* The dollar rallied against most major currencies on Tuesday on more signs of a deepening global recession as international trade plunged. The US trade deficit fell the most in 12 years as imports plunged while surplus countries saw their trade surplus narrowing. Federal Reserve Chairman Ben S. Bernanke warned that a fiscal stimulus won't be enough to spur an economic recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. The sentiment was echoed by Fed Vice Chairman Donald Kohn, who said he would expect the remaining TARP funding to be devoted to strengthening financial institutions. The EUR/USD declined for a third day as speculation mounted that the European Central Bank may accelerate its interest rate cuts. Sterling fell as UK retail sales registered their worst Christmas performance on record and home sales dropped to the lowest level since at least 1978. The Canadian dollar declined as monthly trade surplus shrank to its lowest level in 11 years and the Austrian dollar fell on increased safe haven flows and carry-trade unwinding.

* The EUR/JPY fell for a seventh day pressured by increased risk aversion and carry-trade unwinding as the global economy slumps. The pair and other yen crosses are at important supports. The recent improvement in many financial risk spreads does not seem to help the yen crosses as the global economy has been deteriorating. Bernanke's statement today indicates he does not think the financial crisis is over. The next few days will be important as a break of support would indicate further deterioration in risk sentiment and continuing declines in the EUR/JPY and other yen crosses. There are support in the 115-area and resistance from the downtrend in the 122-area.


Financial and Economic News and Comments

US & Canada

*The US trade deficit narrowed by the most in 12 years, shrinking a more-than-expected 29% to $40.4 billion in November, Commerce Department data showed. Exports fell for a fourth consecutive month, declining $8.7 billion in November, led by autos/parts, petroleum, and chemicals. Exports fell 1.7% y/y. Imports declined $25.0 billion in November, the fourth straight drop and the largest fall on record, led by petroleum, pharmaceuticals, and autos/parts. Imports dropped 10.6% y/y.


* The US budget deficit soared to a record $485.2 billion in Q1 2009 fiscal year, surpassing a $454.8 billion shortfall for all of 2008, the Treasury said. The monthly budget condition worsened, with the excess of spending over revenue widening to $83.6 billion in December, compared with a $48.3 billion surplus a year earlier.

* Federal Reserve Chairman Ben S. Bernanke urges strong measures to revive the US economy, signaling the government may need to buy or guarantee banks' tainted assets. Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system. More capital injections and guarantees may become necessary to ensure stability and the normalization of credit markets, Bernanke said.

* Canada's trade surplus shrank to C$1.28 billion ($1.05 billion) in November, the narrowest since October 1997, following October's downwardly revised C$2.25 billion surplus, Statistics Canada reported. Exports fell 6.8% to C$39.2 billion, the largest monthly fall since May 2003. Canada's trade balance with the US narrowed to C$4.53 billion in November, the lowest level since 1999, from October's C$5.92 billion. Imports declined 4.8% to C$38 billion.


* Germany's wholesale prices fell 3.3% y/y in December, its largest fall since March 1999, following November's 0.8% y/y decline, the Federal Statistical Office said. Wholesale prices fell 3.0% m/m, after November's 3.3% m/m slide. The figures support further European Central bank interest-rate cuts.

* The UK goods trade deficit unexpectedly rose to a record high £8.3 billion in November, following October's revised £7.6 billion deficit, the Office for National Statistics said. Exports fell 6% to £19.8 billion in November, while imports declined 2% to £28.2 billion. The UK trade deficit with non-EU countries rose to £5.3 billion in November, following October's revised £4.4 billion deficit, while the trade deficit with EU countries fell to £3.0 billion, from the previous month's £3.2 billion deficit. The UK total trade deficit was £4.48 billion, up from October's revised £3.86 billion.

* UK DCLG house prices fell a slightly more-than-expected 8.6% y/y in November after declining 7.4% y/y in October, according to the Department for Communities and Local Government (DCLG). Excluding house prices in London, which declined 7.0% y/y, UK house prices dropped 9.0% y/y in November, following October's 7.5% y/y fall.


* Japan's current economic conditions are deteriorating, with the Economy Watchers index falling to 15.9 in December, the lowest since the survey started in August 2001, from 21.0 in November, the Cabinet Office said. The outlook index dropped to 17.6 from November's 24.7.


* Japan's corporate bankruptcies rose 11% y/y to 15,646 cases in 2008, the fastest rate since 2000 amid a deepening recession, and a total of 33 publicly traded companies went out of business in 2008, the most in the postwar period, Tokyo Shoko Research Ltd. reported.

* Growth of less than 6% in China and a plunge in financial markets were cited as bigger threats than a year ago to the global economy, according to a World Economic Forum report.

FX Strategy Update