US Dollars: Best Trade of 2007, What Is In Store for 2008?
Selling US dollars was one of the best trades of 2007. Since the beginning of the year, the dollar has fallen as much as 13 percent against the Euro, 10 percent against the Japanese yen and 8.5 percent against the British pound. The story of the dollar’s weakness also captured headlines around the world. It became so pronounced that supermodel Gisele announced her preference for being paid in Euros over dollars. Everyone from our barbers to our bartenders has been asking us when the US dollar will bottom and just when that happened – the dollar’s slide came to a screeching halt. The question now is will the turn in the dollar last or will the weakness resume in the New Year. There are many factors at play. With high inflation still a problem, the Federal Reserve is running out of options. Over the past few months, Bernanke has needed to come up with more creative ways to calm the credit market. Their big liquidity injections have helped to bring down LIBOR rates, but uncertainty in the markets could also reverse their efforts in a blink of an eye. This is why they have pledged to conduct biweekly auctions of short-term funds for as long as necessary. However subprime problems will not go away until banks have reported all of their off balance sheet losses. When we stop hearing bad news and start hearing some good news, we will see the major shift in the markets that everyone has been hoping for. 2007 has also been about the decoupling story and we believe that recoupling will become the story of 2008. Many countries around the world have been lucky enough to skirt a major slowdown but if US growth continues to slow, the surprises next year could be from places like the Eurozone. Hawkish comments from the European Central Bank have encouraged traders to price a rate hike next year. If growth slows, those expectations could shift from a rate hike to a rate cut, which in turn would be positive for the dollar and negative for the Euro. 2008 is also an Election Year. The financial markets tend to favor Republicans over Democrats, especially since taxes are expected to be increased under a new leadership. In the coming week, liquidity should be particularly thin with the currency market closed on the 25th and 26th. There are no US economic releases until Wednesday.

Euro: Strong Data Fails to Please the Market
The Euro has been trapped within a 200- to 250-point trading range for the past week and even though the currency rebounded against the US dollar today, the move was just a rebound and nothing else. Economic data was strong with German import prices, French business confidence, French consumer spending and producer prices all surprising to the upside. The current account was weaker, but the data mattered little because it was from October. The Euro is stronger today, but the bulk of the move happened in the late Asian trading session and not on the heels of the economic releases. Economic data out of the Eurozone has been strong, but this strength has long been discounted by the market. Also, the recent liquidity injections by the ECB suggest that even if they want to raise rates, they will not be able to do so anytime soon. ECB President Trichet repeated the central bank’s goal of making sure the inflation spike is short lived, but Constancio took a different stance and warned the market that the risks to growth have increased as a result of the credit crisis. Like the US, the Eurozone economic calendar is exceptionally light in the coming week. The only potentially market moving report is Eurozone Retail PMI on Friday. Switzerland on the other hand will be releasing the UBS Consumption Indicator and the KoF Leading Indicator.

British Pound: No Relief Yet
There is no relief yet for the British pound which failed to rally for fourth consecutive trading day. Retail sales doubled expectations, but consumer confidence deteriorated. The UK economy is falling into a black hole and that weakness is being reflected in the British pound. At this point, the UK will need to lower interest rates again in the coming year as the credibility of the country’s new Prime Minister is tested. The recent developments in the UK and the British pound are a perfect reflection of what could be in store for the Euro. If data starts to turn so will market sentiment. In the week ahead, we are only expecting housing market reports from the UK. This includes Nationwide house prices and BBA loans data.

Strong Gains for Canadian, Australian and New Zealand Dollars
Canadian GDP and retail sales were stronger than expected in the month of October, triggering another day of gains for the loonie. This is the sixth consecutive day of strength for the currency pair , which up until last week was undergoing a near vertical reversal after hitting an all time low of 0.9059 on November 7. The Australian dollar is also stronger thanks to a nice jump in the Conference Board Leading indicators report and new motor vehicle sales. Even the New Zealand dollar benefitted from a rise in credit card spending. In the week ahead, we have no Canadian or Australian data due for release, but New Zealand will be reporting their November money supply figures.

Dow Rises 200 Points, USDJPY Hits One Month Highs
Wall Street’s preholiday rally has helped to take all of the Japanese yen crosses higher. There was no economic data released from Japan overnight, but they will be the only country releasing economic data on Monday and Tuesday. These reports should not be market moving however because most traders will be out for the holiday. Meanwhile, sovereign wealth funds continue to dominate the headlines with Singapore’s state-owned Temasek Holdings planning to inject $5 billion into Merrill Lynch. They have become the new saviors for banks who have been badly burned by subprime losses. Expect this new trend to continue.

Kathy Lien is the Chief Currency Strategist at FXCM.