US Dollar, Japanese Yen Recoup Some Losses as US Stocks Fall to Lowest Levels Since 1997

The US Treasury, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and the Federal Reserve issued a joint statement this morning clarifying some of the government’s plans, as first discussed by Treasury Secretary Tim Geithner on February 10. Like Geithner’s speech, the announcement did little to boost investor sentiment as the S&P 500 and Dow Jones Industrial Average bother closed at their lowest levels since 1997. While the US dollar and Japanese yen did end the day lower across most of the majors compared to Friday’s close thanks to sharp declines on Sunday, they strengthened throughout most of the New York trading session. The joint statement tried to suggest that the government had no intentions to nationalize banks, as it said that “the strong presumption of the Capital Assistance Program is that banks should remain in private hands.” Nevertheless, the government is clearly stepping up their intervention efforts, noting that it would evaluate institutions to see if they are sufficiently capitalized, and if they are not the government will offer a “temporary capital buffer” in exchange for convertible preferred shares for banks that were are not able to build a buffer with capital from private sources. As mentioned in our Forex Weekly Trading Forecast, the outlook for the US dollar hinges upon where the DXY index goes next, as price could go higher for a bullish break above the 2008 highs, or a bearish drop below trendline support near today’s lows.

Looking ahead to Tuesday at 10:00 ET, the Conference Board’s consumer confidence index for the month of February is forecasted to reach a fresh record low of 36.0, down from 37.7. With record keeping having begun in 1967, the plunge in sentiment makes the extent of the recession even more clear. However, with Federal Reserve Chairman Ben Bernanke due to testify before the Senate on the economic and Fed policy at the same time, the consumer confidence result may have little impact on the markets. Instead, traders will be listening closely for more detailed outlooks on growth, unemployment, inflation, and the financial markets. Bearish commentary could weigh heavily on risk appetite, and as a result it will be important to keep an eye on the link between the currency markets and stocks, as the Japanese yen hasn’t been responding as strongly to shifts in equities while the US dollar still tends to benefit from flight-to-quality.

Euro Rally Loses Steam as Risk Appetite Dissipates During US Trading Session

The euro rallied on Sunday, only to retrace the move and end Monday lower as a brief pick up in risk appetite – as evidenced by a jump in US stock market futures during the European trading session – was followed by a reversal lower. There was little in the way of European news on hand, but a speech by European Central Bank President Jean-Claude Trichet did suggest that they will become more instrumental in financial regulation, as Trichet said that the financial crisis was a “loud and clear call to extend regulation and oversight to all systemically important institutions,” such as hedge funds, credit rating agencies, and the OTC derivatives market.. Looking ahead to Tuesday at 4:00 ET, the IFO index of German business confidence is forecasted to show broadly weak sentiment on the business climate (steady at 83.0, just above the record low of 82.7), current economic conditions (down to a nearly 6-year low of 84.9 from 86.8), and the outlook for growth (up to 81.1 from the December record low of 76.9). As we saw with the February 17 release of the German ZEW survey, investor confidence on the economic outlook has improved somewhat, but sentiment on current conditions continues to falter. The release of this indicator tends to be a short term market-mover for the euro, though traders shouldn’t look for follow-through during the rest of the day.

British Pound Ends Day Slightly Higher as UK’s Darling Orders Northern Rock to Lend

The British pound pulled back against the greenback after testing 1.4650 during European trading, but ultimately managed to end the day up slightly from Friday. In UK news, Chancellor of the Exchequer Alistair Darling ordered Northern Rock, which was nationalized last year, to expand lending by 14 billion pounds in order to fill a “gap” left by withdrawals by foreign-based banks. The move is meant to increase the availability of mortgages, as the credit crisis led to financial institutions holding on to as much cash as possible as fears about counterparty risks intensified. The release of the British Bankers’ Association’s (BBA) measure of mortgage lending on Tuesday morning may highlight the persistent tightness in the consumer credit markets, as mortgage approvals are likely to remains near 16-year lows.

Canadian Dollar Slumps Lower as Retail Sales Fall by Most Since 1991

The Canadian dollar fell versus the greenback on Monday as data showed that Canadian consumer spending plunged by the most since 1991. Indeed, Statistics Canada reported that retail sales fell for the third straight month at a rate of 5.4 percent, which was far worse than expectations for a 2.7 percent decline, as job losses continue to climb and the economy encounters its first recession in 17 years. As we discussed last week, cheaper oil has extremely negative repercussions for the Canadian economy as a whole. Combined with last Friday’s inflation data, which showed that the annual rate of CPI growth tumbled to a 2-year low of 1.1 percent in January, the odds remain in favor of further rate cuts by the Bank of Canada, even though interest rates are already at a record low of 1 percent.

Terri Belkas is a Currency Strategist at FXCM.