The US dollar and the yen look poised to end the first month of 2009 with solid gains as persistent concerns about the global economy and the banking sector continue to dampen risk appetite and foster safe-haven flows into those currencies.
A barrage of economic data next week, highlighted by the advance reading of US fourth-quarter gross domestic product and German Ifo business climate survey for January, is set to heighten worries about a deepening recession around the world.
Also vying for the market's attention will be the Federal Reserve's two-day policy meeting starting on Tuesday. With no room to cut interest rates further, the spotlight will be on the statement the central bank is due to issue after the meeting and which is expected to shed light on the Fed's thinking on more unconventional policy tools to stimulate the economy.
Demand for the dollar and the yen as safe havens firmed in recent sessions after news of more troubles at US and British banks reminded investors that the global banking crisis is far from over. Further deterioration in the euro zone economy following a spate of sovereign ratings downgrades also aided the greenback's relative attractiveness.
"What's clearly dominating the market flow right now is the return of risk aversion. It's very clear in the dollar and the yen because they're the primary beneficiaries of fear in the markets," said Boris Schlossberg, director of currency research at GFT Forex in New York.
Given a worldwide economic slump, the risk aversion trend is likely to persist for some time, he added. The dollar hit a 23-year peak against sterling and six-week high versus the euro on Friday after data showed the UK economy contracted by 1.5 percent in the fourth quarter, far more than analysts had expected, confirming a recession.
So far this year, the euro has declined about 7 percent versus the dollar, on track for its biggest monthly decline since last October. The euro also fell 9 percent versus the yen in January.
The dollar was on pace for its biggest monthly gain since October of more than 5 percent versus a basket of currencies. Against the yen, the dollar fell about 2 percent this month. Any new details on President Barack Obama's $825 billion fiscal stimulus package may also impact the markets, analysts said. The plan will be voted by the House of Representatives next week.
INTERVENTION, STERLING: The risk of currency intervention was rising after officials from Japan and Switzerland stepped up jawboning this week to weaken their currencies. The sharp slide in sterling also attracted attention, with a G7 official warning that its weakness will be discussed at the group's next meeting.
For that reason, the upside potential in the yen may be limited as investors remain on alert for possible yen-selling by Japan. The yen hit a 13-1/2-year peak against the dollar this week. "I am watching dollar/yen and its stubbornness to make a significant move towards 85," said Dustin Reid, senior currency strategist at RBS Global Banking & Markets in Chicago.
Reid said the possibility of Japanese intervention "has become slightly more compelling over the past 48 hours or so" after Treasury Secretary nominee Timothy Geithner's comments that China is manipulating its currency. "Talk is that China might then opt out of purchasing US Treasuries in retaliation. This would likely leave Japan as the key foreign purchaser of US debt," he said.
The data calendar in the coming week is busy. US fourth-quarter GDP is due on Friday. The economy likely contracted by 5.4 percent in the final three months of 2008, the latest Reuters poll showed. A weaker number "will further fuel market fears that the recession is deeper than anticipated and might last longer than anticipated," said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto.
A slew of housing data including existing homes, home price indexes issued by S&P/Case-Shiller, and new home sales will be released. Other indicators include jobless claims, durable goods, and reports on consumer confidence and sentiment. Investors will also keep an eye on the value of sterling and some traders said the currency looks oversold and a bounce is likely after a 7 percent drop versus the dollar this week.
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