Talking Points

* Japanese Yen: Tests 93.40
* Pound: Construction Activity Falls To Lowest Since 1997
* Euro: ECB's Papademos Signals More Rate Cuts
* US Dollar: Stimulus Plan Talk May Impact Price Action

Euro Nosedives As ECB's Papademos Talks Rate Cuts

The Euro fell almost 300 bps to 1.3656 as European trading started on comments from ECB Vice-President Lucas Papademos that deflation has become a concern for the central bank and further easing may be necessary to achieve price stability. These remarks were reinforced by Italian CPI dropping from 2.7% to 2.4% in December. Meanwhile, The Euro-Zone Sentix investor confidence reading unexpectedly rose to -34.4 from -42.3 on the back of interest rate reductions and fiscal stimulus packages from the various nations. The positive fundamental data helped slow the Euro's decline as it has since consolidated above 1.3660.

Papedemos's comments that 'We will do what is necessary, in terms of the timing and in terms of the size (of interest rate policy action) to ensure that price stability is preserved,' signals that the central bank is becoming concerned about deflation. The central bank is clearly considering more easing which could come as soon as January 15th. Markets are pricing in another 157 bps of rate reductions over the next twelve months. Expectations that the region's economy will continue to slow and the drop in prices will accelerate will leave the MPC will little choice but to continue their current easing cycle. Indeed, Papademos on January 3rd would state that he 'cannot rule out that economic activity in 2009 may turn out to be weaker than suggested.' The Euro/ U.S. dollar pair has fallen below the 20- day SMA on today's move with the 100-Day SMA providing potential support at 1.3617. A break below this level could see price action look to test the 50-Day SMA at 1.3175.

The Pound saw see-saw action during the overnight session as it fell over 100 bps after an earlier test of 1.4580 before retracing back above 1.4500. The recent bullish momentum would ignore the lowest construction PMI reading since 1997. The activity gauge dropped to 29.3 from 31.8, as the sector continues to be impacted by the worse housing crisis since the Great Depression. The failure of the sector to bottom has dragged on the economy. The BoE may be forced to continue its aggressive easing policy and is expected to reduce rates by another 50-100 bps on Thursday. The expected rate reduction may lead to the Sterling trading heavy leading up to the decision.

The Yen dropped over 100 points against the dollar as the prospect of the U.S. fiscal stimulus plan has led to a boost on risk appetite sending the Nikkei higher by 2%. The pair would reach as high as 93.40 before finding resistance. However, we may see weakness going into the U.S> session as European markets have pared gains and U.S. futures are pointing to a lower open. Another dismal U.S. NFP report looms at the end of the weak which may curb bullish sentiment.

The economic docket will provide little event risk for the dollar today with only the second tier indicators vehicle sales and construction spending. The dollar's overnight strength may continue today if investors subscribe to the argument that the U.S. economy will be the first to emerge from the current financial crisis. The New Year brings the fiscal stimulus plan proposed by President Barack Obama in sight .Details are starting to emerge regarding the aide package which includes $300 billion in tax breaks. Potentially 40% of the stimulus will include a $50 tax reduction for individuals and $1000 for couples. This proposal could help boost consumer demand which already gaining from the reduction in gasoline prices. However, giving the dollar's strong correlation to risk appetite the prospect of the increased consumer spending could lift equity markets which could weigh on the greenback.

Economic Indicators Update