The US dollar rallied through the Asian and European session hours Tuesday as the scent of fear wafted through the market. Speculative interests were put on the defensive starting in the early hours of the new trading session after a Japanese airline filed for bankruptcy protection in the nation’s fourth largest failure in history.

•    US Dollar Rally Stunted by New Highs for the Dow, A Rough Start for Q4 Earnings
•    British Pound Rallies as Inflation Sparks Long-Lost Interest Rate Speculation
•    Euro: Investor Sentiment Turns Sour as the Health of the Euro Zone Economy Comes into Question

US Dollar Rally Stunted by New Highs for the Dow, A Rough Start for Q4 Earnings
The US dollar rallied through the Asian and European session hours Tuesday as the scent of fear wafted through the market. Speculative interests were put on the defensive starting in the early hours of the new trading session after a Japanese airline filed for bankruptcy protection in the nation’s fourth largest failure in history. Heading into London and Frankfurt hours, a survey of European investor sentiment reflected confidence among speculators was not as robust as many had expected with the global economy’s still young recovery. Finally, adding to bearish sentiment just before US markets came online, Citigroup reported a hearty $7.6 billion loss for the fourth quarter. All told, these unfavorable events would bolster the appeal of the save haven dollar long enough to push the currency to the verge of a meaningful breakout before risk appetite eventually stabilized. When New York liquidity descended on the market, traders would find their bearings and reverse their bearish position – subsequently preventing the greenback from taking the final step towards a meaningful breakout and potential trend. Reflecting how close the dollar would come to developing a trend, EURUSD would break the bottom of its month-long rising trend channel before stalling at a 200-day moving average and range low.

Outside the flippant nature of risk appetite, US-based fundamentals were a mixed bag. The disappointing earnings numbers for Citigroup – the world’s largest bank – held its obvious implications for investor sentiment. However, looking beyond the tone this sets for the fourth quarter earnings season, this accounting data in particular is evidence of the impact that the withdrawal of government aid and stimulus can have on the markets. Much of the quarter’s losses can be assigned to the approximately $6 billion in expenses to repay the US government for its bailout. What’s more, looking beyond the costs to banks; the roll back of the market’s safety net will no doubt dampen confidence, weigh on liquidity and perhaps even reduce credit availability as lenders become more conscious of their exposure. Looking at tomorrow’s listings, Bank of American, Wells Fargo, Morgan Stanley and US Bancorp are all scheduled to release their fourth quarter numbers. This round along with Thursday’s hearty list represents the height of the earnings season for the financial sector.

Turning to macro data, the November TICS data showed global demand led to a net $126.8 billion purchase of US equities, notes and bonds.  Interest in government debt was particularly robust with buying private investors buying a record $87.1 billion of the low-yield, safe haven Treasuries. However, this is not a trend that is likely to subsist through the long-term. Efforts to diversify reserves away from the US dollar are gaining momentum. And, those leading the charge say the value of the US dollar and its assets is eroded by the government selling record amounts of debt and printing money to fill its deficit. On deck for Wednesday, earnings reports will be mixed with factory-level inflation figures and construction data. Upstream price pressures and the stability of the housing market can certainly weigh on interest rate speculation. 

Related: Discuss the US Dollar in the DailyFX Forum, US Dollar Forecast Calls For Breakout

British Pound Rallies as Inflation Sparks Long-Lost Interest Rate Speculation
The British pound managed an impressive rally Tuesday after the Office for National Statistics released its most recent inflation statistics. Expectations were already inflated with the forecast consensus projecting a 0.3 percent increase through the month of December which would contribute to a 2.6 percent annual pace of growth. What the market received through the actual numbers though was a 0.6 percent pickup through the month and a 2.9 percent rate for the year. The increase in the year-over-year measurement was the largest on records going back to 1997 and more importantly sets price pressures well above the Bank of England’s target 2.0 percent target. In fact, should price pressures cross the three-percent threshold, the central bank will have to produce a letter to the Chancellor of the Exchequer explaining why inflation is so high and what will be done to return it to normal levels. What can be done? The market has taken this news to mean the BoE’s plans to return to a hawkish monetary policy will have to be moved up. Indeed, Credit Suisse overnight index swaps show the market bumped up the outlook for rate hikes over the coming 12 months by 14 basis points to 85 bps. The argument has been made that this is a temporary impact through high fuel prices and BoE Governor Mervyn King said after the report that an "undesirably low” money supply will return inflation to target. However, the core CPI reading hit a 2.8 percent rate of its own and the money supply could easily reverse course on the abundance of stimulus in the economy.

Perhaps the economic outlook proffered by the tomorrow’s jobless claims figures or the assessment of the country’s future in the BoE minutes will help clarify the situation – or at least speculators’ expectations. According to forecasts, the economy is expected to reported its second monthly drop in unemployment – the first back-to-back decline since the January and February of 2008. While this is far from putting the economy on a solid footing (the jobless rate is still near a 14-year high); it is a clear step in the right direction for a currency still under the weight of negative forecasts.

Related: Discuss the British Pound in the DailyFX Forum, British Pound at Risk With BoE Minutes And CPI Ahead

Euro: Investor Sentiment Turns Sour as the Health of the Euro Zone Economy Comes into Question
Whereas the pound was up across the board through the virtue of its economic data, the euro would be weighed by its own economic docket. Not only does the currency stand to lose the most when the US dollar advances (as it is the primary alternative for those market participants looking for a reserve alternative); but the Euro Zone has seen structural problems of its own develop recently. With the focus on Greece and its unsustainable deficit, investors have clearly grown worried over the stability of the collective economy and its financial health. The German ZEW market professional survey for January revealed the consensus forecast for regional economic activity dipped below the important 50 level (anything below this level reflects net pessimism among those polled). The issue and concerns will likely worsen before they improve.

Related: Discuss the Euro in the DailyFX Forum, Euro Struggling to Maintain its Range as Greek, Dollar Troubles Loom

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com

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