• Weakness in Housing Data Could Send Dollar Lower
• Canadian Dollar Sells Off Despite Rate Hike and New Prime Minister
• Sterling Bulls Pare Back Ahead of BoE Minutes and GDP Report

US Dollar
After Monday's bloodbath, the dollar has managed to recuperate some of its losses, although the extent of the recovery still pales in comparison to the prior day's sell-off.  The markets have been relatively quiet, especially in the EUR/USD currency pair, which has been trapped within a relatively tight trading throughout the US session.  The same could be said of the dollar's price action against the Japanese Yen and for the most part, also the British pound.  With the lack of any significant US economic data, oil prices retracing modestly and the stock market trading higher on merger and acquisition news, dollar bulls have been given a bit of breathing room. Iran and Russia have also released what may or may not be viewed as a consolatory statement.  According to our friends at IFR, "the two agreed that the IAEA was the best mechanism to work out its nuclear issues with the US and EU-3. With the IAEA taking a go-slow approach to what many in the west view as a crisis, this is not much of a concession on Iran's part and harkens back to the run up to the war in Iraq." Instead, the main focus today was on the US' northern neighbor Canada, who not only raised rates by a quarter point, but also voted in a new Prime Minister.  Next to the US, Canada has been the second most aggressive central bank over the past few months, having increased interest rates four times in the past six months.  However, the rather toned down  accompanying comments from the Bank of Canada and a voting in of a minority government headed by Stephen Harper has instilled a good deal of bearishness in the Canadian dollar.  Tomorrow's focus will shift back over to the US housing market.  The fragile sector is up for criticism as the market looks for signs of a slowdown.  Existing home sales are expected to slide for the third consecutive month.  David Bowers of Merrill Lynch is already seeing "signs of softening in the new homes market in the US if you look at prices and the number of sales."  He believes that this "is going to hit discretionary spending."  It is widely believed that the US will follow a stage of adjustment similar to that experienced by the UK, which is concurred by Bowers.  If this is true, then the US' monetary policy could also follow a similar path with the Fed pausing for a few months and then lowering interest rates.  We are at the cusp of a shift in the US' interest rate cycle and going into the January 31st FOMC meeting, the market will be on the lookout for whether this shift happens sooner rather later. 

Euro
The Euro gave back some of its gains against the dollar, but for the most part, prices remain relatively well supported.  Stronger economic data as well as continual talk of central bank demand has limited the slide in the pair.  Eurozone industrial orders jumped 4.9 percent in the month of November after sliding 0.6 percent the previous month.  The market was expecting industrial orders to rise by only a modest 1.2 percent but the weakness of the Euro throughout the month of November is certainly to have played a role in bolstering economic activity.  The Euro actually hit a low of 1.1639 that month.  ECB Issing was on the wires this morning commenting on how the central bank is not likely to follow the Fed's path with rate hikes even though they are still ready to act if inflation ticks up once again.  Amidst loftier energy prices, the possibility of higher inflation is very likely at this point.  Yet nothing Issing says is all that groundbreaking.  The ECB was only expected to increase interest rates two or three times this year, which is far more conservative than the Fed's non-stop rate hike campaign.  Meanwhile we expect some interesting trading Wednesday ahead of Germany's consumer price inflation report and their IFO business sentiment index.  Prices are expected to have fallen in the month of January, but business sentiment for the same period is expected to hit five and a half year highs. 

British Pound
Like most of the other majors, the British pound sold off against the dollar.  To the surprise of the markets, the CBI industrial trends report took a dive to -28 from -22.  The market had been expecting the activity index to improve to -20.  1.7900 was a tough resistance for sterling bulls who saw a quick reversal at those levels.   With the minutes from the January Bank of England monetary policy meeting and the fourth quarter GDP report due tomorrow, it is forgivable to see bulls pare back positions.  GDP is expected to improve modestly from 0.4 percent to 0.5 percent, while the BoE is expected to have voted 8 to 1 to keep rates unchanged.  As we mentioned yesterday, Nickell should once again be the dissenting member favoring a quarter point cut.  However, should he move to neutral, we could see a strong rally in the British pound.  On the flip side, if another member sides with Nickell, the pound could see a deep slide.  With the pickup in oil prices and the improvements in the retail sales data reported last Friday, the higher probability scenario is for Nickell to stand pat or shift to neutral.

Japanese Yen
To the bore of most Yen traders, the dollar was trapped in a 30 pip trading range against the Japanese Yen.  The market has remained very quiet with the tertiary activity index falling short of expectations and nationwide department store and supermarket sales ticking higher.  The market had been expecting activity to increase by 0.5 percent in the month of November, but it rose only a modest 0.1 percent.  The Nikkei managed to rally strongly today after two days of back to back triple digit losses.  We will probably have to wait for Wednesday and Thursday to get some Yen based activity since the calendar is relatively light. On Wednesday night the merchandise trade balance is due for release while we do not expect CPI and retail sales until Thursday night.

Kathy Lien is the Chief Currency Strategist at FXCM.