Dollar Disappoints
On net, the greenback lost out against the euro last week despite a spate of positive economic surprises in theUS. Consumer confidence jumped from an upwardly revised 105.3 to 109, the strongest level since April 2006.  With the stock market rallying to record highs on a near daily basis in early December and oil prices remaining low due to the warm weather, consumers were optimistic about current conditions as well as conditions in the months ahead, subsequently relieving some of the market's concerns about a weak holiday spending season. Meanwhile, housing market data was also extremely encouraging.  Existing home sales increased 0.6% in the month of November by 6.28 million, which is the strongest percentage gain since February.  Taken together with the 3.4% jump in new home sales, we are seeing signs of a potential bottom in the housing market. Even the manufacturing sector seems to be doing better, as the Chicago PMI report has rebounded in the month of December after dipping into contractionary territory the prior month.  The expansionary conditions in the Chicago region runs directly counter to the negative Philly Fed number we saw last week, suggesting that we may only see a mild moderation in the National ISM survey next week.

Given the lack of liquidity in the markets last week given the Christmas/New Year holidays, the flood of traders returning to the market mid-week could send the EUR/USD pair reeling. US financial markets are closed on Tuesday to observe a Day of Mourning for President Gerald Ford. There is a huge amount of important data out of the US, with Wednesday getting things starting on ISM manufacturing and the release of the minutes from the December FOMC meeting. If the FOMC minutes prove to be a non-event, the marquee occasion will quickly become the release of NFPs on Friday. Expectations are currently set for a weaker print of 110K, but the figure is notoriously difficult to handicap. Nevertheless, if NFPs meet or exceed expectations, the greenback may have ample opportunity to make up some the massive losses accumulated over the past few months. However, a disappointing print could send the dollar plummeting, with EUR/USD surging to 1.3200.

Mounting Evidence Props Euro
Data out of the Euro-zone was few and far between last week, but sentiment on the euro was generally bullish last week. Thin trade brought the EUR/USD pair slightly higher on mixed data on Friday. First up, German GfK consumer confidence unexpectedly dipped down to 8.7 while the month prior was revised lower to 9.2 from 9.4. The sentiment figure was dragged lower by a plunge in income expectations while the willingness to buy component also slipped. However, the outlook component surged, indicating that while households are wary of their personal finances, they are far more bullish of German economy as a whole. On the flip side, M3 money supply in the Euro-zone picked up more than anticipated in November, as the annual rate hit 9.3%, the highest since February 1990 while the three-month moving average (the European Central Bankââ,¬â"¢s preferred measure) rose 8.8%, the biggest gain since May 1990 and well above the ECBââ,¬â"¢s reference value of 4.5%. The money supply data will add to the arguments of inflation hawks in the ECB, and along with the relatively robust level of consumer sentiment, the likelihood for further monetary policy tightening in 2007 increases.

Traders will be looking for European data to back the M3 money supply report from last week, namely, the CPI estimate for the month of December. If we continue to see a pickup in underlying price pressures, the already hawkish ECB could be pushed to action with a hike in the first quarter of 2007. When market participants return mid-week, these expectations could translate into a short-term surge for EUR/USD back above the 1.3200 level.

Yen Down Despite Rumors
Last week highlighted the difficulty of trading the USD/JPY pair, as price action tends to be contingent more on commentary from Bank of Japan or government officials. This time, it was a report from the Jiji news agency late on Tuesday saying that the BOJ will likely discuss hiking rates 25 basis points to 0.5% in January. As a result, yen surged nearly 100 points against the greenback following days of substantial weakness. Given the unsubstantiated nature of the report, not to mention the broad weakness of recent economic data, such as falling retail sales and contracting wage growth, it is unlikely that the BOJ will dare to hike in January and more probable that the monetary policy committee will opt to do so later in the first quarter of 2007. Traders were likely aware of this as yen gave up its gains throughout the remainder of the week.

Next week will be extremely light on data, as Japan is on holiday until January 4th. The overwhelming sentiment may continue to focus on the carry trade between the US and Japan , which remains at a very wide 500 basis points. No matter what the Federal Reserve decides to do over the next few months, benchmark rates will serve to benefit traders long USD/JPY. Additionally, while there is no doubt that the BOJ has every intention of normalizing interest rates, until shortages for labor start to translate into wage growth, a pickup in consumption will be difficult to come by and leaves little initiative for more aggressive monetary policy in 2007.

UK Housing Sector Proves Relentless
Cable was little changed last week despite indications that the housing sector is failing to let up in the UK, which will only help to drive speculation that the Bank of England will be keen to keep a tight leash on inflation in 2007. Nationwide house prices rose more than expected in the month of December at a rate of 1.2%, bringing the annual rate to surge to a 23-month high of 10.5%. Additionally, the British Bankersââ,¬â"¢ Associationââ,¬â"¢s measure of mortgage approvals surged to 77.8K in November. It appears that the two 25 basis point hikes by the BOE in 2006 have had little effect on the booming sector, which has fed into broader based inflation pressures and will likely keep central bank hawks on edge in early 2007. However, if diminishing affordability for potential homebuyers begins to make an impact, weakening demand could lead house prices to ease on their own.

In economic data this week, an array of PMI releases are on deck and all are anticipated to remain in expansionary territory, indicating that businesses are generally holding up well in a high interest rate environment. Meanwhile, more housing reports are on tap, with the BOE measure of mortgage lending anticipated to rise in line with last weekââ,¬â"¢s BBA data. Traders will also be looking at the final release of M4 money supply, and although the figure has eased back quite a bit from its record of 14.5% just a few months ago, even 13.1% is well above average and will be a major point of concern for the BOE. Should the US FOMC minutes ring a more dovish tone, GBP/USD bulls could continue to take over as the carry trade differential between the US and UK slowly closes towards parity.

Swissie Slowdown
Disappointing data out of Switzerland had little effect on USD/CHF, as the pair ended the week little changed. The Swiss franc has remained under selling pressure ever since the Swiss National Bank hiked rates to 2.00% and revised their 2007 and 2008 outlooks on December 14. Furthermore, data out of the country has only underpinned suspicions that expansion in the Swiss economy peaked months ago. The December reading of the KOF Swiss leading indicator fell more than expected to 1.60 from an upwardly revised 1.75 in the month prior. This marks the sixth consecutive month of falling sentiment and brings the indicator back to about the same level as in January, highlighting the softer domestic growth outlook. Additionally, the UBS consumption indicator dropped to a disappointing 1.886 for the month of November while the October reading was revised down to 1.892. Nevertheless, a tight labor market, buoyant levels of household spending, along with a well supported trade balance should keep the Swiss economy relatively healthy in 2007.

Swissie could be in for losses next week as SVME PMI is anticipated to slip while CPI is expected to hold steady for the month, leaving the annual rate to edge up to a tepid 0.6%. While reports out of Switzerland are no doubt weakening, if data continues to post in line with the central bankââ,¬â"¢s outlook, we will likely see further monetary policy tightening in Switzerland next year which may help prevent the Swiss franc from racking up more substantial losses.

Boris Schlossberg is a Senior Currency Strategist at FXCM.