The automaker bailout drama has exerted its toll on the financial markets. Last night, news that the bailout deal fell apart in the Senate drove the US dollar to a 13 year low against the Japanese Yen. Almost immediately, the dollar rebounded and its recovery accelerated after reports that the White House may provide assistance to the automakers by tapping the TARP funds. Stocks have rebounded from negative territory, but the unconvincing rally in both the currency and equity markets suggest that traders do not know what to make of the automaker bailout saga, which is sure to drag out into the New Year. With the Federal Reserve expected to cut interest rates on Tuesday, the US dollar could remain weak going into the rate decision.

Over the past week, the Australian dollar staged an impressive rally as upside surprises in economic data fueled expectations that interest rates will be left unchanged for the second time in a row. Since March 10th, the Australian dollar has appreciated from a low of 0.6340 to an intraday high of 0.7228 on Friday. The Reserve Bank of Australia has a monetary policy meeting on Monday evening NY time, Tuesday morning in Sydney and the outcome of the meeting will determine whether the Australian dollar is able to sustain its gains. Currently, the market expects the RBA to leave interest rates unchanged, but some people believe that the RBA could cut rates by as much as 50bp, which means the upcoming rate decision, could be a close one. Although, leaving interest rates unchanged has become a common practice of many central banks these days, what sets Australia apart is that interest rates are not at zero, leaving the RBA with room to ease. At 3.25 percent, the country currently has the highest interest rate amongst developed countries.

The U.S. dollar has ended the week lower against all higher yielding currencies as the actions by Washington and leaders of the 20 largest economies have helped to restore risk appetite. USD/JPY which tracks the market’s sentiment broke 100, to trade at the highest level since November. The fate of the dollar in the week ahead will be largely dependent upon whether we are at a turning point in the global recession or if investors have been misled by false expectations.

The next 48 hours in the foreign exchange market should be very interesting as we look forward to three significant events that could trigger massive volatility in the currency market independently, let alone collectively. After some big moves earlier this week, most currency pairs have consolidated as traders wait for the European Central Bank interest rate decision, the G20 meeting and the U.S. non-farm payrolls report. The U.S. dollar strengthened against the Euro and Swiss Franc but lost value against all of the other major currencies. This consolidation should just be a precursor to a bigger move.

The last trading day in the first quarter of 2009 has ended with a bang. The U.S. dollar sold off against most of the major currencies as repatriation flows come to an end. U.S. economic data was weak, but not a game changer and therefore currency investors chose instead to focus on the positive implications of Japan’s stimulus package and the IRS’ new tax break for U.S. car buyers. The currencies that are performing the best against the U.S. dollar are the ones whose central banks are not expected to adopt quantitative easing, namely the Australian New Zealand dollar.

A bank report that we read this week had an interesting line summarizing investors’ attitude towards the U.S. dollar over the past few months. They said that being long dollars means being long pessimism and we believe that this is a valid description of the recent price action in the currency markets. Today, the dollar weakened against every major currency except for the Japanese Yen. This weakness as baffling as it may seem is more of reflection of the market’s optimism than pessimism because equities are higher and gold prices are lower.

With no fireworks from this weekend’s 3 big event risks, the rallies in the currency and equity markets are fizzling. Having been up more than 150 points intraday, the Dow Jones Industrial Average ended the U.S. trading session down 7 points. This lack of follow through was replicated in the foreign exchange market with the Euro and British pound giving up earlier gains. Promises can only take the markets so far and the lack of concrete actions by the G20 has disappointed investors. Although we have previously mentioned that bear markets can rally as much as 25 percent, today’s intraday reversal is worrisome. Looking at the economic calendar this week, there is not much event risk to energize investors

This past week has been marked by recoveries in both the currency and equity markets thanks to better than expected U.S. economic data and reports of profitability from banks. Although the price action that we have seen thus far is still in line with a bear market rally, the move higher has been a breath of fresh air for many investors. For the time being, the downtrend in the EUR/USD has been broken. Even though the currency pair continued to edge higher, it remains to be seen whether the strength can continue. There are a lot of economic data due for release next week, but not before this weekend 3 big event risks – the G20 Meeting, OPEC Meeting and Bernanke’s first ever on-the-record television interview as Fed Chairman.

Breakouts are beginning to occur across the foreign exchange market. After consolidating for the past few weeks, we have finally seen an upside breakout in the EUR/USD with the currency pair trading at the highest level since February 24th. USD/JPY has also fallen significantly and is at risk of breaking its March lows while the Australian and New Zealand dollars are attempting to break month long consolidations. The story today is dollar weakness. The greenback has weakened against every major currency except for the Canadian dollar. Other than the equity market’s feeble attempt to extend Tuesday’s gains, there was no major catalyst for the sell-off in the U.S. dollar.

The Swiss National Bank's interest rate decision has been released one day early. Apparently this was mistake on behalf of the SNB, who faxed the rate decision before the official announcement.

As we have promised, trading currencies have become more interesting following the interest rate decisions in Europe. The next 24 hours should prove to be just as exciting for forex traders with the February non-farm payrolls report due for release. The US dollar has rallied significantly ahead of the payrolls report, which is traditionally the single most market moving economic data for the EUR/USD. The cohesive rally in the US dollar and the price of gold along with the sell-off in US equities indicate that risk aversion is the main theme of the day. This also provides a clue on how the dollar could trade following Friday’s non-farm payrolls report (February Non-Farm Payrolls Preview).

Things will get very interesting in the currency market over the next 48 hours. The Bank of England and the European Central Bank will be making interest rate decisions on Thursday and non-farm payrolls are due for release in the US on Friday. Alone, any one of these releases could trigger significant volatility in the currency market but together, they could easily lead to major breaks especially since the EUR/USD and GBP/USD have been fluctuating within tight trading ranges. The US dollar traded lower against all of the major currencies except for the Japanese Yen. Risk appetite has improved thanks to a new stimulus package for China, more details on the Treasury’s $75B mortgage plan and a stronger than expected service sector ISM report. The Fed’s Beige Book report signaled worsening economic conditions across the nation, but that failed to cause a dent in the currency or equity markets.

The US dollar extended its gains against the Euro, British pound and Japanese Yen as the key players in the recovery story disappoints the market. Overall the price action in the currency market has been muted and the dollar lost ground against other major currencies such as the Australian and New Zealand dollars. US economic data was weak but the dollar rally continued as traders focused on external rate decisions. The central bank of Australia left rates unchanged while Canada cut theirs by 50bp; next up are the Eurozone and UK rate decisions, both of which are expected to lower interest rates.

Over the past 6 months, being long US dollars has been one of the best trades in the currency market but as the dollar extends its gains, many traders wonder how much further it can rise. In the currency market, trends can last much longer than anyone would normally anticipate especially if it is driven by fear. As humans, we run from uncertainty and not towards it. Risk aversion has been pushing investors into the safety of the US dollar and out of higher yielding currencies. When Main Street reads in the papers tomorrow about the slowest pace of economic growth in 26 years, their shock could turn into more selling. Next week, we also have the US non-farm payrolls report due for release. A sour mood could hang over the markets for most of the week as traders fear that another 500k jobs were lost in the month of January. The only thing that could improve risk appetite and give investors a reason to cheer would be if the Senate passes President Obama’s economic stimulus package.

Better than expected US economic data was like a breath of fresh air for the currency markets today. Producer prices fell less than expected last month while manufacturing conditions in the Empire State and Philadelphia regions improved. The dollar rebounded against the Japanese Yen indicating that risk aversion is abating, albeit modestly. The overwhelmingly pessimistic investors will not be easily swayed by a few pieces of secondary economic data, especially since all of the numbers are still in negative territory. Looking ahead, we will have another busy day in the currency market with US consumer prices, the Treasury International Capital flow report, industrial production and consumer confidence due for release.

What to expect from a fundamental and technical basis for the US dollar, Euro, British pound, Japanese Yen and other major currencies in the year ahead.

Bank of England dropped the benchmark UK interest rate to 1.5% easing by 50bp as expected. The Monetary Policy Committee noted that the sharp drop in the pound provided additional stimulus to the UK economy tempering the need for more drastic rate cuts at the present time. The Central Bank acknowledged the severity of the UK recession stating that business and consumer confidence have declines markedly while noting that output is likely to drop sharply in the first half of 2009.

It has been an exceptionally active year in the foreign exchange market as currency volatilities hit record highs. In the first half of the year, everyone was worried about how much further the dollar would fall but in the second half of the year the concern became how much further the dollar would rise. More specifically, after hitting a record low against the Euro in the second quarter, the US dollar surged to a 2 year high against the currency in the beginning of the fourth quarter. From trough to peak, the dollar index rose more than 23 percent in 2008.

It has been an extremely volatile week in the currency market. On Monday, the EUR/USD was trading at 1.3364 and shortly after the European open on Thursday it hit a high above 1.47. However since then it has reversed violently to end the week back at 1.39. This type of price action is characteristic of an illiquid market that is uncertain about how to react to the drastic measures taken by central banks around the world. There was no US economic data released today, but there are reports that the White House has given $17B in loans to the Big 3 automakers. The US dollar strengthened against all of the major currencies except for the Japanese Yen. Next week is a lightened trading week with the Christmas holiday. US economic data is therefore jammed into Tuesday and Wednesday. We expect the final figures for third quarter GDP, housing market numbers, personal income, personal spending and durable goods next week. The data should continue to reflect the weakness of the US economy.

After seeing the US dollar sell off for 5 straight days against the Euro and Japanese Yen, we were not entirely surprised to see today’s recovery, especially on the heels of better than expected economic data. The market has become accustomed to disappointments so good news was a welcome change. The European Central Bank has also reduced the interest rate that it offers to banks that deposit with them in order to encourage lending. The 15 percent rally in the Euro has led many to people to believe that the ECB may reconsider their plan to hold interest rates steady in January and the deposit rate cut was seen as a step in that direction. Thin market conditions near the holidays have exacerbated the volatility in the currency market. However even though the greenback is higher today, we had both positive and negative news impacting the dollar.

Tuesday’s FOMC meeting will be remembered for decades to come as the Federal Reserve brings interest rates down to the lowest level this generation has ever seen. With 2 realistic options on the table and economist and traders divided on how much the Fed will cut interest rates, the only certain outcome is significant volatility for the currency market. The US dollar is selling off aggressively going into the rate decision as traders realize that after tomorrow, the dollar will either be the lowest or second lowest yielding G10 currency. No matter how you look at it, an interest rate of 0.50 percent is just as bad as an interest rate of 0.25 percent.

With dollar denominated assets yielding next to nothing, we have continued to see money flow out of the US dollar. The greenback fell to the lowest level against the Euro since September and dropped to a new 13 year low against the Japanese Yen. The losses have been even more staggering since the beginning of the month. The dollar has fallen 14 percent against the Euro and 8 percent against the Japanese Yen. This significant sell off begs the question How Much Further Can the Dollar Fall? If you watched the price action in the currency market this past year, you will know that trends dominate. With only 2 weeks until the end of the year, we could be stepping into a longer phase of dollar weakness.

The US dollar fell to a 2 month low against the Euro following the Federal Reserve’s decision to cut interest rates by 75bp to 0.25 percent. The greenback is now the lowest yielding G10 currency and for that reason, we should see foreign selling of US dollars exacerbate. At 0.25 percent or more specifically, a target range of zero to 0.25bp, foreigners may not find the yield attractive enough to warrant the risk. Despite the selling that we have already seen in the dollar today, this could just be the beginning of a longer phase of dollar weakness that may last into the first quarter of 2009.

Tuesday’s FOMC meeting will be remembered for decades to come as the Federal Reserve brings interest rates down to the lowest level this generation has ever seen. With 2 realistic options on the table and economist and traders divided on how much the Fed will cut interest rates, the only certain outcome is significant volatility for the currency market. No matter how you look at it, an interest rate of 0.50 percent is just as unattractive as an interest rate of 0.25 percent.