US Dollar, Japanese Yen End on Mixed Note as Bernanke Testimony Reflects Cautious Optimism

Trading in the FX market remained very choppy on Tuesday, as the only notable moves came from the ascent of the New Zealand dollar and British pound, and the drop in the euro and Swiss franc. The US dollar and Japanese yen, on the other hand, ended the day on a very mixed note, though the DXY index did manage to recover from the 04/06 and 05/04 lows of 83.72/69. Looking to US-related news, ISM non-manufacturing for the month of April rose more than expected to 43.7 from 40.8, which is the seventh month that the index held below 50, signaling a contraction in activity. A breakdown of the report showed that new orders and employment experienced some of the sharpest improvements, while prices are still falling.

Meanwhile, Federal Reserve Chairman Ben Bernanke said during his testimony in front of the Joint Economic Committee at 10:00 ET that the housing market has shown "some signs of bottoming" and that the pace of the economic contraction "may be slowing," adding that activity could "turn up later this year." However, Bernanke noted that business investment remains "extremely weak" as spending on equipment and software fell at an annual rate of about 30 percent in both the fourth and first quarters, suggesting that businesses foresee a longer-term need for reduced output. Furthermore, Bernanke said that the Fed's forecast assumes that the financial system will continue to gradually improve, and that "a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall."

There won’t be any huge market-moving reports from the US on Wednesday, though many will likely look to the ADP employment change as a gauge of how Friday’s US non-farm payrolls (NFPs) report may fare. The ADP report is projected to show that private sector job losses amounted to 645,000 in April, down from 742,000 in March, which would suggest that NFPs may reflect fewer job losses as well.

British Pound Continues Rally Above 1.50 As UK Construction Data Improves

The British pound was one of the strongest major currencies on Tuesday, furthering its break above 1.50 versus the US dollar, after the Purchasing Managers’ Index (PMI) for the construction sector rocketed to 38.1 in April from 30.9, beating forecasts for a slight rise to 31.9. This optimism could continue on Wednesday as conditions in the UK services sector are anticipated to have improved. PMI for the sector is expected to have risen to 46.3 in April from 45.5. While this would mark the twelfth straight month that PMI held below 50 – signaling a contraction in activity – it would also be the fifth consecutive increase from the record low of 40.1 reached in November, suggesting that the UK recession is slowing down. There seems to be some potential for a surprisingly strong result since both construction and manufacturing PMI proved to beat forecasts, and as a result, there is some upside potential for the British pound on Wednesday morning. On the other hand, weaker-than-expected results could weigh on the currency.

Australian Dollar Likely to Target 0.75, Canadian Dollar to Face Ivey PMI on Wednesday

The Australian dollar has continued to strength after the Reserve Bank of Australia (RBA) left their cash target rate at 3.00 percent, as expected. As DailyFX Analyst Ilya Spivak noted this morning, RBA Governor Glenn Stevens noted in his monetary policy statement “signs of stabilization” in the global growth, singling out positive developments in the Chinese economy in particular, while also saying that financial markets are “on a path of gradual improvement.” However, Stevens added a dovish tone, saying that the bank will monitor global and financial conditions in assessing the need for “further reductions”. With carry trades continuing to make headway, though, AUD/USD seems like to target the psychologically important 0.7500 mark or the 61.8 percent fib of 0.8524-0.6007 at 0.7562 in the near-term.

Looking ahead to Wednesday, the release of the Ivey Purchasing Managers’ Index (PMI) is projected to show that Canadian business activity slowed during April, as the index could slip to 40.8 from 43.2. This would be the sixth month that PMI held below 50, indicating a contraction in activity, but there really hasn’t been a very clear trend since the index fell to those levels in November 2008. Indeed, in the grand scheme of things, the Canadian economy was one of the last to be hit by the global slowdown, even though it is largely dependent upon trade with the US, which fell into recession in December 2007. Nevertheless, disappointing results could help USD/CAD to continue the pair’s bounce from the 50 percent fib of 1.0299-1.3065 at 1.1684, while a better-than-expected result has the potential to lead USD/CAD even lower following its break below the 200 SMA on Monday.

Euro Backs Off From Monday’s Highs - Bullish Potential Remains

The euro fell across the majors as EUR/USD backed off from a test of Monday’s highs near 1.3435. For the most part, EUR/USD has been moving in sync with the S&P 500, which ended the day down 0.38 percent (EUR/USD ended down 0.50 percent). The currency faces minimal event risk over the next day, but if investor sentiment improves and EUR/USD can push above the noted highs, the pair could easily climb toward the 200 SMA at 1.3507. The euro may see major volatility on Thursday though, as the European Central bank will meet. According to a Bloomberg News poll of economists and Credit Suisse overnight index swaps, the ECB will cut rates by 25 basis points to 1.00 percent on Thursday morning. A reduction in line with Bloomberg's estimates could exert bearish pressures on the euro, but where the currency ends the day may have more to do with what ECB President Jean-Claude Trichet says during his post-meeting press conference at 08:30 ET. Many ECB members have indicated that they will announce “unconventional” measures following this meeting, which many have taken to mean credit easing, and if Trichet makes such an announcement, the euro could tumble. On the other hand, if the ECB leaves rates unchanged, indicates that they have no intention of bringing interest rates lower in the near term, or if they put off credit easing, the euro could rally.

Terri Belkas is a Currency Strategist at FXCM.