Will the US Dollar Fall to a New Record Low?
Tomorrow’s US retail sales report will the catalyst that determines whether where the dollar falls to a new record low. Over the past few weeks, the market has gone from pricing in just one 25bp rate cut to as much as 75bp of easing at the end of this month. The Federal Reserve has grown increasingly bearish, all on the fear that the trouble in the US housing and labor markets have spilled onto consumer spending. Chain-store sales last month were weak and Target’s earnings disappointed Wall Street, but at the same time December retail sales which includes spending during the holidays should have been fairly decent last year. Also, the forecast for 0.1 percent growth is very low, meaning that it will not take much to beat the market’s pessimistic projections. If the number is stronger than forecasted, there could be a fairly material bounce in the US dollar because sentiment is so skewed to the downside. If consumer spending actually falls in the month of December, then not only is a 50bp rate cut from the Federal Reserve guaranteed, but so would a rally up to 1.50 in the EUR/USD. In addition to retail sales, we are also expecting producer prices. We do not think that inflation will rise significantly because Bernanke downplayed the threat of inflation in his speech on Thursday and import prices were flat last month. The Federal Reserve is on track to continue lowering interest rates; the question is by how much. Therefore even if we do not see the EUR/USD hit 1.50 tomorrow, it should be just a matter of time before the dollar falls to a new record low. As more fourth quarter earnings are released, we expect the weak dollar to help boost profits for more US companies. This morning IBM announced that its revenue grew 10 percent from a year ago with 6 points of that growth coming from the weaker dollar.

What Happens to the Euro After 1.50?
In the US dollar portion of the Daily Fundamentals, we talked about whether or not the EUR/USD will hit 1.50, but what should we expect after that psychologically important price point is breached? An immediate reversal? Intervention from the European Central Bank? Although we believe that the ECB is closely eyeing the 1.50 price level, we do not expect the central bank to shower the markets with verbal intervention as soon as it is hit. This morning, France’s European Affairs Minister Jouyet complained that they “cannot live with a euro at this level with three other currencies which are weak.” Instead of placating their worries, ECB officials shot back with hawkish comments that threaten action if inflationary pressures continue to grow. The strong Euro helps to bring down inflationary pressures which is why we believe that the central bank’s uncle point for the Euro is moving higher. An initial break of 1.50 will not worry the ECB unless the currency remains there. However if starts moving to 1.51, 1.52 or 1.53 and refuses to fall, then we expect the ECB to start moaning and groaning because recent economic data indicates that the Eurozone economy is strained. Although the ECB still has the luxury of maintaining a tight monetary policy, if growth slows further, they may have to shift focus. Even though industrial production was stronger than expected in the month of November, it dropped by 0.5 percent from the prior month. Meanwhile comments from SNB President Roth this morning seem to have no impact on the Swiss Franc which is stronger across the board. Roth warned that the Swiss economy faces the double risk of inflation and growth, making it difficult to determine monetary policy.

British Pound: Arguments For and Against Further Weakness
Foreign exchange traders are obsessed with selling the British pound and it seems like there is nothing that can stop the currency’s slide. Producer prices were mostly stronger than expected, which should have helped the pound recover some of its losses, but further slowing in the growth of house prices prevented the currency from rallying. Instead, the British pound gave back all of its gains against the US dollar and fell to a new low against the Euro, Swiss franc and Japanese yen. Earnings season is upon us and according to a study from Ernst & Young LLP, UK companies issued the most profit warnings in six years. Fundamentals continue to point to further losses in the British pound but there are reasons why the currency may bounce. According to our analysis of the Commitment of Traders report, positioning in the pound is at an extreme and the short term Elliot Wave count suggests that relief may be in sight for the currency pair.

Australian Dollar Breaks Higher as Gold Prices Hit New Records
Strong economic data and rising gold prices makes the Australian dollar one of our favorite currencies. The labor market in Australia remains very tight as the number of jobs advertised in Australian newspapers surged 7.1 percent last month. Inflation also continues to rise according to the TD Securities Inflation index, putting more pressure on the Reserve Bank of Australia to raise interest rates. On top of that we have gold prices closing above $900 oz, which has helped to rally not only the Aussie, but also the New Zealand and Canadian dollars. Unfortunately for Canada, we do not expect the currency’s strength to last as economic data continues to sour. New motor vehicle sales fell 2.9 percent in November, the third straight monthly decline.

Dow Rebounds, Helping Only Some Carry Trades
The Dow rebounded 171 points today, helping carry trades recover. Unfortunately the recovery was not broad based as USD/JPY and GBP/JPY continued to sell off. Risk appetite has not fully returned to the market and we would be cautious of going long carry at the moment because earnings season could bring a lot of surprises.

Kathy Lien is the Chief Currency Strategist at FXCM.