The US dollar and Japanese yen ended yesterday lower against most of the majors, but for what it's worth, most of the major currency pairs have simply consolidated gains or losses from Monday. In economic news, the National Association of Realtors (NAR) reported that US pending home sales fell more than expected at a rate of 7.7%, but as one of the most lagging indicators of conditions in the housing sector, there wasn't much in the way of reaction to this release. Instead, risk trends remained the primary drivers of price action for the US dollar and Japanese yen. Ultimately, investor confidence remained on edge after Federal Reserve chairman Ben Bernanke said during testimony on the US economy and budget that the US may need to expand the $700 billion bank rescue fund as they have "clearly" not stabilized the banking system. Bernanke went on to say that rescuing AIG made him "more angry" than any other bailout, but that the Federal Reserve's goal is to make the company viable enough to pay back issued rescue funds.
Looking to Wednesday, conditions in US non-manufacturing sector—which accounts for approximately 70% of total economic activity in the country and includes retail, services, and finance—are anticipated to have worsened in February as the Institute for Supply Management (ISM) index is estimated to fall to 41.0 from 42.9, which is just above the record low of 37.4 reached in November. Indeed, consumer confidence remains exceptionally weak, as the Conference Board's measure fell to a record low of 25.0 during the same month. We already know that the US economy fell into recession in December 2007, but this data will help to gauge how long the recession will drag on. Since risk trends have proven to be the greater drivers of price action in the forex markets, a weaker than expected result could trigger flight-to-quality, and thus, gains for the US dollar. Meanwhile, a surprisingly strong result could boost equities and weigh on safe-haven assets.
Euro, British Pound Continue Trading Above Key Support Levels
Both the euro and British pound finished Tuesday up against the greenback, but in reality, the gains were so small that it is deceiving to say the currencies had a strong day. Instead, we've simply seen EUR/USD consolidate above 1.2550, while GBP/USD has consolidated above 1.4000, and where these pairs go next may hinge upon whether or not the US dollar rally can accelerate. Speculation over upcoming rate decisions by the European Central Bank and Bank of England on Thursday could also impact price action in these pairs. The decline in euro zone CPI estimates well below the ECB's 2.0% target, steady increases in unemployment, and increasingly pessimistic consumer and business confidence all suggest that the central bank will cut rates by 50 basis points to 1.50%. As a result, the 7:45 ET announcement will garner quite a bit of attention, but traders should also look to Trichet's post-meeting press conference at 8:30 ET. Trichet is one of the most opinionated central bank chiefs around, and suggestions that the ECB will continue to cut rates have the potential to lead the euro far lower. Meanwhile, the Bank of England is expected to cut rates by another 50 basis points at 7:00 ET on Thursday to a new record low of 0.50%. This is indeed within the realm of possibilities given the exceptionally dovish commentary we've been hearing from BOE officials lately.
Looking to Wednesday, the Purchasing Managers' Index (PMI) for the UK's services sector is expected to have fallen to 41.9 in February from 42.5, as the index holds near the record low of 40.1 reached in November. This will mark the tenth straight month that PMI held below 50, signaling a continued contraction in business activity for the services sector, as well as a deepening recession for the UK. Ultimately, the data may only be market moving for the British pound if PMI hits a new record low.
Canadian Dollar Tumbles Following BOC Rate Cut on Potential for Further Reductions, Quantitative Easing
The Canadian dollar plunged following the Bank of Canada's rate decision, as they reduced their overnight target rate in line with expectations by 50 basis points to a record low of 0.50% and indicated that the Bank may cut rates further and implement quantitative easing measures. Indeed, the BOC's monetary policy statement said that "the target for the overnight rate can be expected to remain at this level or lower at least until there are clear signs that excess supply in the economy is being taken up," and because the overnight target rate was already so low, "the Bank is refining the approach it would take to provide additional monetary stimulus, if required, through credit and quantitative easing. In its April Monetary Policy Report, the Bank will outline a framework for the possible use of such measures."
Australian Dollar Strong as RBA Signals Neutral Stance, Doesn't Cut Rates
The Australian dollar was among the strongest of the major currencies on Tuesday after the Reserve Bank of Australia unexpectedly left rates unchanged at 3.25% last night. The Reserve Bank Board noted in their policy statement that, "demand has not weakened as much as in other countries and, on the basis of currently available information, the Australian economy has not experienced the sort of large contraction seen elsewhere." Furthermore, the Board left no indications that they felt the need to cut rates later on, which is much of the reason why the Australian dollar has rallied so much. Overall, the RBA's rate decision and remarks on the economy suggest that tonight's release of GDP will reflect relatively stable growth. According to a Bloomberg News poll, economists are forecasting that GDP in Australia picked up slightly by 0.2% during Q4 versus 0.1% in Q3, though the annual rate is anticipated to have slowed to a more than seven-year low of 1.2% from 1.9%. However, if GDP unexpectedly falls negative, the currency could fall sharply as the data could change the RBA's policy bias to a more neutral one going forward.
By Jamie Saettele, senior currency strategist, DailyFX.com
