For the second day in a row, the U.S. dollar has appreciated significantly against the Euro and is also trading higher against the New Zealand dollar and Swiss Franc. However, the extent of today’s rally in the greenback basically ends there. The dollar is practically unchanged against the British pound and Australian dollars and is trading lower against the Canadian dollar and Japanese Yen. The 2.3 percent sell-off in U.S. equities coupled with the outperformance of the two lowest yielding G7 currencies indicates that risk aversion is the dominant theme. Yet, with no major U.S. economic data or market moving news over the past 48 hours, traders may be wondering, what changed. As recently as last week, investors were optimistic about a turnaround in the global economy following the more substantial outcome from the G20 meeting.

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 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.

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.

With US equity and bond markets closed for Presidents Day, trading was relatively quiet for currencies. The G7 meeting did not lead to any fireworks but the dollar did gap higher against all of the major currencies except for the Japanese Yen at the Asian open on Sunday.

This morning, the Bureau of Labor Statistics reported that January was another month of massive job losses. For the third time in a row, more than 500k Americans lost their jobs. The market was looking for payrolls to drop by 540k, but instead they fell by a whopping 598k (Instant Insight on January Non-Farm Payrolls). Yet, currencies and equities traded like non-farm payrolls increased rather than decreased but this baffling response to a very negative number can be easily explained by the prospect of help from Washington.

Dollar rallied strongly on the opening day of the first full working week of the year as enthusiasm over President elect Obama stimulus package pushed the unit higher against the yen while the euro suffered a 300 point loss on worries over the burgeoning Italian bond scandal. According to the Independent in UK , Italian municipalities may face as much as $35 Billion in losses over a financing scheme gone wrong, sold to the them by major investment banks such as UBS and Deutsche Bank. The Italian authorities are considering the possibility of suing the principal market makers or misrepresenting the risks to the municipal investors in these complex over the counter deals.