• Big Day Ahead for Dollar - TIC and Bernanke
• Euro Rallies Despite Sharp Drop in ZEW
• British Pound Weakens as Inflation Dips Below 2% Target

US Dollar
Stronger US economic data has helped the trade weighted dollar end the day virtually unchanged.  Retail sales staged an exceptionally strong recovery, rising 2.3 percent in January after increasing a modest and downwardly revised 0.4 percent the previous month.  This is the biggest rise in sales that we have seen since May 2004 and best yet, the sales excluding autos component also hit a 6 year high.  The US consumer continues to buy up everything in sight, which means that regardless of whether this behavior is sustainable or not, in the immediate future, it means that we could see a nice pop in first quarter GDP.  A strong rise in the figure due out on in April will help traders completely forget about the horrid number released last month. Sales have been strong thanks to record mild temperatures and lower gasoline prices.  The new Fed Chairman Ben Bernanke now has some ammo under his belt when he ascends Capitol Hill tomorrow if he chooses to give some sort of validation that there could be one more rate hike in May.  His much awaited semi-annual testimony to Congress on the economy and monetary policy is this week's main event.  Not only are we going to be listening carefully to his assessment of how the risks to the economy and inflation are tilted, but also to his responses during the question and answer session - expect Bernanke to be grilled.  Greenspan mastered the art of tactfully answering questions while managing market expectations during his tenure, which will make it particularly interesting to see whether the usually clear speaking economist will be able to do the same under such intense pressure.  Aside from Bernanke's speech however, we should not lose sight of the fact that the net foreign security purchases, also known as the Treasury International Capital (TIC) flow report is also due for release.  After rising $89.1 billion in December, purchases are expected to increase by another $76.2 billion, still more than enough to cover the trade deficit.  Unless we see foreign purchases sink below $60 billion, we expect the TIC report to be a non-event.  Yet, market volatility in the dollar can also come from the Empire State manufacturing survey, the industrial production report or the NAHB housing market index.  So clearly, tomorrow will be quite a day and it is no coincidence that many currency pairs are also at a crossroad and looking to tomorrow's developments for direction. 

Euro
The Euro rebounded slightly against the dollar today despite another dose of weaker economic data.  The market had expected German GDP growth to increase by 0.2 percent in the fourth quarter, but instead growth was flat.  The ZEW survey of economic sentiment also dropped from 71.0 to 69.8.  The only glimmer of hope was that the current conditions component remained unchanged at -19.5.  This was actually taken as positive since the market had expected that component to drop to -28.  In the Eurozone as a whole, GDP growth slowed to an as expected 0.3 percent from 0.6 percent.  The ZEW survey of economic sentiment fell modestly to 66.0 from 66.1.  Overall, we see that conditions and sentiment in Europe is deteriorating, led primarily by a slowdown in Germany.  However in the grand scheme of things, this will still not prevent the European Central Bank from moving forward with their plan to raise interest rates.  Eurogroup Chairman Jean-Claude Juncker joined the chorus of ECB officials hinting to the market that their expectations for a March rate hike are valid.  He noted that the ECB will probably do as the market expects.  We already mentioned on numerous occasions that the ECB's justification for a rate hike in the context of weak economic data comes from the fact that they are looking ahead.  As the strength in the Euro has led to the recent downturn in the economy, the present weakness of the Euro should help stimulate the economy extensively and possibly even so much that the ECB feels the need to be preemptive by tackling problems before they surface. 

British Pound
Once again, the British pound has been unable to join the EUR/USD in rallying today.  Weaker inflation figures have given sterling bears support to question the possibility of a rate cut by the Bank of England once again.  The market has been juggling the thought of whether the BoE will continue to remain neutral or as some have forecasted lower rates sometime over the next few months.  Tomorrow's Bank of England Quarterly Inflation report might be able to help us answer this question.  Meanwhile CPI fell 0.5 percent in the month of January, bringing the annualized rate to 1.9 percent, which is the first time it is below the central bank's 2 percent target since May.  This is quite a big surprise and should definitely deal a blow to those expecting interest rates to remain at 4.50 percent for the remainder of the year, especially considering that the original forecast was for annualized inflation to increase from 2.0 percent to 2.1 percent. 

Japanese Yen
For the third consecutive day, the Japanese Yen licked its wounds and continued to recuperate its losses against the dollar.  The Nikkei has also staged a strong recovery after experiencing a triple digit sell-off the previous day.  Like the rest of the world, interest rate expectations are the biggest focus for traders at the moment.  The Japanese government still seems to be reluctant in allowing the Bank of Japan to remove its quantitative easing, which means that for the most part, the US dollar will continue to drive the direction of the currency pair.  Japan's fourth quarter GDP report is due out on Thursday, which is Japan's key economic release for the week and could deliver us some interesting price action.  The market is setting the bar high and expects growth to have been exceptionally strong in the last few months of 2005.

Kathy Lien is the Chief Currency Strategist at FXCM.