By Ilya Spivak, Currency Strategist

Major Currencies vs. US Dollar (% change)

27 Dec 2010 – 31 Dec 2010

EURUSD : ECB Policy Meeting, Periphery Debt Sales in Focus

The Euro all but shed its near-term links with risk sentiment and relative yields. Indeed, the correlation between EURUSD and the MSCI World Stock Index has dropped to just 0.36 while that with the EU – US 2-year Treasury yield spread (not shown) has withered to 0.34 on 20-day studies. The take-away seems to be that developments surrounding the Euro Zone sovereign debt crisis are firmly in charge of the single currency. Interestingly, the problems within the currency no longer appear to be weighing down investor confidence at large as swelling expectations of a resurgent US economy boost risk appetite. On balance, this puts the onus on the monetary policy announcement from the European Central Bank as traders look to Jean-Claude Trichet and company for concrete ideas on how to squash the crisis. Before the announcement however, the outcome of Portuguese and Spanish bond auction will set the tone, with poor uptake likely to weigh heavily on the single currency.

Source: Bloomberg

GBPUSD: Pound Eyes Bank of England Rate Decision, EZ Crisis

Monetary policy expectations remain in focus for the British Pound as GBPUSD continues to track closely with the spread between UK and US 5-year Treasury yields. First and foremost, this puts the spotlight on the monetary policy announcement from the Bank of England . On balance, another non-even seems likely as the central bank remains wedged between stubbornly high inflation and lingering uncertainty about the growth implications government’s austerity program as its more painful elements kick in this month. As such, Mervyn King and company are likely to delay any policy adjustments at least until February when they can be underpinned by updated quarterly inflation report. The Euro Zone debt crisis may also prove to be a significant catalyst if a rapid deterioration of investors’ confidence in the single currency sees capital flee out of Euro-denominated assets to seek shelter in Sterling as an alternative medium of exchange.

Source: Bloomberg

USDJPY : US Data Remains Key as Prices Track Bond Yields

US Treasury yields remain most prominent in driving Japanese Yen price action, although it is interesting to note that USDJPY the strongest correlation readings are shifting down the maturity spectrum. Put simply, whereas prices were closely tied with 2-year and 5-year yields in previous weeks, these relationships have weakened while that with 30-year yields remains significant. On balance, the US economic calendar remains in focus as traders size up the pace of recovery in the world’s top economy to gauge the likelihood of the Federal Reserve ending the second round of quantitative easing (QE2) before its scheduled completion. Indeed, while the possibility of such an outcome seemed virtually nil less than a week ago, last week’s revelation that there exists a “threshold” for making changes to the program now has traders guessing. The Fed’s Beige Book regional survey as well as Retail Sales , Trade Balance , Consumer Price Index , Industrial Production and UofM Consumer Confidence figures are all on tap.

Source: Bloomberg

CAD , AUD, NZD : Comm Bloc Focus Shifts to Rate Expectations

The Australian Dollar looks to have joined its Canadian and New Zealand counterparts in seeing the focus shift away from risk appetite toward interest rate expectations. This bodes ill for the antipodean currency as the floods in Queensland weigh on economi c growth and interest rate hike forecasts alike . December’s Employment figures headline the economic calendar, with the currency hoping to find some support in another decline in the jobless rate. Meanwhile, USDCAD and NZDUSD continue to look toward the spread between December 2011 interest rate futures – a gauge of where traders expect relative benchmark interest rates will be in a year – to guide directional momentum. With little of note on the domestic economic calendars, the spotlight is likely to fall on the US data docket.

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

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