US Dollar Down as Budget Deficit Hits Record, US Retail Sales on Thursday

US Dollar Down as Budget Deficit Hits Record, US Retail Sales on Thursday
The US dollar was generally a laggard on Wednesday and didn’t show much reaction to the economic news of the day. First, the US budget deficit reached a record $91.9 billion in December as higher unemployment cut into revenues and the government spent money on the economic recovery effort. That said, a report from the Federal Reserve suggests the recovery effort may be working. According to the central bank’s Beige Book Report, 10 of the 12 Federal Reserve last month said that economic conditions had improved during December. The remaining two districts, Philadelphia and Richmond, said that conditions were “mixed.” Fed districts reported “mixed conditions.” Most district banks reported that holiday shopping volumes were “slightly greater” in 2009 than the year before, but remained “far below” levels of 2007. Meanwhile, manufacturing improved or held steady in most districts, while the labor market and loan demand continued to reflect some weakness.

The upcoming release of US advance retail sales for December is projected to show that consumption rose for a third month, this time by 0.5 percent. However, given recent reports that retail sales at stores like Sears, Target, and Bed Bath & Beyond rose more than expected during the holiday season suggests that there is potential for the government’s figures to surprise to the upside. That said, this sort of news may already be priced into the market, and the bigger question going forward is if consumption will be able to gain much further in light of Friday’s US non-farm payrolls report, which showed that the economy lost another 85,000 jobs in December.

Related: Discuss the US Dollar in the DailyFX Forum, Top 5 Events for the Week of January 11

British Pound Rallies as Markets Price In End of Quantitative Easing in UK
The British pound was the strongest of the majors on Wednesday as comments from Bank of England (BOE) Monetary Policy Committee (MPC) member Andrew Sentence added to speculation that the central bank will end its quantitative easing program in February. Sentence said that the BOE should shut down the Asset Purchase Facility (APF) and assess the risks for inflation as policy makers expect that inflation will exceed their 2 percent target in the near-term.  Sentence also stated that the BOE could adopt a “wait and see” approach as the “recovery gathers momentum,” and went onto say that the “early phase” of the recovery could feel “fragile and uncertain” as the global financial system remains impaired. As a result, Credit Suisse overnight index swap (OIS) rates have shifted to price in 72.4 basis points worth of Bank Rate increased over the next 12 months.
    
Related: Discuss the British Pound in the DailyFX Forum

Euro Extremely Choppy Ahead of ECB Rate Decision
The euro rallied sharply through the end of the European and start of the US trading session, but subsequently pulled back as volatile price action remains the name of the game ahead of Thursday rate decision by the European Central Bank (ECB). European news was mixed, as Greek Finance Minister George Papaconstantinou said that the nation is on track to resolve its problems and would not need a bailout. Meanwhile, Germany’s Federal Statistics Office showed that GDP contracted at an annual pace of 5.0 percent in 2009 after advancing 1.3 percent in the previous year, which marginally worse than prior expectations for a 4.8 percent drop.

On Thursday, the ECB is anticipated to leave rates unchanged at 1.00 percent at 7:45 ET. Where the currency ends the day, though, may have more to do with what ECB President Jean-Claude Trichet says during his post-meeting press conference at 08:30 ET. Traders will likely focus on any comments regarding the future of interest rates in the region, including statements on exit strategies for the central bank’s liquidity programs, the economic outlook, and how they may deal with Greece’s fiscal problems (if at all). At the time of writing, Credit Suisse overnight index swap rates were pricing in 100 basis points worth of hikes by the ECB over the next 12 months, but indications that the central bank foresees a quicker recovery in growth or inflation could push these expectations, and the euro, higher.

Related: Discuss the Euro in the DailyFX Forum,

Commodity Dollars Follow Equities Higher, Australian Dollar Up Ahead of Employment Figures
The Australian dollar and Canadian dollar remained fairly strong on Wednesday despite experiencing steep drops at the start of the US trading session. Working in favor of these currencies was the afternoon rise in US equities and the Thomson Reuters/Jefferies CRB Index, all of which suggest increased risk appetite. Looking ahead to upcoming event risk, Australia will have an indicator to watch for. Like US non-farm payrolls, the Australian employment change can be market-moving for the nation’s currency due to the fact that actual results tend to differ from expectations. For the month of December, the employment change is projected to rise for a fourth straight month, this time by 10,000. At the same time, the unemployment rate is projected to rise to 5.8 percent from 5.7 percent, due primarily to an increase in the participation rate. With the markets still pricing in just over 128 basis points worth of rate hikes by the Reserve Bank of Australia over the next 12 months, a surprise decline could put a dent in rate expectations, as well as the Australian dollar. On the other hand, further gains in the labor markets could add to the currency’s renewed strength and push AUDUSD to or above the 2009 highs of 0.9404.

Related: Discuss the Canadian Dollar in the DailyFX Forum,


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Written by: Terri Belkas, Currency Strategist for DailyFX.com
E-mail: tbelkas@dailyfx.com