US Dollar: Rally Continues But Momentum Slows
The US dollar continued to rally to fresh two-month highs against the euro and other major currencies, as traders showed little willingness to hold onto dollar shorts ahead of year-end celebrations. The rally began on an overnight sell-off in major Asian equity markets, with Hong Kong’s Hang Seng index losing a sizeable 3.5 percent and forcing a similar carry trade unwind. Continuation in stock market sell-offs through the later London trading session allowed for a further dollar advance, but greenback momentum finally slowed as North American traders took their seats through the New York open. Impressive Current Account and Net Treasury International Capital Flows results boosted the greenback’s prospects, but the news was not enough to push the buck to fresh heights. The national Current Account Deficit shrunk to its smallest in two years through the third quarter, while foreigners invested a net $114.0 billion in domestic securities through October. The Current Account result was largely expected, as a noteworthy decline in monthly trade balance deficits allowed the balance of payments to stabilize through the period. Yet the subsequent TIC’s report was very much unexpected—with the sharply positive surprise beating even the most optimistic of economist forecasts. A surge in foreign private investment into US capital markets was the driving force behind the positive surprise, but sovereign buying interest actually moderated through the period. Indeed, sovereign entities bought a mere $21.8B in US securities—a number that paled in comparison to a $94.0B buying binge by private interests. The results suggest that foreigners have not lost their appetite for downtrodden US equity and fixed income markets. Yet it will be important to see whether this trend will continue through subsequent months, with a further deterioration in financial market conditions to undoubtedly damage foreign interest in US asset classes. So far the news is bullish for the US dollar, but a tepid reaction the release highlights forex traders’ indifference to October TIC’s results.

Euro Positioning Continues To Unwind
Euro traders sent the single currency lower against most forex counterparts through the day of trade, as year-end squaring and a broader carry trade unwind doomed the EUR to further declines. Economic data for the Euro Zone was relatively mixed through the session, with PMI Manufacturing and Services results coming in almost squarely at consensus forecasts. According to official breakdowns of composite Purchasing Managers’ Index data, output growth in services and manufacturing industries slowed to their lowest levels in at least five months. Such figures are hardly a ringing endorsement for European economic strength, and a continued downtrend in these key numbers damage the case for further European Central Bank interest rate increases. As it stands, markets have clearly scaled back expectations for ECB rate hikes. Yet the central bank remains resolutely hawkish, and forex speculators may wait for a clear shift in rhetoric before ruling out further rate increases.

British Pound Tests 2.01, Bulls Reemerge
Selling pressure is building in GBPUSD, and it seems the only thing holding the pair back is technical support and inflation hopes. Friday’s selloff was revived this morning after the Rightmove House Prices indicator crossed the wires in worse shape than fundamental traders had expected. There was no official consensus attached to the report, but steady trend and sustained credit problems through the past few weeks suggested the reading would be yet another negative print. Officially, the 3.2 percent drop in prices for their December period marked the biggest monthly decline in five years. More discouraging than the sizable decline though was the fact that London prices were guiding the headline reading down, as the residential market in the capital represents a significant source of private investment. After this data hit the ticker, GBPUSD dropped for an exact touch of 2.01, though an 18-month old trend took the steam out of selling. Tomorrow’s inflation data could be a deciding factor for the pound’s long term trend with the MPC having already gotten the first rate cut out of the way.

Yen Loses Traction as Equities Decline
The prospect of the Federal Reserves first term auction for $20 billion didn’t seem to boost the risk sensitive USDJPY Monday morning. Not even the unexpected announcement from the ECB that they would offer unlimited funds below the market rate could revive traders’ taste for risk. In fact, the usually uncorrelated dollar-based pair actually joined its brethren by easing off resistance seen building around 113.50/75. From the economic calendar overnight, only the Tertiary Industry index for October was garnering interest. A 1.1 percent pick up in the service-based figure was only slightly below the market’s consensus for a rebound. The breakdown revealed that activity in retail, financial and software services were the leaders for the month.

Mixed Data Lends Little Help to Canadian, Australian and New Zealand Dollars
There was little buying interest in the comm bloc this morning as market participants shunned risk in the carry and mixed data added little value for fundamental traders. Early in the Asian session, the New Zealand calendar kicked things off with Performance of Services Index for November, which reported improvements in all its components, including sales, employment and new orders. The Australian dwelling starts figure for the third quarter matched its best reading since the first quarter of 2006, though there was no change to the housing component. Finally, the Canadian calendar was the most surprising. According to Stats Canada, net investment dropped a record C$24.3 billion. However, this disappointment was curbed somewhat when the outflow was seen through stocks and specifically through mergers.

Kathy Lien is the Chief Currency Strategist at FXCM.