US Dollar Surges Despite Spike in Unemployment - Is Risk Aversion Back?

* Euro Pulls Back from Resistance - Declines Likely Ahead of ECB Rate Decision
* British Pound Due to Retrace Gains Next Week?
* Commodity Dollars Slip as Risk Appetite Wanes, Canadian Unemployment Rate Hits 3-Year High

US Dollar Surges Despite Spike in Unemployment - Is Risk Aversion Back?

US non-farm payrolls fell by a whopping 524,000 in December, which was broadly in line with expectations, and brought the cumulative amount of job losses in 2008 to 2.589 million, the most since 1945. Meanwhile, the unemployment rate rose more than expected to a 16-year high of 7.2 percent from 6.8 percent. The data only confirms the already bleak outlooks for growth going forward, as the minutes from the Federal Open Market Committee's last meeting showed that some members saw the potential for a prolonged contraction. Looking at historical data from the National Bureau of Economic Research (NBER) and the Bureau of Labor Statistics (BLS), between 1945 and 1990 the peak in unemployment generally coincided with an end to recessions. However, since 1990 the unemployment rate has extended higher long after recessions ended, as was the case in the contractions experienced during 1990-1991 and 2001. This suggests that until we see the end of this economic slowdown in the US, we cannot even begin to judge where the unemployment rate will peak, but it doesn't look good given the rapid increase in job losses over the past year.

So why did the US dollar rally in response? As it stands, most of the major currency pairs are trading within massive ranges, but major support levels for the US dollar have helped to stabilize its decline. For EUR/USD, falling trendline resistance prevented the pair from rising higher, while yesterday's highs weighed on GBP/USD. From a fundamental perspective, it is necessary to consider the fact that interest rates in the US can't really go any lower since the Federal Reserve has already cut the fed funds target to a record low range of 0.0 percent - 0.25 percent, and it is that interest rate dynamic (or lack of it), that is allowing the greenback to brush off this abysmal data. Furthermore, other trends witnessed today, including the __ percent drop in the Dow Jones Industrial Average and surge in the Japanese yen, suggest that risk aversion is lingering in the financial markets. In reality, all it will take is some negative piece of news to shake investor confidence to lead equities to plunge and send the US dollar and Japanese yen spiraling higher.

Euro Pulls Back from Resistance - Declines Likely Ahead of ECB Rate Decision

The euro fell versus all of the major currencies on Friday, despite the fact data showed that retail sales growth in the Euro-zone actually rose 0.6 percent during the month of November. However, it is important to note that the annual rate was still negative for the sixth straight month at -1.5 percent, indicating that the economic situation remains dour. When taking this into considering with the decline in Euro-zone CPI estimates below the European Central Bank's 2.0 percent target, steady increases in unemployment, and increasingly pessimistic consumer and business confidence, it seems increasingly likely that the central bank will do as the market's expect: cut interest rates on January 15 by 50 basis points to 2.00 percent to match the 2005 record low. This easily leaves the 7:45 ET announcement as one of the most important pieces of event risk next week, but traders will also have to look out for comments by ECB President Jean-Claude Trichet during his post-meeting press conference at 8:30 ET. Mr. Trichet is one of the most opinionated central bank chiefs around, and suggestions that the ECB will continue to cut rates have the potential to lead the euro far lower. On the other hand, if the ECB goes the route of the BOE and signals that they may leave rates unchanged during their next meeting, the currency could actually rally.

British Pound Due to Retrace Gains Next Week?

The British pound remained relatively strong on Friday, as it surged against the euro but slipped versus the US dollar toward support at 1.5135. The moves have been somewhat surprising in light of the fact that the Bank of England cut the Bank Rate to the lowest level since the bank was founded in 1694. However, the BOE's 50 basis point reduction was in line with expectations, so there was no surprise factor coming in to play. Meanwhile, though the Monetary Policy Committee's (MPC) subsequent policy statement was quite bearish on economic conditions in the UK and abroad, they did not give any indication that they would cut rates again during their February 5 meeting. At this juncture, actual rate cuts are having little impact on the currency markets, as traders are more focused on comparative long-term interest rate expectations. Next week, there will be no key UK economic indicators released, but it will be very important to watch sentiment trends as we've started to see signs emerge that risk aversion is making a comeback, which tends to work in favor of US dollar and Japanese yen strength.

Commodity Dollars Slip as Risk Appetite Wanes, Canadian Unemployment Rate Hits 3-Year High

The commodity currencies - which include the Canadian dollar, New Zealand dollar, and Australian dollar - all fell back on Friday on a variety of factors. Waning risk appetite sapped demand for carry trades, which hurt commodities like oil and higher-yielding currencies, while benefiting lower-yielding currencies, such as the Japanese yen and US dollar. Disappointing data certainly did not help to prop the Canadian dollar higher, as the Canadian economy lost 34,400 workers during December after a loss of 70,600 workers in November. Furthermore, the unemployment rate jumped more than expected to a 3-year high of 6.6 percent from 6.3 percent, suggesting that domestic demand, and thus expansion, is bound to slow further. Looking ahead to next week, most of the event risk will be contained to the US dollar and euro, but on January 14, the Australian unemployment rate is anticipated to pick up to 4.5 percent from 4.4 percent while the net employment change is forecasted to fall negative for the second straight month by 20,000. The latter report tends to have a greater impact on the Aussie since the figure rarely meets expectations and can lead to volatile short-term price action for the Australian dollar immediately following the news at 19:30 EDT. The other important thing to watch is the status of risk, as an increase in market-wide volatility could send the commodity bloc diving lower.