The U.S. Dollar managed to hold on to its overnight gains despite a lackluster trading session. Following a couple of overnight events and intra-day economic reports, the Dollar remained range-bound as many large traders stood aside ahead of tomorrow’s Fed FOMC announcement. Traders are looking for the Fed to leave interest rates alone and to continue to leave them low for “a prolonged period of time.”

The Dollar surged overnight, driven by bearish news out of Asia. The Dollar rallied sharply overnight after a couple of negative economic events drove traders to the safety of the Greenback. The Dollar was up today against European and Pacific Rim nations while falling against the lower yielding Japanese Yen. The initial move to the upside was triggered by Japanese debt issues and more evidence that China was beginning a tight monetary policy.

Firm U.S. corporate earnings reports coupled with a better than expected U.S. consumer confidence report helped to weaken the Dollar at one point during the day because of an increase in demand for higher risk assets. Investors didn’t turn outright bearish on the Dollar, but instead realized that the new data was sufficient enough to warrant a lightening of positions. The Dollar also got a boost from the new Obama proposal to freeze the budget in certain areas for three years. This sent a sign to traders that the U.S. was serious about its burgeoning debt situation.

Greater demand for lower-yielding assets helped to drive the USD JPY lower this morning. Most of the selling pressure took place early last night after the S&P debt rating service put a negative spin on Japan’s AA credit rating. Talk is circulating that S&P may cut the rating to -AA after expressing concerns about Japan’s ability to gain control of its growing debt levels as well as stave off the deflationary pressures haunting the economy. Technically, the USD JPY reached a key downside target at 89.30 before profit-taking drove it off the low.

The Bank of Japan voted to keep interest rates unchanged at its last meeting, but reiterated its commitment to fighting deflation. In the meantime, it raised its deflationary forecast from a predicted drop of 0.8% to 0.5%.

In addition to Japan’s debt rating concerns, China singled out the banks required to raise their reserve ratios for excessive lending while telling others to stop lending. Both events are signs that the Chinese government is serious about shoring up its finances and cooling down its economy. This action is expected to keep pressure on demand for commodities.

General weakness in higher risk assets helped to pressure the EUR USD. This market traded weaker but held above last week’s low at 1.4029. A failure at this price could trigger a further decline to 1.3800. Losses may have been limited because of the possibility that Greece’s debt problems may be resolved by a new bond issuance.

The GBP USD traded sharply lower after the U.K. GDP report showed that the economy grew at a slower than expected rate. The low figure of 0.1% was smaller-than-forecast and showed

that the economy narrowly avoided prolonging the recession. This report confirms that the U.K. economy is lagging behind the rest of world’s recovery and could signal that additional stimulus may be needed to revive the economy. Technical retracement areas prevented this market from collapsing.

Lower crude oil and gold continued to provide support for the USD CAD while threatening to weaken the Canadian economy. Upside momentum indicates that 1.0745 is the next target. Recent action by the Bank of Canada to provide stimulus to the economy is also helping to weaken the Canadian Dollar. Technically, this market is overbought, but will remain steady to better unless a support angle at 1.5044 is violated.

News that China took a major step toward tightening its monetary policy helped to pressure the AUD USD and NZD USD. A slowdown in the Chinese economy will have a direct negative effect on the Aussie and Kiwi economies. Demand for raw materials could drop drastically in the near futures because of China’s tighter monetary restrictions.

In addition to the news from China, global investors are becoming more risk averse. This is putting more pressure on higher yielding assets. Losses were limited by the stronger than expected U.S. equity markets. On Wednesday, the Reserve Bank of New Zealand is likely to leave interest rates unchanged while remaining committed to leaving rates low until the middle of 2010.

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