Non-Farm Payrolls Will Determine if January Can Still be a Strong Month for the US Dollar
December non-farm payrolls are due for release on Friday and now more than ever, the number will be critical in determining where the US dollar is headed. January is generally a strong month for the US dollar and the greenback still has a chance to rally as long as payroll growth is stronger than November’s 94k print. Even if NFPs are right in line with expectations of 70k, the dollar could still rally because it would suggest that the labor market has not deteriorated enough to warrant more aggressive easing by the Federal Reserve. With oil prices hovering around $100 a barrel, inflation pressures are back and we are sure that this is wrecking the minds of central banks around the world. Just when oil prices were stabilizing, central banks felt comfortable enough to focus on growth and lower interest rates. If oil prices do not back off now, the Federal Reserve will reluctantly dole out each additional rate cut. Most of the leading indicators for non-farm payrolls are projecting softer job growth. The Monster.com Index of online job advertisements, help wanted ads and the Hudson Employment index all fell to significant if not record lows while ADP only reported private sector payroll growth of 40k. However, the risk of a revision to the November number is high because of the strong ADP figure that we saw in November. NFPs are a tough call this time around because we do not have the luxury of seeing the service sector ISM report prior to the NFP release. Also, there is reason to believe that non-farm payrolls will not be horrid because consumer confidence rebounded unexpectedly and Challenger reported an 18.7 percent drop in layoffs. We believe that even though there were not many layoffs in the month of December, companies probably did not hire aggressively either.

Euro: Headed for 1.50?
Eurozone economic data continues to surprise to the upside while US economic data disappoints repeatedly, leading many traders to wonder whether the Euro is headed for 1.50. Unless there was negative job growth in the month of December, we do not expect to see 1.50 anytime soon. However we do expect the European Central Bank to be even more hawkish than they have been over the past few months. This morning, ECB member Orphanides warned that they are ready to raise rates if needed because the current inflation projections are too optimistic. With economic growth steady, their focus will continue to be on how much second round effects will be caused by the recent rise in oil prices. Originally we did not expect the ECB to actually follow through with an interest rate hike next year because we believed that inflation rates would stay steady and slowly begin to fall. As long as the ECB remains hawkish, that would be enough. However, now that inflation is on the rise, if the pressure refuses to abate, the ECB may be forced to put action behind their words even if they do not want borrowing costs to rise once again. The German labor market improved for the 21st consecutive month. The number of people filing for unemployment dropped by 78k in December to a six-year low. This took the unemployment rate down to 8.4 percent from 8.6 percent. Meanwhile we are continuing to see evidence of slower growth in Switzerland. Last week, the UBS Consumption Index and the KoF fell short of expectations and this morning, manufacturing PMI reported slower growth in the month of December.

British Pound: Unable to Rally on Stronger Data
The British pound fell to a four-month low despite stronger construction sector PMI, which unexpectedly increased in the month of December from 54.3 to 56.0. This additional weakness may be due to the fact that even though there was growth in the commercial and civil engineering sub-sectors, construction firms reported the first reduction in residential construction activity since August, 2006. For pound traders, the health of the consumer and the economy is contingent upon the health of the housing market. According to a BoE survey released today, credit conditions for households could tighten further as problems in the money markets persist. The same problem is expected to plague the corporate sector, and collectively these factors are the dynamics that will restrain growth in the UK economy and a recovery in the British pound. Even though the market’s focus will be on Friday’s US non-farm payrolls report, the UK has a lot of data due for release during the European trading session, which means that we could see further volatility in the pair in the early hours of trading. We are expecting service sector PMI, mortgage approvals and consumer credit.

Commodity Prices Still a Central Focus for Currency Traders
Commodity prices and the commodity currencies are still the central focus of the currency markets even though there has been no economic data released because the trend of commodity prices will impact the direction for many of the major currencies. The Financial Times said in today’s paper that oil prices hit $100 yesterday because a lone trader paid up to seek a minute of fame and claim that he “did it.” Whether or not this is true does not matter as much as whether we will see $100 again. Expect continued action in the commodity currencies over the next 24 hours as we are expecting Australian service sector PMI, Canadian raw material prices and IVEY PMI.

Carry Trades Off Their Lows
Carry trades are off their lows, thanks to today’s recovery in the Dow. On an intraday basis, new lows were made, but the Japanese yen crosses have recovered, which is encouraging. However, the rebound in the Dow is not strong enough to offset even half of yesterday’s losses, which makes us skeptical that the rally will continue. It remains to be seen whether the January effect will happen again in 2008.

Kathy Lien is the Chief Currency Strategist at FXCM.