Euro May See ECB Rate Cut Tomorrow, But Credit Easing is the Topic to Watch

The euro remained one of the biggest laggards on Wednesday, falling against every major but the US dollar, ahead of an expected rate cut by the European Central Bank at 7:45 ET on Thursday. A reduction in line with 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. Multiple 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.

US Dollar, Japanese Yen Down Ahead of Official US Stress Test Announcement

The US dollar and less-so the Japanese yen came under pressure across the majors, tumbling especially hard against the commodity dollars, as risk appetite picked up and sent the S&P 500 up 1.74 percent to nearly 5-month highs. The moves came following reports from Bloomberg News that Goldman Sachs, JPMorgan Chase & Co., Bank of New York Mellon Corp., Morgan Stanley, Metlife, and American Express all passed the US government's stress test. However, up to 10 of the 19 financial institutions that went through the tests are expected to require additional capital, including GMAC ($11.5 billion), Bank of America ($34 billion), Wells Fargo ($15 billion), and Citigroup ($5 billion).

Looking to US economic reports, the ADP employment change fell less than expected for the month of April and reflected 491,000 job losses, which is the least since October 2008. Meanwhile, Challenger, Gray & Christmas reported that job cuts rose by 47 percent in April from a year ago, the smallest increase since September 2008 and down significantly from the March increase of 180.7 percent and the record increase of 274.5 percent in December. Ultimately, the data suggests that this Friday’s non-farm payrolls (NFPs) could be somewhat optimistic compared to what we’ve seen in recent months, as Bloomberg News is currently calling for NFPs to fall by 600,000, down from losses of 663,000 in March and 741,000 in January.

Thursday is likely to be a very hectic day throughout the financial markets since the Bank of England and European Central Bank will both be announcing rate decision. FX traders will also need to watch for the official results of the US stress test, even though there has been quite of information leaked, which we’ve noted above. That said, if the government’s report is disappointing and suggests that more than 10 financial institutions require additional capital or if they require more than rumors have indicated, risky assets could take a heavy hit and propel low-yielders like the US dollar and Japanese yen higher. On the other hand, better-than-anticipated results have the potential to stoke demand for risky assets, including FX carry trades and equities.

British Pound Trading Below Key Resistance vs. Japanese Yen Ahead of BOE Policy Announcement

The British pound gained against the US dollar, Swiss franc, and euro on Wednesday after the Purchasing Managers’ Index (PMI) for the UK services sector was much better than anticipated, rising to an eight-month high of 48.7 in April from 45.5 and beating forecasts for only a slight rise to 46.3. However, the currency wasn’t able to break above resistance against the Japanese yen at 149/150, but with volatility likely to pick up for the British pound on Thursday, GBP/JPY could see more directional price action. At 7:00 ET, the Bank of England is expected to announce that they’ve left the Bank Rate unchanged for the second straight month at 0.50 percent. A look at the minutes from their April policy meeting showed that the MPC voted unanimously in favor of leaving the Bank Rate at 0.50 percent and to continue their quantitative easing (QE) program. They also said that there was a "high degree of uncertainty" over the amount of asset purchases that would be necessary to keep inflation at target, and if "the evidence warranted it," the Committee could reduce or expand their program. Ultimately, how the British pound responds will likely depend on the BOE’s QE stance. Signs that the BOE may increase their gilt purchases could weigh heavily on the British pound, especially against the euro, while the opposite (steady rates, no QE expansion) could provide a boost to the UK’s currency and push GBP/JPY above 150.00.

Australian Dollar, New Zealand Dollar Dominate on Increased Demand for Risky Assets

The commodity dollars were the biggest beneficiaries of a broad pickup in risk appetite, which also sent the S&P 500 up 1.74 percent. While investor sentiment has certainly been helping these currencies, the New Zealand dollar and Australian dollar will both face event risk overnight. The 18:45 ET release of New Zealand's unemployment rate is anticipated to increase for the fifth straight quarter in Q1 2009 to a more than 7-year high of 5.3 percent from 4.7 percent. The news would suggest that the New Zealand economy may have contracted for the fifth consecutive quarter, though Q1 2009 GDP results won't be released until June 25. Nevertheless, readings in line with or worse than expectations has the potential to weigh on the New Zealand dollar as traders will move to price in a 25 basis point rate cut by the Reserve Bank of New Zealand on June 10. On the other hand, surprisingly strong results could boost the commodity currency.

Then, at 21:30 ET, the Australian net employment change is forecasted fall by 25,000 during April, marking the second month of job losses. Furthermore, the unemployment rate is anticipated to have risen to a more than 5-year high of 5.9 percent from 5.7 percent. Since the employment change tends to be a very volatile release, this should have the greater impact on the Australian dollar, with a sharper than expected drop likely to weigh on the currency and an unexpected positive result likely to push it higher.

Terri Belkas is a Currency Strategist at FXCM.