US Dollar
It has been a quiet day in the foreign exchange market as the US dollar continues to test the resilience of the 1.30 level against the Euro.  The currency market is essentially trading sideways going into the three major event risks this week which are the European Central Bankââ,¬â"¢s interest rate decision, the US trade balance report and the US retail sales report on Friday.  The ECB is expected to keep interest rates unchanged at 3.50 percent, which means that the actual interest rate announcement should be a non-event.  However EURUSD traders will be watching the accompanying press conference for details on how aggressive the central bank plans to be with monetary policy in the months ahead.  As for the US trade balance, after hitting a record high back in August, we have probably seen the worst.  The trade deficit is forecasted to increase from -$58.9 billion to -$60 billion due to rising imports.  However with oil prices remaining low for most of November and the dollar index falling close to 4 percent that month, the deterioration in the US trade balance should be limited.  Import prices, which is an inflationary indicator is also due for release.  Prices are predicted to have accelerated in the month of December, which if validated, would be yet another reason to expect the Federal Reserve to keep interest rates on hold at 5.25 percent for a few more months.  The weekly indicators released today were also mostly dollar positive.  Both the ICSC-UBS and Redbook reported stronger chain store sales in the first week of January.  The IBD/TIPP confidence report also rebounded from 53.5 to 53.7 while oil prices eased on hedge fund selling.  Dollar bears are struggling to regain control in what may be proving to be a Goldilocks economy. 

Euro
Euro traders are hanging tight for the ECB monetary policy meeting on Thursday before deciding whether or not to take the currency below 1.30.  It has flirted with that level a thousand times today but dollar bulls retained control of the currency pair.  Even though this morningââ,¬â"¢s German data was stronger expected, it was not enough to erase the bearishness that came from yesterdayââ,¬â"¢s disappointing retail sales report.  The German trade surplus hit a record high thanks to a much smaller than expected drop in exports.  Given that domestic spending has been lackluster at best, it seems that foreign demand is behind the surge in business confidence.  Industrial production also jumped by 1.8 percent which makes it very difficult to tell whether or not the ECB President will retain his hawkish tone.  It is an exceptionally close call, which is why the meeting has the potential to be a major event risk.  The right question to consider in the meantime may be whether the economy is able to handle 1 to 2 more interest rate hikes given the increase in Germanyââ,¬â"¢s Value Added Tax.  In the meantime, we have French industrial production and trade balance tomorrow.  Like Germany, France is also expected to report acceleration in its industrial sector activity.

British Pound
As the one economy that is unambiguously healthy, the UK continues to deliver upside surprises in its economic data.  Last night, the BRC retail sales monitor increased from 2.5 to 4.4 percent in the month of December, indicating that holiday sales were strong.  Even though the market expects the Bank of England to forgo a rate hike on Thursday, the central bank is still expected to lift rates later this year.  UK trade data and the BRC shop price index are due for release tomorrow.  The strong currency is expected to cause deterioration in the trade balance but neither of tomorrowââ,¬â"¢s reports should have much of an impact on the currency.  Merger and acquisition flow continues to keep the currency supported as a part of todayââ,¬â"¢s sterling strength may be linked to flow related to Japan Tobaccoââ,¬â"¢s recent purchase of Gallaher PLC. 

Japanese Yen
The Japanese Yen continued to sell off against the majors today as the market debates whether the Bank of Japan will really be ready to lift interest rates next week.  We believe that in all likelihood, even if the Bank of Japan lifts interest rates, it will not be particularly positive for the Yen.  The lack of support from the Japanese government suggests that should the BoJ decide to lift interest rates at all, any rate hike will probably be followed by a prolonged period of steady monetary policy, in which case carry trades may still prevail since 0.5 percent rates would remain the lowest in the industrialized world.   It appears that the market may also be expecting the same as carry trade currency pairs continue to rebound.

Commodity Currencies (CAD, AUD, NZD)
The Australian and New Zealand dollars continued to bounce today as commodity prices stabilize.  Gold prices ended the day higher while oil prices ended virtually unchanged.  Australian retail sales were weaker than expected which conflicts with the stronger building approvals and job ads data that we saw yesterday. The countryââ,¬â"¢s November trade balance is due out tonight and improvement is expected after the sharp rise in October.  Increased exports and a drop in oil prices are expected to contribute to the rebound.  Meanwhile Canada will also be releasing their trade report along with building permits.  The trade surplus is expected to increase as export values edge up.  Building permits unfortunately are expected to drop as the housing market softens on slower economic growth.  There is not much going on in the New Zealand dollar as its economic remains empty until Friday morning New Zealand time. 

Kathy Lien is the Chief Currency Strategist at FXCM.