Talking Points

• US Dollar Recovers in Asia, Commodity Bloc Bears Brunt of Selling
• German, Portuguese Bond Auction Outcomes Take Spotlight in Europe
• Eurozone CPI to Hit Four-Month Low, May Boost ECB Rate Cut Bets
• S&P 500 Futures Point to Risk Aversion, US Factory Orders on Tap

TheUS Dollar (ticker:USDollar) recovered against most of its leading counterparts in overnight trade as currency markets digested yesterday’s selloff that saw the greenback slide 0.9 percent against the majors, marking the largest daily drop in two weeks. TheAustralian Dollar underperformed, down as much as 0.5 percent against its US namesake. The likewisesentiment-linkedCanadian and New Zealand Dollars were not far behind, down as much as 0.4 percent apiece.

Looking ahead, the spotlight turns to a pair ofbond auctions in Germany and Portugal. Berlin will sell €10 billion in 10-year paper while Lisbon will offer €1 billion in 105-day bills. Traders will keep a close eye on average yield levels and bid-to-cover readings – a measure of demand – to get a sense of sovereign solvency fears in the region as Eurozone countries face the need torefinance a whopping €157 billion in maturing debtjust in the first three months2012.

Conflicting cues abound. The 3-month Euribor-OIS spread, a measure of liquidity risk, fell to the lowest in two weeks yesterday, meaning credit market conditions have improved. On the other hand, the ECB reported that banks parked €446 billion in its deposit facility yesterday, just shy of the record €452 billion on December 27, meaning most of the nearly €500 billion banks borrowed via the 3-year LTRO has yet to begin moving into the real economy to offer any viable funding relief. All told, markets will have to wait for the auctions’ outcome for greater clarity.

On the data front, the preliminary estimate of December’sEuro Zone CPI reading headlines the docket, with expectations calling for the annual inflation rate to drop to a four-month low at 2.8 percent. The result may bolster expectations that theEuropean Central Bank will reduce benchmark interest rates or introduce new non-standard easing measures to head off fears of a credit crunch and stoke sagging economic growth, weighing on theEuro. As it stands, markets are pricing in a 40 percent probability of a rate cut at the policy meeting coming up on January 12. Final revisions of the December set of German and region-wideServices PMI numbers are also on tap.

On the sentiment front,S&P 500 stock index futures are trading meaningfully lower in late Asian hours, hinting at the return of risk aversion that offers a lifeline to greenback at the expense ofstocks-correlated currencies.US Factory Orders figures will come into the picture in the afternoon. Expectations call for the largest increase since July, fueling hopes that improvement in the world’s largest economy will help offset slowdown in the Eurozone and China – the other leading engines of global GDP expansion – and boost risk appetite anew.

Asia Session: What Happened

Euro Session: What to Expect

Critical Levels

---Written byIlya Spivak, Currency Strategist forDailyfx.com

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