US Dollar: Good Enough

With only one major release this week the market spent most of the week marking time as the pair traded listlessly around the 1.1950 level. On Friday US Trade deficit came basically in line at -$65.4 Billion. The US is headed for a three quarter of a trillion dollar Trade Deficit in 2006 but until and unless the TICS can not cover the imbalances the market will shrug off the numbers. TICs is expected to report next Wednesday at $89 Billion well in excess of December's Trade deficit.

Also on the calendar nest week will be Ben Bernanke's first Humphrey Hawkins testimony and it will interesting to see how Mr. Bernanke handles himself in the wake of maestro's departure. Chairman Greenspan was notorious for clever obfuscation in front of generally reverential and confused members of Congress. Mr. Bernanke on the other hand is a strong believer in transparency so perhaps his rhetoric wil be more direct.  More importantly still will be the tone of Mr. Bernanke's remarks. Last week at a private meeting of investors,  newly retired Chairman Greenspan hinted that the Fed may be much more hawkish than the market anticipates. If that's the case then currency traders will begin to price in 5% money and the greenback may have more rally left.

Euro: Red Sky in the Morning

Red sky in the morning sailors take warning goes an old seafaring expression that may just as well apply to currency traders looking at euro longs. The week brought nothing but red data, as Retail PMI, French Manufacturing and German Trade Balance all reported sub-par results. High oil prices were the primary culprit for the poor performance but  as we wrote on Friday,"it is becoming clearer by the day that (France) EZââ,¬â"¢ s second largest economy is in dire need of reform as the sclerotic government in Paris is unable to create any forward momentum. With Germany unable to single handedly pull the region out its chronic malaise the EUR/USD will have a hard time rising against the greenback on a fundamental basis and will only do so in response to strong anti-dollar sentiment."

Next week the ZEW survey and Eurozone GDP data are the main items on the calendar and given the weak results this week, the eco surprises are likely to be to the downside. Overall, it looks like euro bulls will have little work with this week, unless some geo-political crisis or an especially dovish Bernake rankles the markets.

Yen Rollercoaster

On Friday we noted that, "Regardless of the fundamental news and technical factors that may push the pair up or down, the one key fact to emerge at the start of this year is that USD/JPY will be a much volatile instrument in 2006. With US rates expected to rise to 4.75% or possibly higher and Japanese rates still at 0% USD/JPY has become the preeminent carry trade in the currency market. This influx of speculative flow into the pair will likely create exaggerated moves in either direction as speculator sentiment shifts one way or the other. For those traders participating in the move, buckle up your seat belts, its likely to be a bumpy ride."

Last week was the perfect example of that dynamic in action as the pair first spiked to 119.30 and then dropped like a stone on the back of the news that Japanese Corporate price index expanded at the fastest rate in 16 years. Despite the cheers of yen bulls however, other data was far less supportive of any immediate change in the ZIRP.  Household spending dropped disturbingly by -0.7% against expectations of a rise of 1.2%. That was the fourth consecutive drop in the data and suggests that the Japanese consumer spending is not ready to demonstrate robust growth. That in turn should keep BOJ on the sidelines for a while longer.

British Pound Walking a Thin Line

The pound dropped nearly 150 points last week as the much larger than expected Trade deficit highlighted the structural weaknesses of the UK economy. UK economy appears to be perched on a precipice with only the service sector demonstrating unabashed growth.

Next week should yield more clues about the strength of the overall UK demand as a slew of reports including PPI output and the unemployment claimant count are expected to hit the wires. Traders will watch the inflation data with particular care, since last month's evidence of absence of any pricing power amongst UK producers caused weakness in the pound on the assumption that BOE could lower rates without fears of reignting inflation. The employment and Retail Sales should also provide some clues about UK economic affairs. If the data continues to be dour cable may be pounded down to the recent swing lows near the 1.7200 figure. On the other hand any upside surprise will likely keep the unit stable rather than rally it materially. Note finally that sterling is now at interest rate parity to the dollar and will soon slip to a negative carry. Once those costs begins to appear on specs daily report sheets the pressure on the pound longs could accelerate.

Swiss Franc: Good News No Effect

Switzerland's unemployment rate stayed at the lowest level in almost three years in January while the previous month's figure was revised down. The jobless rate now stands at only 3.6%. Meanwhile consumer confidence recorded the highest reading in more than four years, as a broadening economic expansion prompted companies to increase hiring. All seemingly good news hat had very little impact on the Swissie.  Indeed the unit declined against the buck almost to the basis point with both euro and the pound.

One possible drag on the franc is the growing perception in the currency market that the SNB may be  more dovish than the ECB in raising rates this year. SNB Chairman Roth has been quite coy in his rhetoric basically taking a wait and see approach to 2006 monetary policy. At present, currency traders expect a 25bp rate hike every quarter. The March hike is almost assured, but future rate hikes appear to be far more problematic and should the SNB decide to hold off the rate differential between the franc and its major counterparts may weigh on the unit.

With the start of Winter Olympics and a likely halt on any geo-political crisis while the world watches the games the Swissie could continue meandering, especially with a very light calendar. Of course, if geopolitical tensions flare up, the dynamic will change in a heartbeat.

Boris Schlossberg is a Senior Currency Strategist at FXCM.