US Dollar, Japanese Yen Remain on Edge Ahead of Key US GDP Report, FOMC Rate Decision

The US dollar and Japanese yen ended Tuesday on a mixed note, but risky assets remain on edge, which may leave the odds in favor of further gains for the low-yielders. US economic data was generally better-than-expected this morning, as the pace of declines in the S&P Case-Shiller house price index slowed to -18.63 percent in February from a year earlier, up from a record low of -19.00 percent. Meanwhile, the Conference Board's consumer confidence index surged to 39.2 in April from an upwardly revised 26.9, which was significantly more optimistic than forecasts for an increase to 29.7. A breakdown of the index shows that sentiment on economic expectations improved far more than opinion on the present situation, suggesting that if consumers do not see signs of recovery for themselves in coming months, broad sentiment could fall lower once again. Finally, the Richmond Fed's manufacturing index jumped to -9 in April from -20, as shipments, new order volume, number of employees, the average workweek all contracted at a slower pace.

Looking ahead to Wednesday, there will be two big economic releases. First, the 08:30 ET advanced reading of Q1 GDP for the US is forecasted to contract for the third straight quarter at a rate of -4.7 percent, following the Q4 contraction of 6.3 percent. The National Bureau of Economic Research (NBER) has already declared that the US has been in recession since December 2007, but a plunge in GDP that is sharper than expectations will only suggest that the contraction in growth will continue to worsen. The Federal Reserve really has no room to make monetary policy more accommodative, so traders should watch for the impact of this report on equities, as a surge in risk aversion may only lead the US dollar higher despite the disappointing fundamental scenario. That said, with the Fed scheduled to announce their latest policy decision later in the day, the markets may not show any response whatsoever.

At 14:15 ET, the Federal Open Market Committee (FOMC) is widely expected to leave the fed funds target range at 0.0 percent - 0.25 percent, and this should remain the case throughout much of the year. In fact, the FOMC started saying in January that they continue “to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time,” and they went on to say something similar in March. Furthermore, the last statement highlighted that the Committee's policy focus is to support the functioning of financial markets via measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. As long as we see these sorts of statements continue to be published, the news shouldn’t be too market-moving. However, the statement could send the US dollar spiraling lower if the FOMC announces an expansion of their quantitative easing efforts, and ultimately, any news that is positive for the stock markets may be negative for the greenback (which has been trading solely as a safe-haven asset lately), and vice versa.

British Pound Contained to Range Versus US Dollar of 1.4525 - 1.4685

The British pound generally lagged against many of the majors, with the exception of the ultra-weak Australian and New Zealand dollars, but for what it’s worth, GBP/USD has simply stuck to a tight trading range of 1.4525-1.4685. In UK economic news, the CBI retail survey showed that retailers surprisingly saw positive sales, as the index rocketed up to 15-month high of +3 in April from -44 in March. The data comes on the tails of last week’s news that the UK economy contracted 1.9 percent during Q1, and suggests that while GDP results are likely to remain weak through the rest of the year, they may not reflect the drastic drops we’ve seen in recent quarters.

Euro Gains as ECB’s Bini Smaghi Writes Off Quantitative Easing, Zero Interest Rates

The euro was actually one of the stronger currencies on Tuesday, falling only against the Swiss franc, as data showed that German inflation picking up during April. According to the latest figures, the annual rate of CPI growth rose to 0.7 percent from 0.5 percent, though the monthly rate went unchanged after falling 0.1 percent in March. Meanwhile, European Central Bank (ECB) Executive Board member Lorenzo Bini Smaghi signaled that the bank may be nearing the floor for interest rates as “Bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending.” Bini Smaghi also said that quantitative easing would “make sense only when the interest rate is at zero or very close to zero,” and noted that buying corporate securities may prove a “difficult endeavor.” As a result, an increasing amount of attention is going to be paid to the ECB’s next meeting on May 7, not only because they could cut their benchmark lending rate by 25 basis points to 1 percent, but also because they’ve said that they will announce “unconventional” measures. Ultimately, there are substantial downside risks for the euro, but the EUR/USD outlook in the near-term hinges upon US dollar trends, which could be shaken up by US-related event risk.

New Zealand Dollar Outlook Hinges Upon RBNZ Rate Decision, Outlook

The New Zealand dollar was the weakest of the majors on Tuesday, as the high-yielding currency may face a rate cut on Wednesday afternoon. According to a Bloomberg News poll of economists, the Reserve Bank of New Zealand (RBNZ) is forecasted to cut rates by 50 basis points to 2.50 percent. Meanwhile, Credit Suisse overnight index swaps are pricing in at least a 25 basis point cut, but are also pricing in a 40 percent chance of a 50 basis point reduction. Based on the RBNZ’s policy statement from March, 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 said “future cuts will be much smaller than observed recently.” With growth still slowing, the financial markets not yet stable, and inflation pressures receding, the odds are in favor of a 25 or 50 basis point cut at 17:00 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.