US Dollar, Japanese Yen Driven Higher Amidst Broad-Based Risk Aversion

Risk aversion was alive and well throughout the financial markets at the start of the week, contributing to gains for the low-yielding US dollar and Japanese yen, increased demand for Treasuries, and declines in “risky” assets that equities and oil. Indeed, concerns about the swine flu outbreak in Mexico and subsequent announcements that the flu has spread throughout a few US states, including New York, led to considerable weakness for travel, energy and hotel shares but also highlights the fact that some market event risk just cannot be anticipated. Ultimately, the FX market moves kept the DXY index within its uptrend, as the greenback bounced from trendline support, and helped the Japanese yen break higher against many currencies, including the euro and British pound.

Adding to the mix, the Japanese government said overnight that it has reduced its growth forecast for the economy down to -3.3 percent in the year to next March, down from previous estimates of zero growth, as the nation feels the impact of plunging export demand. The Cabinet Office said that downside risks remain "over the outlook for the stabilization of the global financial system as well as the economy."

Looking ahead to Tuesday, the Conference Board’s consumer confidence index for the month of April is forecasted to continue creeping higher from its record low of 25.3 reached in February up to 29.9. With record keeping having begun in 1967, the steady plunge in sentiment from the 2007 highs of 111.90 makes the extent of the recession especially clear. Nevertheless, a surprisingly strong result could provide a boost to risky assets, as the move would indicate that sentiment may have bottomed out. However, if consumer confidence goes little changed or rises right in line with expectations, the news is unlikely to evoke any reaction from the markets.

British Pound Falls as UK Mortgage Approvals Drop 25% from a Year Ago

On Friday we noted that the GBP/USD consolidation within a rising wedge (on the hourly charts) suggested that price could fall in the near-term, and this is exactly what we saw on Monday as the pair dropped for a test of 1.4525. Indeed, the British pound fell against the US dollar and Japanese yen – the strongest of the majors – but actually held up rather well against the rest of the majors, especially the ultra-weak euro and Australian dollar. Fundamental news remains bearish after last week’s release of Q1 GDP for the UK showed that the economy contracted for the third straight quarter, this time at a rate of -1.9 percent. This was the worst drop since 1979, and the plunge dragged the year-over-year rate down to match the Q4 1980 low of -4.1 percent.

On Monday, the British Bankers’ Association (BBA) said that banks approved 26,097 mortgages in March, down from 28,024 the month prior, and all told, the decline leaves mortgage approvals down 25 percent from a year earlier. There won’t be much in the way of event risk for the British pound on Tuesday, so traders may be better off looking to risk trends. Focusing on GBP/JPY in particular, the pair’s break below trendline support suggests further declines may be in store, though immediate support looms at the 50 SMA at 141.15.

Euro Driven Lower as ECB’s Trichet, Nowotny Signal Credit Easing Announcement on May 7

The euro fell hard on Monday, losing 2 percent against the Japanese yen and 1.6 percent versus the US dollar. While the currency experienced gradual declines throughout the European trading session and start of the New York trading session, the sharpest moves occurred around 13:00 ET when European Central Bank (ECB) Governing Council member Ewald Nowotny said that the ECB will keep rates very low as long as required, and that they stand ready to use “unconventional” measures, suggesting that the ECB could announce credit easing efforts during their next meeting on May 7. Adding to evidence of this, ECB President Jean-Claude Trichet said that the view that “monetary policy is the more effective response to a downturn” is “too simplistic," and that by comparing “only the levels of policy rates without consideration of the resulting market rates and other economic variables is looking at just one part of a far broader canvas.”

Meanwhile, signs of deflation continue to emerge as the German import price index fell more than anticipated at a rate of 0.4 percent in March, bringing the annual rate down to a nearly 22-year low of -7.1 percent. The declines were led by energy prices, but an appreciation of the euro against the US dollar and British pound during the survey period likely contributed to the drop as well. As we mentioned last week, the annual rate of CPI growth Spain and Portugal 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.

Terri Belkas is a Currency Strategist at FXCM.