few surprises, but in an effort to be more transparent, the central bank started to issue longer-term forecasts for growth, unemployment, and inflation. FOMC members apparently discussed on January 16 the prospect of creating an inflation target, and while they did not make a decision, today's press release shows that many FOMC members "judged that a longer-run PCE inflation rate of 2 percent would be consistent with the dual mandate," which is in line with the inflation targets of other central banks, such as the Bank of England and European Central Bank. Another notable factor was that “some FOMC members saw some risk for deflation,” which is a timely comment because Friday's release of US CPI is forecasted to fall negative for the first time since 1955.

Looking ahead to Thursday, signs of deflation may continue to emerge at 8:30 ET as the US Producer Price Index (PPI) is forecasted to rise a slight 0.3 percent in January, while the annual rate may tumble to a nearly 7-year low of -2.4 percent. Meanwhile, the measure that excludes volatile food and energy costs could slow to an annual pace of 3.8 percent from 4.3 percent. Overall, the news would suggest that input costs are falling dramatically with declining commodity prices, which should translate into lower consumer prices. At 10:00 ET, the Conference Board’s US leading indicator for the month of January is forecasted to fall flat, after rising 0.3 percent in December. However, any strength in the index may be contained to M2 money supply as a result of the Federal Reserve’s efforts to boost liquidity. As a result, the headline reading may ultimately be deceiving and it will be important to look at the breakdown as well, including the components gauging average workweeks, jobless claims, consumer goods orders, orders for non-defense capital goods, and building permits. At the same time, the Philadelphia Fed index for the month of February could slump to -25.0 from -24.3, but if the report fares as the Empire Fed index, it could break below the November lows of -39.8. Indeed, the US manufacturing sector has been hit particularly hard by the recession, as both domestic and foreign demand has fallen.

Euro Consolidates Losses, British Pound Remains Range Bound Despite BOE Minutes Signaling BOE Buying of Gilts

The euro and the British pound both drifted lower for much of the day Wednesday, with EUR/USD consolidating losses after breaking below key support at 1.2725 on Tuesday while GBP/USD remains contained to a tight range of 1.4150 - 1.4300. There were few key European economic releases, though data showed that Euro-zone construction output failed to rise for the tenth straight month during December. However, the British pound faced major event risk on the release of the minutes from the Bank of England’s February meeting, and immediately plunged to the bottom of its latest trading range. The minutes showed that all Monetary Policy Committee (MPC) members voted for a cut, though David Blanchflower dissented in favor of a more aggressive 100 basis point cut (the BOE only cut by 50 basis points to 1.00 percent), but the more notable factor was that all MPC members agreed that BOE Governor Mervyn King should ask Chancellor of the Exchequer Alistair Darling for permission to buy gilts in order to boost money supply. At the same time, the MPC suggested that they may avoid cutting rates to zero since it may discourage lending as bank profit margins would be cut dramatically. By the end of the day, UK gilt yields tumbled amidst prospects for lower interest rates, and with the odds increasing for additional rate cuts by the BOE, there is still potential for GBP/USD to break below noted support at 1.4150.

Japanese Yen Down as Carry Trade Gain, Threat of Risk Aversion Lingers Ahead of BOJ Rate Decision

As mentioned in the US dollar section, the Japanese yen ended Wednesday broadly lower, signaling at least a slight improvement in sentiment. However, event risk will pick up overnight, leaving the currency prone to volatility. The Bank of Japan is widely expected to leave rates unchanged overnight at 0.10 percent, but subsequent commentary will be watched closely for clues as to where the central bank thinks the economy and financial markets are headed next. As we saw on Sunday, the Japanese economy contracted in Q4 by the most since 1974 as exports fell a record 13.9 percent, and things are only expected to get worse. However, with few options available for dealing with the economy, the Japanese government and BOJ have been trying to grapple with liquidity issues. Currently, the BOJ is buying corporate debt and banking shares in an attempt to get them to lend, while the ruling Liberal Democratic Party proposed issuing zero-interest bonds last week in return in exchange for a cut to future inheritance taxes so that they can fund stimulus measures. Overall, the rate decision shouldn’t be hugely market-moving, though extremely dour forecasts or signs of concerns about the appreciation of the Japanese yen could spur volatility.

Terri Belkas is a Currency Strategist at FXCM.