How Will the US Dollar Trade Post Payrolls?
It has been an active trading week in the currency market and things are only expected to get even more interesting with tomorrow’s November non-farm payrolls report. According to our Employment Preview, the arguments are skewed heavily in favor of weak job growth causing everyone from traders to analysts to second guess their original estimates. In fact, many professional analysts have even been spooked into revising their official forecasts. Although everyone may be skeptical of the ADP report, they realize that they cannot dismiss it. As traders, we should first recognize the fact that the dollar has been strengthening for the better part of this week. Although this may be due to external factors such as central bank meetings and stock market strength, it means that traders have not been selling dollars ahead of the release. According to our latest FXCM SSI index, speculative traders are still net short Euros. The forecast for non-farm payrolls is 80k, but we suspect that the whisper number is closer to 100-125k. Therefore a dollar rally on the heels of a strong release could be limited unless we see job growth in excess of 200k. This has become a market of pessimists which means that even if we get a strong non-farm payrolls number, they will be skeptical about whether the number is real and if that strength can be repeated the following month. If we get a bad number however, expect mayhem in the markets because the revisions in payroll forecasts and the recent rally in the US dollar indicates that traders are not expecting payroll growth to be at or below 80k. The reference point here is clear and we could even see dollar weakness if payrolls are 100k or less. With the Bank of England surprising the market with an interest rate cut today, a better reactive trade may be to short the GBP/USD over the EUR/USD. If it is a weak number, the hawkish comments from ECB President Trichet this morning makes the EUR/USD a better trade.

ECB Stands Ready To Raise Rates
The European Central Bank left interest rates unchanged at 4.00 percent today and to the surprise of the market not only did Trichet hold onto his hawkish inflation bias, but he made sure to let the market know that he will not hesitate to raise interest rates if inflation does not come under control. When it comes to talk, the ECB is the most hawkish central bank out there even though they last raised interest rates in June. This characteristic should help the Euro outperform other currencies in the coming week. According to Trichet, price pressures are very strong and economic fundamentals, despite everyones skepticism remain sound. He has pledged to do all it takes to ensure that second round effects will not happen so traders should be prepared for a rate hike if inflation does not give. As a central bank, the ECB is notorious for making good on their words. On the Euro, Trichets comment that external demand will support exports indicates that he is not worried about the level of the currency at the moment. We continue to believe that 1.50 is the pain threshold for the central bank and we do not expect it to reach that price level before the FOMC meeting.

Bank of England Cuts Interest Rates by Quarter Point
The Bank of England cut interest rates by 25bp for the first time in 2 years, marking a sharp shift in monetary policy. Yet, the British pound failed to extend Thursdays losses because the statement made by the BoE did not suggest that they will ease monetary policy further. With the interest rate curve still pricing in 75bp of easing next year, the central banks neutral tone has scared traders from continuing to sell pounds. As we mentioned in yesterday's Daily Fundamentals, the BoE had good reasons to cut interest rates. Growth is weakening, the housing market is deteriorating and LIBOR rates have increased sharply in recent weeks. Going forward however, inflation is still a big concern which means that if it remains high, the central bank may sit on their hands next month. The minutes from the meeting will be extremely important in determining the timing of the next rate cut. The British pounds lack of follow through weakness has led some traders to believe that we have seen a spike bottom in the GBP/USD. If that is true, it will be because of US and not UK fundamentals.

Canadian, Australian and New Zealand Dollars Strengthen
The Canadian, Australian and New Zealand dollars strengthened today as oil prices rallied back above $90 a barrel and gold prices held steady above $800 an ounce. There was no Australian or New Zealand data released overnight but Canadian building permits and IVEY PMI were stronger than expected. After selling off for five days straight, the latest data has helped the Canadian dollar recover. In fact, this turn is beginning to look real and we believe that USD/CAD could now move back below parity and at least test 99 cents. The employment component of the IVEY PMI also accelerated last month which suggests that Canadian employment numbers could be firm tomorrow. The forecasts are very low indicating that it will not take much to surprise to the upside.

Carry Trades Trail Stocks Higher After Bush Unveils Plan to Save Home Owners
Another strong day in the Dow has helped to take carry trades higher. Risk appetite has returned to the market following the Bush Administrations plan to give relief to subprime homeowners. According to President Bush, close to 2 million homeowners will be able to take advantage of a five-year mortgage rate freeze. Risk appetite however can turn on a dime so watch out for payrolls tomorrow because if it is bad, stocks may reverse quickly, taking carry trades lower as well. Japanese GDP is due for release this evening, but these are final numbers which means that they will not be market moving.

Kathy Lien is the Chief Currency Strategist at FXCM.