US Dollar, Japanese Yen Trading Above Key Support Levels - Watch Status of Risk Appetite

The US dollar and Japanese yen both came under pressure on Thursday as demand for “risky” assets increased. From a technical perspective, we saw the DXY index end the day just above a trendline connecting the March and April lows, as well as the 38.2 percent fib of 82.64-86.86 at 85.26. Likewise, almost all of the Japanese yen crosses, such as USD/JPY, EUR/JPY, and GBP/JPY, are trading just above critical support at trendlines connecting the 2009 lows. As a result, the status of investor sentiment over the next 24 hours is incredibly important, as a return to risk aversion could send both the US dollar and Japanese yen spiraling higher.

On Friday, signs that domestic demand is showing no sign of recovery should continue to emerge as US Durable Goods Orders are forecasted to have dropped 1.5 percent in March and even excluding transportation is anticipated to fall 1.2 percent. All told, this would mark a return to disappointing results after the index surprisingly rose 3.5 percent in February, and while this will have the most impact on forex trading, the markets should keep an eye on non-defense capital goods orders excluding aircraft, as this number serves as a leading indicator for business investment. The 3-month annualized figure has fallen sharply over the past few months, and combined with the weak outlook for the headline reading, the news could weigh on risk appetite and subsequently provide a boost to the US dollar, thanks to increased flight-to-quality. On the flip side, surprisingly strong results could provide a boost to carry trades, and thus weigh the greenback down.

British Pound Dominates - UK Q1 GDP Could Weigh Heavily on Friday

The British pound was the biggest gainer on Thursday, helping GBP/USD to break above 1.4700. However, the tide could turn for the currency on Friday as the 04:30 ET advanced reading of Q1 GDP for the UK is forecasted to contract for the third straight quarter at a rate of -1.5 percent, the worst drop in nearly 29 years, which could drag the year-over-year rate down to match the Q1 1981 low of -3.8 percent. The UK has been hit particularly hard by the credit crunch, especially since the country became one of the biggest financial centers in the world. This has translated into a full-on collapse of the housing market, climbing job losses, and weak consumption. Furthermore, with growth slowing around the world, demand for British exports has declined as well, putting a large burden on manufacturers. Overall, a greater-than-expected decline could lead the British pound lower as the data would raise the odds that the Bank of England will expand their quantitative easing efforts. On the other hand, if GDP is a bit better than forecasts, the currency could surge.

Euro Gains as Euro-zone PMI Reflects Surprisingly Strong Results - What About Deflation?

The euro made solid headway against the US dollar and Japanese yen on Thursday, but fell against the British Pound, commodity dollars, and Swiss franc. Economic news provided a positive surprise, for once, as the Purchasing Managers’ Index (PMI) for the Euro-zone’s services and manufacturing sectors improved more than anticipated in April, rising to 43.1 from 40.9 and to 36.7 from 33.9, respectively. All told, these moves pushed the composite measure up to a six-month high of 40.5 in April from 38.3. While this is a positive development, this marked the eleventh straight month that PMI held below 50, signaling a further contraction in activity, albeit at a slower pace.

The outlook for the Euro-zone otherwise remains relatively bleak, and while European officials have consistently said that they don’t see a risk for deflation in the region, evidence may suggest the opposite. In Spain and Portugal the annual rate of CPI growth fell negative during March, and in Ireland, the annual rate has held negative for the past three months. However, with inflation growth still holding positive in larger member countries like Germany and France, headline CPI numbers for the Euro-zone as a whole have held positive as well. The ECB has said in the past that they expect CPI to fall negative later in the year, and once those figures come to fruition, deflation concerns may become more widespread.

Canadian Dollar Surges as Bank of Canada Leaves Door Open to QE If Nominal Interest Rates Fall Negative

The Canadian dollar was the second strongest of the majors, leading USD/CAD to fall sharply from a region of resistance at 1.2379-1.2495. Canadian retail sales unexpectedly rose 0.2 percent in February, suggesting that consumers haven't been entirely deterred by soaring job losses and slowing business activity. The bigger market-mover, though, was the Bank of Canada's Monetary Policy Report, as they left the door open to quantitative easing (QE) and credit easing if nominal interest rates start to fall below zero. Indeed, the Bank stated that while they could cut rates to zero in theory, it would ultimately "eliminate the incentive for lenders and borrowers to transact in markets, especially in the repo market." As a result, inflation reports will be key to gauging whether or not the Bank of Canada will go the route of QE, but with total CPI at 1.2 percent (YoY) and the Bank's core CPI at 2.0 percent (YoY), there doesn't seem to be potential for such measures in the near-term.

Terri Belkas is a Currency Strategist at FXCM.