US Dollar Strengthens Against Euro, Yen and Pound

It was another day of mixed trading in the US dollar.  The greenback rallied against the Euro, British pound, Japanese Yen and Canadian dollar but lost ground against the Australian and New Zealand dollars.

The lack of economic data this week has given traders and economists the opportunity to think about how bad the US economy will fare in 2008. Since the disturbingly weak non-farm payrolls number released on Friday, there has no been economic data to confirm or deny that the US economy is headed for a recession. As a result, most traders have braced for the worst as rate cut expectations continued to edge higher. According to Fed fund futures, the probability that the Federal Reserve will lower interest rates by 50bp at the end of the month is now 74 percent compared to 68 percent yesterday and 24 percent a week ago. The current debate in the market is 25 versus 50, but lets take a look at what economists are expecting beyond the January meeting. Assuming the Fed cuts by only 25bp, we could see as much as 150bp of further easing. Goldman Sachs and BNP Paribas expect interest rates to be at 2.50 percent by the end of the year, while Merrill Lynch is calling for rates to hit 2 percent in early 2009. On the other side of the spectrum, RBS Greenwich and Bear Stearns only believe that another 25bp is needed before the easing cycle comes to an end. At DailyFX, expect another 75 to 100bp of further easing before the cycle is over and we believe that it is still premature to call for 50bp of easing without seeing how consumer spending and consumer prices fared in the month of December. These numbers are expected next week. Recent comments from Federal Reserve Presidents confirm our belief that the members of the US central bank have not made up their minds. This morning, Poole said that even though the economic outlook is uncertain, it is too soon to tell if housing troubles will push the US economy into recession. Jobless claims, wholesale inventories and chain store sales are due for release tomorrow – these numbers should not be market moving.

                Commodity prices saw huge gains with gold and platinum rising to record highs as investors increased their holdings due to pessimistic growth prospects for the US economy, and oil reached a record of $100.09 a barrel before falling down to $95. However, commodity prices were not able to hold its gains as the Mortgage Bankers Association reported mortgage applications increase the most in seven years, which led investors to regain some confidence in the US. The rise in refinancing pushed interest rates down to a two year low, with the 30 year fixed loan rate falling to 5.73 percent from 6.05 percent, and the 15 year rate falling to 5.21 percent from 5.61 percent.

                The Dow Jones Industrial Average gained 146 points while the S&P500 climbed 18 points.  The stock market has been extremely volatile. At one point, the Dow was down over 80 points. It was not until the last 2 hours of trading did equities reverse violently higher. Whether or not this rally will last remains to be seen as equities still have a long way to go before recovering all of its year to date losses.

                US treasury prices rose today as a result of the volatile trading session in the securities markets, with the 10 year benchmark yield declining to previous record low of 3.77 percent in 2004. Many investors have begun to move over their assets holdings into the safe haven of US treasuries due to the increasing volatility in the stock market, but not all is safe guarded by risk free bonds as rising inflation will wipe away any gains made from the investment. The US Treasury will be selling $8 billion in 10 year Treasury Inflation-Protected Securities (TIPS) tomorrow and can offer some insight of how investors are acting amid concerns of increasing inflation.