• Dollar Rebounds as Oil Prices Recede and Dow Tests 11,000
• Euro Fails to Rally Despite Stronger Data and Hawkish Comments
• Reserve Diversification Back in Focus

US Dollar
After starting the New Year on a weaker footing, the dollar has managed to recuperate some of last week's losses.  The recovery however was far from broad based since the dollar only managed to register gains against the Euro, British Pound, Swiss Franc, Australian Dollar and the Canadian Dollar.  Against the Japanese Yen and New Zealand Dollar, the greenback lost ground once again.  With no major US economic releases on the calendar, except for consumer credit late in the day, the dollar simply benefited from profit taking by dollar bears, softer oil prices and another strong day in the stock market.  In fact, even though prices have since moved lower, today was the first time that we have seen the Dow break above 11,000 since June 2001.  Even though the stock market is continuing to move higher, the prospect for the dollar is not as optimistic.  The market continues to believe that the Fed is shifting to a more neutral policy.  Fed Presidents Hoenig and Guynn were both a bit more cautious with their outlook for US rates.  Hoenig, who is a non-voter this year said that interest rates are near "neutrality" while Guynn who tried to avoid making any direct comments about interest rates did mention that he expects the housing market to slow this year.  The handing off of the baton will make Fed speeches even more important this year since the market may no longer write-off the Fed decision as the Chairman's decision.  Through most of Greenspan's tenure, there was an age old rumor that Greenspan penned the statement before the actual meeting, even though the decision is suppose to be a majority vote.  With the new leader, the voting process may be more important, especially in the beginning of Bernanke's tenure.  Consumer credit fell for the second month in a row at a time when the market had originally predicted for borrowing to rebound.  This is yet another piece of evidence that higher interest rates have taken a bite into the pocketbooks of consumers * a trend we expect to continue.

Euro
The Euro experienced its first meaningful day of losses since the beginning of the year.  Stripping out the dollar component, the move is actually counterintuitive to the day's developments since the ECB made positive comments while Eurozone economic data surprised to the upside.  The German current account surplus for the month of November increased to EUR 8.1 billion from EUR6.2 billion.  Both imports and exports fell on a monthly basis, but on an annualized basis, exports and imports increased.  The export sector is still recovering modestly but it seems that the country will be relying more on domestic demand to accelerate the recovery.  This will be even truer as the Euro continues to rally, since the increased valuation will only make European exports less attractive.  Nevertheless, the retail sector is also improving with the Eurozone retail PMI index increasing from 50.7 to 52.2.  Accelerated activity was reported in all three of the major countries - Germany, France and Italy.  Even though the market shrugged off comments from ECB member Wellink, his words is illustrative of where the central bank stands.  According to Wellink, "with given inflation expectations, with the economy getting stronger, the chance of a rate rise increases."  It is only a matter of time when the central bank will raise rates again. 

British Pound
Like the Euro, the British pound gave back some of its recent gains against the dollar.  Despite an up tick in house prices, the growth was the slowest in ten years.  Halifax reported that house prices increased 1.0 percent in the month of December, leading to an annualized pace of growth of 5.1 percent.  The housing market is recovering gradually, but the growth remains below trend, solidifying expectations for no changes at Thursday's monetary policy meeting.   Tonight's BRC retail sales monitor should shed additional light on how well the economy is performing.  Retail sales are expected to be particularly strong, rising over double the previous month.  Should this be true, the British pound could resume its rise.

Japanese Yen
Japanese markets were closed for a holiday, but that did not stop the Japanese Yen from rising for the fifth consecutive day.  In fact, the Japanese markets have been closed for most of last week, which means that foreigners have been fairly bullish on the Japanese Yen.  Finance Minister Tanigaki gave the green light to recent movements by saying that he believes recent moves in the Yen are "in line with fundamentals."  Asian reserve diversification continues to bolster the Yen.  Thailand, Taiwan, Japan and the Philippines have all recently reported an increase in foreign investment flows.  This has helped to rally not only the stock markets of those respective countries but also their currencies.  China has been a leader in this talk as they brought the issue back to the forefront with recent comments about diversifying their reserves away from the dollar.

Kathy Lien is the Chief Currency Strategist at FXCM.