• Japanese Yen Catapults in Thin Trading
• Possible Yield Inversion Bearish for Dollar
• Pound Slides for Fifth Consecutive Day as Data Weakens

US Dollar
As traders leave early for the three day weekend and even close their books until the New Year, you could almost hear a pin drop at most trading desks.  Unsurprisingly, US data was very mixed, leaving no clues on the state of the US economy as we prepare to step our feet into 2006.  Durable goods orders jumped 4.4 percent in the month of November, but this sharp rise was primarily due to a four fold increase in orders for Boeing's aircrafts.  Stripping out the transportation component, orders actually fell 0.6 percent, which was far weaker than the market's 1.0 percent forecast.  Confidence as measured by the University of Michigan survey was revised up to 91.5 from 89.0 for the month of December, but what is worrisome is that new home sales fell 11.3 percent to 1.245 million last month.  As another sign of a top in the housing market, the situation could worsen.  The stronger housing starts and building permits released on Tuesday indicate that more supply should be coming onto the market.  If the supply is not met with sufficient demand, which as suggested by the new home sales report could very well be the case, then the possibility of a meaningful drop in house prices becomes even more likely.  The fate of the housing market is a very important theme that could easily set the tone for trading in the year ahead.  Meanwhile also weighing on the dollar and a development worth watching is the possible inversion in the 2 year and 10 year bond yield spread, which if happens would be perceived as a recessionary signal.  Lastly, the market is closed on Monday December 26 and will resume trading on Tuesday.  

Euro
The range of trading in the EUR/USD continues to contract as prices remain unchanged ahead of the Christmas Holiday.  Economic data was mostly bearish for the Euro.  Contrary to regional state data, consumer prices for Germany as a whole actually was not as optimistic as initially thought.  Inflation on an annualized basis slowed from 2.3 percent to 2.1 percent.  French producer prices also slipped 0.4 percent on a monthly basis, which brings the annualized rate down to 2.8 percent from 3.0 percent.  The business confidence and production outlook indicators for France also ticked lower.  As for the Eurozone, the current account deficit increased from 3.5 billion to 9.0 billion.  As we go into 2006, one of the most important themes for Euro traders to watch is how much longer the Euro can remain weak against the dollar.  Even though Dutch Central Banker Wellink who is also a member of the ECB stated the obvious today when he said that if growth picks up, the ECB would be ready to act, there is an important point that he is making.  Growth is indeed very important and to date, most of the growth in the region has been from the stimulative effect that the weaker Euro has had for the export sector.  If the Euro begins to shoot higher rapidly, this stimulus could easily evaporate and the rallying Euro could restrict the central bank from raising rates too aggressive next year because it would be similar to a quasi dose of tightening. 

British Pound  
The British pound suffered its longest period of weakness in over a month as the currency pair traded lower for the fifth consecutive day.  The outlook for the UK economy is pretty bleak at this point with an increasing trend of weaker data.  Productivity slowed in the third quarter from 0.6 percent to 0.4 percent, the lowest reading in 15 years.  Even though the Bank of England believes that this is only a cyclical slowdown, it still leans them closer to another rate cut.  As we learned earlier this week, the latest decision to keep interest rates unchanged was an 8 to 1 vote, with the one dissenting member voting in favor of another cut.  Of the major central banks that we follow, the BoE continues to remain the only central bank to be reducing interest rates.  This sheer difference between them and the 3 other major central banks (Fed, ECB and BoJ) that have already raised interest rates or are prepared to do so, will keep a bearish tone in British Pound for the beginning of the year.  

Japanese Yen
With the Japanese markets closed for the Emperor's holiday, the US dollar and Euro resumed their sell-off against the Japanese Yen.  The markets are extremely thin in the two currency pairs, exacerbating every move.   Even though these same trading conditions are expected to extend into the week ahead, Japan does have a number of important economic data slated for release.  On Christmas Day, the Ministry of Finance will be releasing its business outlook survey.  We expect the MoF to echo the bullish sentiments already expressed by the Bank of Japan and the Japanese government.  Consumer prices are also scheduled for release.  As the BoJ's favored inflation indicator, a further negative reading will stifle any residual expectations for an early rate hike.  Labor market data, personal income, industrial production and retail sales should all shed more light on the health of the Japanese economy.  For the most part, recovery is continuing but whether it is significant enough to tempt the Japanese government to join the BoJ in calling for an end to the country's zero interest rate policy still remains to be seen.

Kathy Lien is the Chief Currency Strategist at FXCM.