It is not often that we can see the US dollar hit a 23 year high against one currency and a 13 year low against another on the very same day. However that was exactly what happened this morning when the greenback surged against the British pound and collapsed against the Japanese Yen. Volatility ripped through the foreign exchange market as central bank and other US officials comment on their economies and currencies. The milestones were not limited to the GBP/USD and USD/JPY as the NZD/USD and EUR/JPY also fell to a 6 year low intraday. However what was most impressive is the fact that none of the staggering losses were sustained.

What Was Volcker Thinking?

Comments from former Fed Chairman Paul Volcker triggered a wave of risk aversion that led to a technical break in the currency market. He said the US is n serious recession, with no end clearly in sight. Although there is no question that the US economy is in trouble, by saying that there is no end in sight suggests that there is no hope. Coming from the chairman of Obama's newly formed Economic Recovery Advisory Board, we would expect more advice. Treasury Secretary Nominee Geithner expects an Obama economic stimulus plan to be released in the next few weeks but unfortunately Volcker's comments overshadowed the prospect of a stimulus plan for the foreign exchange markets. Investors were already nervous following yesterday's sell-off and Volcker's comments pushed them over the edge.

FX, Stocks and Bonds: Who is Right?

With the Dow rising 279 points, the correlation between the currency and equity market broke down leading traders to wonder which market participants had the right reaction to Volcker and Geithner's comments. Given that bond and gold prices fell as well, it suggests that today's developments made investors less pessimistic about the outlook for the US economy. Therefore we could see currencies catch up over the next 24 hours which means the potential for a corresponding bounce in the EUR/USD, GBP/USD and USD/JPY. We are already beginning to see an intraday reversal going into the US close and we would not be surprised to see it continue in Asia and Europe. Looking ahead, housing market data and the weekly jobless claims report are due on Thursday. The NAHB Housing market index measuring builder confidence fell to another record low in the month of January.

The British pound staged a dramatic recovery after having fallen to a 23 year low of 1.3621 against the US dollar. The strength of the reversal will have many investors wondering if the currency has hit a bottom. Since last Friday it has fallen more than 1000 pips as the market grows more concerned about the UK's ability to pay for all of their stimulus packages and the threat of Standard and Poor's putting the country on credit watch negative. The sell-off in the British pound over the past few trading days has been driven by a pessimistic outlook for the UK economy and there has been no UK news during the US trading session to fuel the currency's reversal. Therefore the GBP/USD could still resume its downtrend since nothing has changed that can shift UK sentiment. According to the minutes from the most recent Bank of England meeting, the members of the monetary policy committee voted 8-1 to cut interest rates by 50bp in January. The dissenter continues to be Blanchflower who called for a larger 100bp rate cut. The minutes were not entirely dovish as the committee also considered leaving interest rates unchanged. Their plans to buy private sector assets is a move towards quantitative easing which suggests that the BoE will continue to cut interest rates. Employment data was mixed with the number of people claiming jobless benefits rising more than expected but the unemployment rate surged while average hourly earnings plunged. Given that the outlook for the pound has not changed, the latest rally could be nothing more than a bear market bounce.

The Euro rebounded strongly despite ECB President Jean-Claude Trichet's warnings of further rate cuts. German producer prices continued to fall, albeit less than the market expected. Trichet defended the central bank's less aggressive monetary policies and indicated that they have decided if 2 percent is the lowest level for interest rates. However declining prices will support the market's call for more rate cuts from the ECB. Trichet reiterates that there is presently no threat of deflation and recognized the recent downgrades in the credit rating of Spain and Greece. With more downgrades expected to follow, Trichet is convinced that the vast span of the European Union will inevitably have certain disequilibriums. Meanwhile the Swiss franc collapsed after SNB Hildebrand said that the central bank is considering selling francs to halt the currency's gains. With interest rates already at 0.5 percent, there is no room to ease monetary policy and they may have to resort to fixed rate currency intervention. We believe that this is more bark than bite from the SNB since they have always opted for verbal over physical intervention.

The Australian, New Zealand and Canadian dollars have recovered against the greenback. The rallies are based on a small pocket of risk tolerance as spurred by advances in US indices and some significant rallies in Crude Oil. Crude showed more than a 8.3% gain in today's trading. The Canadian dollar has reacted favorably. The level of urgency expressed within the ranks of Canada's economic policy-makers has not alleviated since the rate cut. We are now learning that the Finance Minister, Jim Flaherty, is trying to obtain the power to inject capital directly into the country's banks. Even though this technique was common practice in the last few months, it appears that the Canadians are seeing their situation worsen considerably. We saw a disappointing Wholesale Sales report today which should be overshadowed by the importance of tomorrow's Retail Sales figures. New Zealand's Minister of Finance, Bill English, had some more upbeat news to share with traders. Apparently the quick recovery many were expecting may be materializing for the country as the severe depreciation in the NZD is starting to benefit exporters. However, Mr. English acknowledged the fact that the country was put on S&P's warning list for a credit downgrade as well as the need for additional rate cuts. For Australia, no economic news will be reported until tomorrow's Consumer Inflation Expectations and New Motor Vehicle Sales.

The unrelenting strength of the yen presents many questions for the rate decision expected tomorrow. It is clear that rate cuts are over as the Japanese are looking at practically zero interest rates despite the marginal 10bp buffer. Therefore the potential for something truly market moving will exist in either the BoJ's announced attempts to combat the strength in the Yen or some more proposed strategies that will replace rate cuts as the monetary tool of choice. One major probability is that the bank tries to talk down currency prices like many expect the SNB is doing. This should provide a relatively short period of breathing room for the Japanese to plan for a large scale decision. One major catalyst for a potential intervention would be a break of the 87.00 level in USD/JPY, which would bring the pair down to fifteen year lows. Aside from the rate decision, we expect the Merchandise Trade Balance to come in tonight.
EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency in play for the next 24 hours. A vast array of European data is expected, which includes French Consumer Spending at 2:45 am ET or 7:45 GMT, the ECB Monthly Report at 4:00 am ET or 9:00 GMT, and EZ Industrial New Orders at 5:00 am ET or 10:00 GMT. Following these European events will be Housing Starts and Building Permits reported by the US at 8:30 am ET or 13:30 GMT.

EUR/USD has managed to stay in the Bollinger band sell zone for an impressive eight days. The sheer strength of the upswing encountered in the month of December has almost been completely countered. The retracement levels drawn from the October 28th lows to the December 18th high does a fairly good job at providing us with the most relevant levels. For support, we have seen prices fail the 78.6% retracement at 1.2839 for the second consecutive day. For resistance, we have the confluence of the 61.8% retracement, one-standard deviation Bollinger band, and the 10-day SMA. Since prices have not been able to break from the sell zone, it is likely that this level will be sufficient in pushing prices downward. A break of the 1.2839 support should see prices extend down to 1.2328, or the October 28th low.