Dismal Data Weighs on USD

The dollar’s recent rebound against the euro and sterling was undermined by weak economic data. The reports released earlier today added to burgeoning fears that the US economy is headed toward a recession. A combination of poor housing data and a disappointing Philadelphia Fed survey set the tone for the trading session, with the greenback initially weaker across the board. The reports also fueled expectations for aggressive policy easing from the Fed beyond the largely priced-in 50-bp rate cut anticipated at the end of the month.

Housing starts for December plunged by over 14% to 1.006 million units, its lowest level in 16-years. Consensus estimates were calling for a drop to 1.14 million units versus 1.187 million units from the previous month. December housing permits declined by 8.1% to 1.068 million units, versus a 0.7% drop in November at 1.162 million units. On a positive note, weekly jobless claims declined to 301k from 322k.

The January Philadelphia Fed survey revealed dismal economic conditions, falling to its lowest level in six-years to -20.9, far greater than expectations for a decline to -1.0 from -1.6 from December. The employment index dipped into negative territory in January to -1.5 from 3.8 in December, its lowest level since September 2003. The new orders component fell to -15.2 in January, a sharp reversal from the 12 reading in December.

USD Recovers

The dollar stabilized against the majors on Monday following last week’s US data-induced plunge. The greenback climbed to a 4 ½-month high against the sterling to 1.9655 while edging up to 109.72 versus the yen. Sentiment over the direction of global interest rates will dictate currency movements this week, with both the ECB and BoE announcing the results of their policy deliberations on Thursday and Fed Chairman Bernanke speaking on “Financial markets, economic outlook and monetary policy”.

The lackluster US economic reports last week fuelled speculation for a 50-basis point rate cut from the Fed when it meets at the end of the month. However, given the current outlook for inflation it remains to be seen whether the FOMC will move aggressively to stimulate the struggling economy. The coming week will see a barrage of Fed speakers, including Board members Plosser, Rosengren, Poole, Hoenig, Mishkin and Chairman Bernanke. The comments will be closely scrutinized for clues on the scope for additional easing.

Atlanta Fed President Lockhart delivered a somber assessment of the economy, saying the negatives may be gaining momentum and that now is a time of heightened uncertainty. He said that market contacts have expressed serious concern about further market deterioration and spillover. However, he remains troubled by the elevated level of inflation despite expecting inflation to moderate this year. He believes the Fed has been attentive in making appropriate policy responses to the economic situation. Lockhart added that the Fed is balancing concerns about inflation with serious concerns about growth.

Divergent CB Outlooks Drive FX

The dollar tumbled against the euro, breaching the 1.48-level in the face of sharply divergent comments from each respective central bank’s chief. ECB President Trichet hinted at further tightening on the back of Eurozone economic strength, while Fed Chairman Bernanke offered a somber assessment of the economy and raised expectations for a 50-basis rate cut at the next policy meeting.

Chairman Bernanke said the Fed stands ready to take “substantive action” to support growth and that further easing “may well be necessary” in light of risks to growth. While the December jobs data was disappointing, Bernanke said it would be a mistake to read too much into one report. Nevertheless, he feels the baseline outlook for 2008 has deteriorated and the downside risks are now more pronounced. Further, Bernanke said that inflation expectations remain reasonably anchored.