US Dollar Plummets as US Assets Lose “Safe Haven” Luster, Japanese Yen Mixed Ahead of BOJ Announcement

The combination of the plunge in the US dollar and Treasuries, vast drops in FX carry trades, the equity markets, and oil, along with a jump in the CBOE’s VIX volatility index tells us one thing: the greenback and US assets in general may be losing their luster as “safe haven” assets. Following S&P’s downgrade of the UK’s economic outlook from “stable” to “negative” due to “deteriorating public finances,” there has been increased discussion of the same thing happening to the US as national debt levels soar in light of the government’s efforts to bail out Main Street and Wall Street. However, the Japanese yen did, to a certain degree, maintain its link with risk trends.

Meanwhile, the release of the US Labor Department’s jobless claims report reflects very little change in the employment outlook, as initial claims fell by 12,000 during the week ending May 16 to 631,000 while continuing claims jumped by 75,000 during the week ending May 16 to another record high of 6,662,000. Indeed, these moves suggest that while the pace of job losses, as reflected by non-farm payrolls (NFPs, will slow further, the unemployment rate is likely to continue climbing higher. This was something projected by the Federal Reserve during their April policy meeting, as the FOMC meeting minutes showed that the range of forecasts shifted from 8.0 percent - 9.2 percent up to 9.1 percent - 10 percent.

In more positive news, the Conference Board’s leading economic index jumped 1.0 percent in April, the first increase since June 2008 and the biggest increase since November 2005. The improvement was led by components such as average workweek, jobless claims, consumer goods orders, stock prices, interest rate spread, and consumer expectations. Also, the Philadelphia Fed’s manufacturing activity index rose to -22.6 in May from -24.4, signaling a slower contraction.

Looking ahead to Friday, there will be very little in the way of US event risk ahead of Monday’s US Memorial Day holiday and market closure. That said, RSI on the daily charts of the DXY index has fallen into oversold territory, and when this happened in December 2008 and March 2009, we subsequently saw price bounce higher. As a result, there is potential for the greenback to stage a recovery versus the majors in the near-term, though it could ultimately be short-lived. For the Japanese yen, traders will see the release of the Bank of Japan’s rate decision, and they are widely anticipated to stay neutral at 0.10 percent. The thing to watch will be the BOJ’s economic outlook, as indications that the recession is nearing an end could offer a boost to FX carry trades overnight.

Euro, British Pound Rally Continues Despite UK Outlook Downgrade by S&P

The British pound fell sharply this morning versus most of the majors, pushed GBP/USD down roughly 250 points toward 1.5550 and EUR/GBP up over 150 points toward 0.8850 on news that S&P lowered its outlook on UK debt to “negative” from “stable,” but ultimately affirmed their long-term credit rating at AAA. Negative news for the currency also came from the UK’s Office for National Statistics, which said that business investment contracted for the third straight quarter in Q1 at a rate of -5.5 percent, marking the steepest drop since Q1 2004 when investment plunged 21.38 percent. A breakdown of the report shows that manufacturers and non-manufacturers alike cut back on their investments, though construction firm reductions were less than in recent quarters at -9.0 percent. Ultimately, a lack of investment indicates a lack of confidence in future demand and the potential for further job cuts down the line. Positive news came in the way of a 0.9 percent rise in UK retail sales for the month of April, the second straight increase.

By the time the US trading session got going, though, a steady and steep plunge in the US dollar across the majors propelled both GBP/USD and EUR/USD above Wednesday’s highs while EUR/GBP eased back down toward 0.8750. Now, daily charts of GBP/USD show that RSI is in overbought territory while EUR/USD is nearing that point, suggesting we could see reversals in the near-term, though another spike higher may not be out of the question.

Looking ahead to Friday, UK GDP for Q1 is projected to go unrevised at a nearly 30-year low of -1.9 percent, while the annualized rate should hold at a 28-year low of -4.1 percent. If these figures are downgraded in any way, the British pound’s rally could easily be cut short, while readings in line with forecasts should have too much of an impact on price action. According to the Bank of England’s median growth projections published in the latest Quarterly Inflation Report, GDP may be posted at -4.72 percent in Q2, -4.54 percent in Q3, and -3.20 percent in Q4. These forecasts are based on interest rates staying on 0.50 percent and a continuation of the BOE’s 125 billion pound quantitative easing (QE) program, but if the growth outlook starts to deteriorate further, there’s no stopping the BOE from considering expanding their QE program further.

Canadian Dollar Could Break Recent Highs vs. US Dollar on Canadian Retail Sales Report

USD/CAD continued its consolidation above 1.1350 on Thursday, and on Friday morning the release of Canadian retail sales could offer a boost to the Loonie as spending is anticipated to have risen for the third straight month in March at a rate of 0.5 percent. Indeed, Canadian data has generally been better-than-expected latest, as the Canadian economy surprisingly added on employees during April and Ivey PMI rose above 50 – signaling an expansion in business activity - for the first time since October 2008. If the indicator rises in line with or more than expectations, the Canadian dollar could rally, but if retail sales actually fall, the currency could tumble.

Terri Belkas is a Currency Strategist at FXCM.