Turn in the Dollar?

Although smaller than anticipated Novemberâ�,��"�s -$64 Billion Trade Balance shortfall is nothing to celebrate. At that pace US is headed for nearly three quarter of a trillion dollar trade deficit in 2006.  To paraphrase the late Senator Dirksen a trillion here,  a trillion there and pretty soon you are talking about real money. After the initial knee jerk reaction lower on Thursday, the EUR/USD promptly regained its losses as currency traders considered the bleak implications for the buck. Retail Sales, also printed below consensus (0.7% vs. 0.9% projected) suggesting that the once mighty US consumers may be finally tiring of carrying the global consumption burden all by themselves.

As we wrote on Friday, â�,�Amidst much Central Bank speak yesterday, we think one comment was lost in the noise. Chicago Fedâ�,��"�s Moskow stated that Fed funds are now at a neutral rate. This was the first clear signal from any US monetary officials that the tightening cycle may indeed be coming to a close. Mr. Moskow did state  that rates need to go higher to  fight inflation, but these words were simply there to give him cover. â�,�¦Therefore it appears that the Fed will now become far more sensitive to monthly economic numbers before considering additional hikes after the expected 25bp rise on January 31st.  Overall,  the action suggests that the 1.2000 level in the EUR/USD may be near term support, unless US growth suddenly picks up allowing Fed to go to 5% money. â�,��"

Euro: ZEW Clue?

Nothing but green for the euro this week as both Retail PMI and the ZEW survey materially exceeded their projections. The ZEW especially was impressive printing 66.1 versus 54.6 expected as German money managers have become more confident about the regionâ�,��"�s export based recovery.  The ZEW results were the highest in 24 months and many analysts now believe that EZ 2006 GDP could be revised higher from 1.5% projected to 2%. These are all bullish possibilities for the euro as they would lead to compression of growth rate and interest rate differentials between EZ and  US.

The EUR/USD now finds itself at an interesting juncture. It has clearly made a rounded bottom with support at 1.2000 seemingly well established. However the 1.2250 region represents major resistance and so far the pair has been unable to surmount it. Next week the US calendar is far more crowded than the European one and the tone of trading is likely to be set by US results. Most important of those will be the TICS numbers which will have to continue demonstrating healthy +$80 Billion surpluses to offset the massive Trade Deficits. Following TICS the traders will focus on the housing data to assure themselves that housing demand hasnâ�,��"�t slowed materially. Overall this may be the pivotal week where the pair either breaks out above 1.2200 or retreats below 1.2000 once again.

Yen at Crossroads

End of ZIRP? Donâ�,��"�t bet on it just yet. Despite positive corporate results and the rally in the Nikkei, Household Spending â�,�“ the true measure of growth in the economy continued to disappoint registering 0% gain versus expectations of 1.40%. On the flip side, the Eco Watchers survey reached a new 21 month high printing well above the 50 boom/bust level. However, as we noted on Friday, â�,��"up to now sentiment has not translated into action as Household Spending figures has not kept pace with rising consumer confidence readings.â�,�  Nevertheless USD/JPY is unlikely to rally much in the near term until positioning improves. Indeed the dollar lost 14 basis points against the yen despite the dour Japanese data. As weâ�,��"�ve been stating during the past week, our proprietary SSI index continues to show two dollar bulls for every one yen long suggesting that specs are still trying catch falling knives and getting nicked in the process. Still for longer tern players USD/JPY may represent an interesting value at these prices as carry traders may plow back into the pair if Japan continues to keep rates at zero while US continues to hike the Fed funds.

British Pound Bounce Continues

GBP/USD has traced a classic â�,��"Wâ�,� double bottom formation over the past three months and like the euro now finds itself at a key inflection point. Will the pair turn down and trade back into range or will it make a run for the 1.8000 figure? Last week buoyed by a smattering of positive results which included a nice jump in BRC Retail Sales Monitor and a slight recovery in the downtrodden industrial activity gauges, the pound managed to add an additional 29 basis points against the greenback.  IFR reported specific buying interest from the Middle East especially as US yield curve continued to flatten. For its part the BOE left short rates unchanged, still maintaining a slight 25bp advantage to the dollar.

Next week CPI and Housing surveys may command some attention at the start of trading, but the key reports will come later in the week with Unemployment data and Retail Trade of particular interest to the market. In order for pound bulls to really make their case these key economic gauges must show improvement rather than deterioration. Cable could still rally even if these results disappoint, but only on the back of poor Us results rather than its own inherent strength and such a rally would very vulnerable to a retrace as it would be built on a very shaky foundation.

Swiss Mystery

Gold is holding near $550. Swiss Retail Sales post impressive 2.8% year growth. Iran appears to be on a one way trip towards confrontation with the rest of the world, fueling geo-political fears everywhere. So why is the franc down? Swissie was the only major to actually lose ground against the greenback this week slipping 53 basis points.  The short answer is readjustment. After catapulting by 340 basis points against the buck last week, the franc simply ran ahead of itself and had to retrace some of its rally especially against the euro.  In fact the main reason for francâ�,��"�s weakness was its drop against the crosses, most notably the euro. One other possible source of weakness for the franc is the marketâ�,��"�s perception that the SNB may be less aggressive that the ECB in its monetary approach in 2006. Up to now the market assumed that the two banks would hike rates step in step with each other. However, should the SNB hesitate while the ECB makes its planned quarterly rate hikes, the rate differentials may push EUR/CHF higher as the year progresses.

Next week, the eco calendar is very quiet but the unit may see more volatility as the Iranian nuclear dispute escalates.

Boris Schlossberg is a Senior Currency Strategist at FXCM.