• Euro Traders Watching for Trichet Comments Tomorrow
• Dollar Extends Post FOMC Gains
• Improving Manufacturing Sector Limits British Pound Losses

US Dollar
It is always fascinating to see what interest rate expectations can do to the markets.  With another 25 basis points under their belt, the Federal Reserve's not so subtle hints that they are still thinking about a quarter point rate hike in March has dollar bulls elated.  The futures market is now pricing in an over 80 percent probability of 4.75 percent rates by the end of March and is going into Friday's non-farm payrolls report on an optimistic note.  Even conflicting US economic reports failed to stifle gains.  Construction spending in the month of December and total vehicle sales for January were stronger than expected.  In fact, 2005 was a record year for homebuilding activity.  However mortgage applications and pending home sales as reported by the National Association of Realtors both fell more than expected.  Even though the group expects sales to pick up, we wonder how much longer this could last.  Mortgage rates are already ticking higher with the average 30 year contract rate increasing from 6.04 to 6.20 percent.  The ISM manufacturing index fell from 55.6 to 54.8 with the prices paid component rising from 63.0 to 65.0.  Given the upward revision for the month of December, the dip in the index is not all that bad, especially since it remains above the 50 expansion / contraction level.  Oil prices are also a bit softer as crude and gasoline stocks rise.  The US data calendar tomorrow is relatively light with only jobless claims and Q4 non-farm productivity scheduled for release.  This means that after the 8:30 numbers and ECB President Trichet's post monetary policy meeting press conference, the market will be turning its full attention to Friday's non-farm payrolls report.  The bar is set high again this month, with 250k jobs expected to be created.  In the past year, there have only been two months that payrolls came out higher than expected and one of those months was still a negative decline.  This suggests that the odds are stacked against a strong payroll report and in our opinion; the forecast is priced for perfection.  Look for our non-farm payroll preview report soon. 

Euro
The Euro extended its sell-off against the dollar today and will be moving into the limelight tomorrow as the market considers what ECB President Trichet could say at the accompanying press conference.  Recent economic data suggests that the central bank President could err on the caution and in the worst case scenario, remain neutral by refraining from expressing his opinion that they need to be vigilant when dealing with inflationary pressures.   If he does do so, it would not be all that disastrous since the market has already priced in this possibility.  On the flip side, if Trichet decides to be hawkish, we could see a nice pop higher in the EUR/USD.  Manufacturing sector data released this morning indicates that activity accelerated in Germany, but slowed in Italy and France.  The deterioration in the 2 countries dragged the entire region's manufacturing PMI down slightly to 53.5 from 53.6.  Up until last week, the market had believed that growth was beginning to pickup, especially after the robust German IFO report.  This week however, the fundamental outlook has shifted quite a bit, which may tempt Trichet to wait another month before saying anything that could set market expectations too high.

British Pound
The US dollar rallied against all of the major currencies today including the British pound.  However, on a percentage basis, next to the Canadian dollar, the pound suffered the smallest loss.  Similar to the Eurozone, fundamentals have shifted quite a bit this week, but unlike the Euro, it has been to the British pound's favor.  The housing sector is rebounding quite nicely and today, we learned that the manufacturing sector also experienced accelerated activity in the month of January with an upward revision to the previous figure as well.  So all appears to be rosy in UK land for now which means that for the time being the Bank of England's policy is probably closer to neutral than dovish.  This should keep the EUR/GBP currency cross tipped to the GBP's favor. 

Japanese Yen
After a quick breather, the dollar resumed its impressive ride higher against the Japanese Yen.  Labor cash and overtime earnings increased in December, which continues to confirm the gradual recovery in Japan.  However any recovery has been discounted since the market knows that it will have a limited impact on the Bank of Japan's ability to increase interest rates.  Instead, USD/JPY continues to rally on the growing interest differential between the US dollar and Japanese Yen.  The economic calendar for Japan is light for the remainder of the week, which means that once again USD/JPY trading will be dictated by dollar factors alone.

Kathy Lien is the Chief Currency Strategist at FXCM.