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Forex: Euro To Retrace September Rally, British Pound Marks Longest Losing Streak Since 2008

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Talking Points

* Japanese Yen: Benefits From Rise In Risk Aversion
* British Pound: Weakens For The Eighth Day
* Euro: Inflation, Unemployment Hold Steady
* U.S. Dollar: Consumer Confidence, S&P/Case-Shiller Home Price Index on Tap

Fears surrounding the outlook for Portugal and Spain pushed the euro lower throughout the overnight trade, and the single-currency may face increased headwinds going into December as the risks for contagion intensifies. Ireland’s Justice Minister, Dermot Ahern, said members of the European Central Bank pressured the ailing country to request a bailout during an interview with a local broadcast station, and argued that the ECB is “doing the same with Portugal now” as the central bank tries to restore market confidence. At the same time, market participants speculate Spain will ultimately share the same fate as Ireland as the government faces rising borrowing costs, and the ongoing turmoil within the European financial system could lead the central bank to maintain the expansion in monetary policy throughout the beginning of the following year as it aims to balance the risks for the region.

As the headline reading for inflation holds at an annualized rate of 1.9% in November, with unemployment at its highest level since 1998, the ECB is likely to keep its exit strategy on pause later this week in order to encourage a sustainable recovery. We expect ECB President Jean-Claude Trichet to talk down the risks for contagion at the press conference tomorrow, but comments from the central bank head may fail to encourage a rebound in the exchange rate as market sentiment falters. As a result, the EUR/USD should continue to retrace the advance from September, which would expose the 23.6% Fibonacci retracement from the 2009 high to the 2010 low around 1.2620-40, but there could be a small correction before we see anther selloff in the exchange rate as the recent decline remains oversold.

The British Pound extended the decline from the previous day as investors continued to scale back their appetite for risk, and the GBP/USD may face increased selling pressures going into the North American trade as it searches for support. However, as the relative strength index holds above oversold territory, there could be a corrective retracement in the pound-dollar following the eight-day losing streak, but the uncertainties surrounding the European debt crisis could generate additional selling pressures for the pair as risk trends continue to dictate price action in the currency market. As the GBP/USD breaks out of the upward trend from May, the sharp reversal in the exchange rate could lead the pair to fall back towards the 200-Day moving average at 1.5347 as it looks for support, and the British Pound is likely to depreciate further throughout the day as equity futures foreshadow a lower open for the U.S. market.

The greenback advanced against most of its major counterparts on Tuesday, while the USD/JPY halted the four-day advance as the Japanese Yen rallied across the board, and the recent rally in the dollar may gather pace in December as the reserve currency benefits from the flight to safety. Nevertheless, the major currencies are likely to face increased volatility later today as the economic docket is expected to show home prices in the U.S. contract another 0.40% in September after falling 0.28% in the previous month, but a rise in consumer confidence could spark a shift in market sentiment as the outlook for future growth improves.

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