US Dollar Drops as Geopolitical Risks Rattle the Currency Markets
Weak economic data as well as the assassination of Pakistan’s former Prime Minister Benazir Bhutto sent the US dollar tumbling. In the past, we have seen the dollar rise in response to geopolitical risks as traders flock to the safety of the greenback, but that was not the case today. Since the US has interests in the region, the markets fear that they may end up getting involved especially if extremists are able to wrestle control of the nuclear armed country. Although scary, as long as the situation does not get worse over the next week, we believe that this fear will slowly subside, allowing traders to turn their focus on trading opportunities in the New Year. Ending the year with weaker US economic data makes it hard to believe that the January seasonality effect on the US dollar and US stocks will take hold of the markets once again. According to our Seasonality study, the dollar tends to rise in January as global investors reinitiate new investments. This is the same reason why we also tend to see US stocks rally in the first trading month of a new year. Even though consumer confidence improved in the month of December, durable goods and jobless claims were much weaker than expected. It is becoming increasingly apparent that the weakness of the US dollar is not having a very beneficial impact on the US economy. The durable goods report is just another piece of news in what has been a string of weak manufacturing data. Earlier this month, the Philly Fed survey dropped to a 4 year low while the Empire State manufacturing survey fell to a 6 month low. Tomorrow we are expecting Chicago PMI, new home sales and the help wanted index. The disappointments in the US manufacturing numbers suggest that there is a strong chance that the Chicago PMI number will also fall short of expectations.

Euro: Strongest Currency of the Day
The Euro was the strongest currency of the day, rising against the US dollar, British pound and Japanese yen. The comparatively rosy outlook of the Eurozone economy and the hawkishness of the European Central Bank made the Euro the de facto safe haven currency. Even though investors have also poured money into the Swiss franc, it outperformed the Euro only marginally. Preliminary data on German consumer prices are scheduled to be released tomorrow along with retail PMI. The 0.6 percent rise in CPI in Saxony suggests that inflation rates across the country should remain high. With business confidence falling to the lowest level in 2 years, there is a good chance that consumer spending could slow. Meanwhile the Swiss franc was the only currency that managed to challenge the Euro’s rise. Even though the currency is no longer backed by gold, it is still benefitting in times of geopolitical uncertainty, especially since it is not clear immediately how bad things may get. Switzerland will be reporting the UBS consumption index and their KoF Swiss leading indicators report. With unemployment rising, industrial production and retail sales weakening, we could see a deterioration in both reports.

British Pound Rebounds, Putting 2.0 in Reach
The British pound rebounded strongly today thanks to better than expected economic data and broad dollar weakness. Both housing equity withdrawals in the third quarter and BBA loans for house purchases in the month of November increased from the prior period which suggests that the UK housing market may be finding some support. However we are skeptical about whether that is true since the UK economy is still very vulnerable at the moment. Nationwide house prices are due for release tomorrow and that should provide a more current reflection of how the housing market is doing. Next to the US, the UK is still the country that has the greatest chance of lowering interest rates in the first quarter. For that reason, we believe that a further recovery in the British pound may be limited.

Stronger Oil and Gold Prices Drive Australian, New Zealand and Canadian Dollars Higher
The geopolitical turmoil in the Middle East has sent gold and oil prices higher today. In a region whose wealth is reliant on commodities, it is no wonder that oil and gold prices were the first to react to the assassination of former Pakistani Prime Minister Bhutto. Gold is the purest form of wealth and almost always rises in times of geopolitical uncertainty. With the implications for the US unclear, we expect gold to continue to trickle higher, which should benefit both the Australian and New Zealand dollars. The Canadian dollar, on the other hand, is higher because oil prices are higher. For a region whose wealth is contingent upon the value of the natural resource, anything that stands to threaten the availability of the resource on the open market will trigger a price increase which eventually filters down to the value of the Canadian dollar.

Dow Falls Close to 200 Points, Taking Some Japanese Yen Crosses Down With It
The Dow fell close to 200 points today on the back of the news that Pakistani Prime Minister Bhutto has been assassinated. However not all of the Japanese yen crosses or carry trades fell with it. USD/JPY was the only yen cross that suffered significantly, which tells us that the move in the currency markets today is more of a dollar story than anything else. We expect traders in Asia to send equities lower as well which could weigh on the Yen crosses in early trading. We have a lot of Japanese economic data due for release tonight including consumer prices, industrial production, retail sales, manufacturing PMI, overall household spending and labor cash earnings, so expect some interesting price action in the Japanese yen tonight.

Kathy Lien is the Chief Currency Strategist at FXCM.