For the second day in a row, the sell-off in USD/JPY dragged all of the major currencies lower. We can tell by the relatively moderate losses in the EUR/USD and more significant losses in EUR/JPY that cross selling drove the EUR/USD lower. The same be can be said for other currency pairs such as the AUD/USD and even the GBP/USD. What we are witnessing is deleveraging. Over the past 2 months, with the blessing of Prime Minister Abe who pledged to ease monetary policy aggressively, many investors jumped back into Yen funded carry trades and now they are taking profits below key levels after Japanese officials expressed concerns about Yen weakness. This goes to show how rapid movements in the foreign exchange market can frustrate policymakers even though it may be good for the economy. Last night, Japanese LDP Secretary General Ishiba said yen weakness would affect some industries negatively.

The Japanese are not the only ones talking about their currency. This morning, the EUR/USD found support from ECB member Nowotny who said the currency was not a major concern. This was a relief because traders got a little nervous after EU Juncker said the euro was at dangerously high levels. While there is a tremendous amount of economic data on the calendar this week, when trends become overstretched currencies can be particularly vulnerable to comments from policymakers. Therefore the potential resumption of the USD/JPY and EUR/USD rallies hinge not upon this week’s economic reports but rather the Bank of Japan’s willingness to follow through with a more aggressive and convincing plan to increase monetary stimulus next week.

In the meantime, deleveraging also drove the dollar higher against all of the major currencies except for the yen. The most important event risk today will be the Beige Book report, which is scheduled for release later this afternoon. This up to date assessment of economic conditions in the 12 Fed districts is used by the central bank to determine monetary policy. Consumer prices were released this morning and the data continues to show muted inflationary pressures. CPI was flat in the month of December after falling 0.3% in November. Core prices which exclude volatile food and energy costs increased a mere 0.1%. On an annualized basis, CPI growth eased to 1.7% from 1.8%. The lack of inflation allows the central bank to keep monetary policy extremely easy. The Treasury International Capital Flow report, a measure of demand for U.S. dollars showed foreigners buying $52.3B worth of long term Treasuries, which is encouraging considering it, was during the height of the Fiscal Cliff uncertainty. Industrial production will be released later this morning following by the Beige Book report in the afternoon.

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