Sovereign debt risks and fiscal concerns continue to dictate the underlying sentiment in Forex markets at present. Moody’s rating agency threatened to down grade Spain’s credit rating overnight weighing heavily on Euro price movement and overall investor sentiment. The euro has fallen back towards the $1.33 price level against the USD and retraced 70 pips against the GBP which now currently holds above 1.18 in early European trade. The Euro decline from yesterday highs at 1.3000 has extended below 1.2800, with the Common currency sold across the board on renewed sovereign debt fears, and the pair reached an all time low at 1.2758. On the bigger picture, the pair has been going through a steady decline from November highs at 1.3835, retreating all the September-November rally, to reach support area at 1.2855/65.

The US Dollar outperformed in overnight trade, rising against all of the major currencies in the aftermath of the Federal Reserve rate decision as policymakers offered no substantive changes to the established monetary policy outlook, opening the door for a continuation of the post QE2 noted since early November. Despite the improving growth figures coming out of the worlds largest consumer market last nights FOMC statement confirmed that the US central bank will continue to pursue a very accommodative policy stance.

The Federal Open Market Committee held its key benchmark rate between 0 and 0.25 percent, as expected, and maintained its pledge to leave the rate at its historic low for an “extended period.” Policy makers also kept their plan to purchase $600 billion of Treasury securities by June, citing a slow U.S. recovery that appears “insufficient to bring down unemployment.” In addition, committee members said that price pressures are still muted, as underlying inflation continues to “trend downward” and future inflation expectations remain “stable.”

Looking at the key releases from yesterday, sterling was modestly supported by yesterday morning’s release of the UK CPI report for November, which showed that the inflation rate remains well above the BoE’s target, further reducing the likelihood of further QE. The report showed that the headline rate of inflation ticked up to 3.3% in November, compared to market expectations for a modest fall to 3.1% from 3.2%. This marks the eleventh consecutive month that UK inflation has been above the Bank of England’s 2.0% target and will be heavily observed going into 2011 when spending cuts and VAT rises start to take effect. The Pounds volatility in recent days still confirms the fact the Pound continues to follow the broad based sell off in riskier assets, with trends and indicators suggesting the the Pound is still heavily correlated to various asset classes and leading indices. Following the consumer and Retail price index figures the Pound initially sett monthly highs against the US Dollar touching over 1.5900 yet a later Greenback reversal left the GBPUSD almost squarely where it traded 24 hours prior with the USD generally benefitting from the “On Risk” cyclical pattern we have become so used to seeing.

Overnight Index Swaps now show that 12-month rate expectations trade at their highest since May however UK jobless claims data released this morning below expectations may impact the MPC’s stance going forward. Looking at the higher yielding currencies the GBP/AUD continues to follow its bearish trend pattern with reports from Australia revealing business confidence had declined from the previous month while the number of new homes for the 3rd quarter contracted by -13.2%. The Aussie dipped to an intra-day low of 0.9940 against the Greenback upon release of the data however remained reasonably stable against the Pound. GBP/AUD this morning continues to test the all time low at 1.5765 following the Jobless claims release, with a break of “support” opening up the way up to significant selling from speculators. New Zealand retail sales figures disappointed investors, contracting -2.5% in November. Economists had estimated sales to contract -0.8% from the previous month, this caused the Kiwi to slip below 2.1000 – touching 2.0930 (intra day low).

Commentary by Tom Trevorrow