• Dollar Rallies Ahead of Bernanke's First Testimony on Monetary Policy
• Market Continues to Shrug Off Hawkish Comments from ECB
• FXCM SSI Signals Recovery Limited in USD/JPY

US Dollar
It has been quite an exciting day in the markets today as the US dollar first sold off against the majors on the back of a larger than expected trade deficit to then completely reverse the move an hour later. The initial sell-off in the US dollar against the Euro stopped short of critical resistance levels as there was quickly evidence of little follow through.  As the market failed to have enough momentum to rally beyond 1.2025, currencies began to revert back to their dominant trend.  The EUR/USD, which has remained under pressure for the past three weeks closed below its 100-day SMA, something we have not seen since the beginning of the year.  Even though USD/JPY ended the trading day lower, it staged a very nice recovery after hitting a low of 116.89.  The performance of the majors has been very mixed, but overall, the trade weighted dollar racked up another week of gains.  The trade deficit for the month of December increased from -$64.7 billion to -$65.7 billion. This brought the total deficit for 2005 to a new record high of $725.8 billion.  Strong demand for Chinese goods as well as high oil prices caused a sharp rise in imports while rebounding growth overseas helped to boost exports.  The jump in purchases of Chinese made goods is sure to step up the gas on criticisms of China's foreign exchange policy. We expect members of Congress to once again threaten China with a variety of sanctions if they fail take more initiatives to revalue their currency.  On the flip side, the US posted its largest budget surplus in four years.  Even though the government continues to spend more and more money, tax receipts also hit a new high, which brought in a surplus of $21 billion in January compared to a forecast of $9.5 billion.  The US dollar will be starting the new week on a very good footing with both technicals and fundamentals on its side.  The market fully believes that the Federal Reserve will not only be delivering a quarter point rate hike in March, but quite possibly also another one in May.  Economic data due out next week is expected to be constructive but the highlight will certainly be Ben Bernanke's first ever semiannual testimony on the economy and monetary policy.  The market will be listening in very closely to hear where the new Fed Chairman stands on interest rates and we expect the question and answer session to be particularly interesting. 

Euro
For the first time since the beginning of this year, the Euro has broken the 1.1900 level.  This week has proved one thing to us and that is that the dollar reigns king.  Regardless of the outlook for the Euro, as long as the US outlook is better, the dollar will win out.  This is unsurprising since the dollar is the base currency for so many pairs and is undoubtedly the most traded.   The weakness of the Euro could be driven by the market's lack of conviction in the ECB.  Even though the central bank continues to make hawkish comments, economic data also continued to prove otherwise.  Joining Trichet and Liebscher, Weber chimed in about how vigilance may be warranted.  However, German consumer prices fell in the month of January, while France reported a larger trade deficit, weaker GDP growth and negative industrial production.  Recent data suggests that both Germany and France performed rather poorly in December and January.  The only reason why the ECB could still remain hawkish in the context of bad data is the possibility that they have far timelier data at their disposal.  They must be thinking further ahead and seeing the stimulative effects that the 1.1900 level in the Euro will have on the economy.  If you recall, the ECB last raised interest rates in December of 2005, right after the EUR/USD sold off from a high of 1.26 to 1.1640 and spent a good month trading between 1.1640 and 1.1900.  The ECB would not be issuing so many hawkish comments and priming the market for a rate hike if they were not planning to deliver one.  Yet, because the US may very well one up the ECB by delivering a rate hike in both March and May, the dollar could hold onto its gains. 

British Pound
Despite a strong reversal, the British pound managed to end the day positive against the dollar.  Surprisingly enough, the British pound held up far better than the Euro which may be due to the fact that the GBP/USD sold off every day this week except for today while the EUR/USD fluctuated in a tight trading range.  Of course, it certainly didn't hurt that Dubai Ports won the right to buy UK based Peninsular and Oriental Steam Navigation for GBP 3.9 billion.  Next week will be a very busy week in the UK which means that we could see far more volatility in the GBP/USD.  We have a great deal of inflation data as well as unemployment and retail sales due for release.  Consensus figures at this point are calling for weaker numbers.  If this proves to be the case, we could very well see more weakness in the GBP/USD. 

Japanese Yen
Even though USD/JPY recovered strongly after hitting a low of 116.89, it ended the trading day lower.  Economic data released last night was mixed with household spending falling short of expectations but machinery orders rising four times more than expected.  Either way, that does little to change the outlook for monetary policy. For the time being, the Bank of Japan is expected to continue to sit on their hands as the Japanese Government prevents them from hiking interest rates.  Meanwhile, our FXCM Speculative Sentiment index flipped from negative to positive, indicating that there are now more long positions than short  positions in USD/JPY.   As a contrarian signal, this suggests that despite today's intraday rebound, USD/JPY may find difficulty breaking above the 119.00 level.   Of course, this outlook would change if the ratio flipped back to negative once again.

Kathy Lien is the Chief Currency Strategist at FXCM.