US Dollar, Japanese Yen End Day Lower as Bernanke Optimism, Citigroup Report Boost Risk Appetite

Risk appetite was strong for much of the day, pushing the S&P 500 up 6.37 percent by the end of the day and weighing on the US dollar and Japanese yen on word that Citigroup was having its best quarter since posting a profit in 2007 and amidst reassuring comments by Federal Reserve Chairman Ben Bernanke. During a speech to the Council on Foreign Relations, Bernanke said that the US will ensure banks have sufficient capital, and urged the overhaul of rules for the biggest financial firms in order to “make the financial system as a whole better able to withstand future shocks, but also to mitigate moral hazard and the problem of too big to fail by reducing the range of circumstances in which systemic stability concerns might prompt government intervention.” Meanwhile, wholesale inventories fell for the fifth straight month in January at a rate of 0.7 percent, as businesses try to keep up with declining demand. Indeed, wholesale sales have been consistently falling negative since July 2008, which has led the inventory/sales ratio to climb from 1.06 in June 2008 to 1.30 in January 2009, suggesting that business are burdened with additional costs as they carry excess supplies.

Looking ahead to Wednesday, there will be no key US economic indicators released, leaving the forex markets to move with risk trends during the US trading session. Something that I’ve been focusing on in particular is the status of the DXY index, which has thus far managed to hold above support from the March 6 lows and a rising trendline. If we see a break below this level, the move will likely signal an important turn for the greenback across many of the majors. However, as long as the index holds above support, bullish potential remains for the US dollar.

British Pound Remains a Laggard as UK Industrial Output Hits 28-Year Low

The British pound was unable to stage any recovery and subsequently dropped for a test of 1.37 against the greenback during the afternoon. Economic news out of the UK was disappointing as UK industrial production fell more than expected a rate of 2.6 percent in January, dragging the annual rate down to a 28-year low of -11.4 percent from -9.3 percent. A bulk of the decline was due to contractions in output by manufacturers as businesses compensate for weak demand. This will likely be highlighted on Wednesday as well since the UK's trade balance is forecasted to reflect a wider deficit of 7.5 billion pounds in January from 7.367 billion pound in December as exports to the EU may have declined for the fourth straight month. The only real potential for the trade deficit to improve would be for imports to continue falling rapidly for the sixth straight month, as domestic demand wanes. Overall, if the trade deficit widens more than expected, the British pound could pull back in response as it would suggest that conditions in the UK are still deteriorating.

Euro Tests 1.28, Tumbles Lower as ECB’s Weber Signals Further Rate Cuts

The euro only ended the day slightly higher against the US dollar on Tuesday despite a surge at the start of the New York trading session up to 1.2800, as comments by European Central Bank Governing Council member Axel Weber reiterated the sentiment of ECB President Jean-Claude Trichet’s March 5 press conference and weighed on the currency. Weber said that the “bottom line” for the ECB’s main refinancing rate “should fall at 1 percent,” and went on to see that he had a “problem” with cutting the deposit rate to zero and would “prefer to leave it at 0.5 percent.” Meanwhile, ECB Executive Board member Lorenzo Bini Smaghi said that they were ready to lower interest rates to zero if economic conditions in the Euro-zone worsen and “if deflation becomes a threat.” In the end, these comments add to evidence that the ECB is open to cutting the main refinancing rate down to 1.00 percent or even 0.50 percent in coming months, but says little about what the central bank will do during its next meeting on April 2. As we’ve said repeatedly in recent days, this leaves potential open for further declines in the euro against the greenback, but because of the UK’s quantitative easing efforts, upside risks remains for the euro against the British pound.

New Zealand Dollar Could See Heightened Volatility on Expected RBNZ Rate Cut

The NZD/USD pair has spent the past few days consolidating above support at 0.4915, while Tuesday’s US trading session has shown that price hasn’t been able to break above 0.5050. However, the New Zealand dollar is likely to see heightened volatility on Wednesday as the Reserve Bank of New Zealand will announce their next rate decision at 16:00 ET. According to a Bloomberg News poll of economists, the RBNZ is forecasted to cut rates by 50 basis points to 3.00 percent. Meanwhile, Credit Suisse overnight index swaps are pricing in at least a 50 basis point cut, but are also pricing in a 68 percent chance of a 75 basis point reduction. Based on the RBNZ’s policy statement from January, the central bank is still open to making monetary policy more accommodative, but they will not seek to implement the same aggressive cuts they’ve applied in the past as they said that they would “expect any further reductions to be smaller than those seen recently.” With growth still slowing, the financial markets not yet stable, and inflation pressures receding, the odds are in favor of a 50 or 75 basis point cut at 16:00 ET on Wednesday. That said, the outlook for the New Zealand dollar will hinge upon their policy statement, as indications that they are open to further cuts could weigh on the currency. However, if the RBNZ suggests in their policy statement that they will leave monetary policy unchanged going forward, the New Zealand dollar could actually rally.

Terri Belkas is a Currency Strategist at FXCM.