US Dollar
It has been a very exciting trading day today and for once, the news flow was not dominated by US data.  Everyone in the FX market was focused on the developments across the Atlantic, which we cover in more detail in our Euro commentary.  In the US, we look ahead to the retail sales report on Friday, which is probably the single most important piece of data this week.   After the strong non-farm payrolls report last week, many economists have revised their retail sales forecasts upwards on the belief that a strong labor market should translate into healthy holiday spending.  Given the lines that we have seen in late November, December and even January for hot items such as the new game consoles by Sony and Nintendo, we doubt that consumer spending during the holiday season could have been that weak.  In addition, the stabilization in the housing market and the warm weather should also help to fuel spending.  Import prices are also due for release with a projected up tick due to a rebound in oil prices.  One way or the other, tomorrowââ,¬â"¢s economic releases will probably not do much to sway the Federal Reserve from their stable monetary policy.  Even though Federal Reserve Presidents Bies and Geithner refrained from speaking directly about interest rates, they were both fairly optimistic about the economy.  According to the Fed fund futures, the odds are next to zero for a first quarter rate cut at the moment and there is still a less than 50 percent chance of a cut in the first half of the year.  The sharp drop in jobless claims below 300k confirms the health of the labor market, which is helping to boost the US dollar.  All the market needs now to take us back into the summer of 2006 trading range is a strong retail sales report. 

Euro
So far, it has been an extremely difficult month for the Euro as the currency pair makes yet another year to date low against the US dollar.  Traders were hoping that ECB President Trichet would reassure the markets by remaining committed to their aggressive plans to raise interest rates.  However besides leaving rates unchanged, which was expected, Trichet introduced a bit of doubt into the market about a February rate hike.  Originally the market was expecting a hike in next month, but now, a move may not come until March.  Trichet also clearly pointed out that his statement no longer includes the words strongly vigilant which suggests that he is attempting to prepare the market for some sort of shift.  By doing this, he is either telling us that he will delay a rate hike to March so that they can digest incoming data or that he is planning to raise rates in February, but put the end to their tightening cycle after that.  Either way, this is not particularly good for the Euro, especially after the Bank of England surprised with an interest hike this morning.  Do not be mistaken, there will still be one more rate hike from the ECB, but with four weeks to go until to the next monetary policy meeting, the Euro could remain weak.  German retail sales were pretty disappointing last month which could have influenced Trichetââ,¬â"¢s comments.  We will probably need to see some positive reports before he can justify a February hike. 

British Pound
The British pound was the story of the day after the Bank of England surprised with a quarter point interest rate hike this morning.  This is not the first time that the central bank has chosen to catch the market off guard by delivering a premature rate hike.  According to the central bank statement, fear that inflation could accelerate to their fastest pace in 10 years as measured by money supply growth has forced them to accelerate the timing of their rate hike.  For the seventh month in a row, the inflation rate remained above the central bankââ,¬â"¢s target, indicating that their monetary tightening over the past year has done little to slow economic growth.  UK rates are now at the same level as US rates, eliminating any carry advantage to being long or short the GBP/USD.  The economy has done very well over the past few months thanks to the housing market.  The industrial production report, which was released this morning was also stronger than expected.  The December consumer price report due out next Tuesday should also be very strong since this is probably the data that the BoE keyed off of.  Although it is not publicly available yet, they already have access to it. 

Japanese Yen
The Japanese Yen was weaker across the board as the rate hike by the Bank of England brings carry trades back into play.  All of the high yielding currency pairs gained against the US dollar today, which has also translated into strength against the yen.  Having breached the 120 mark, the Japanese Yen is now at very weak levels against both the Euro and the US dollar.  Of course, the Japanese economy is benefiting a lot from the weak currency as it encourages exports.  In fact, this may pave the way for a rate hike by the BoJ later this month.  With a weak Yen, the Japanese government may feel comfortable allowing the central bank to tighten monetary policy.  Meanwhile the bigger story in Asia was the milestones made by China today.  For the first time in 13 years, the value of the Chinese Yuan has finally surpassed the value of the Hong Kong dollar and for the first time ever, the value of the stock market has topped $1 trillion.  This is a testament to the countryââ,¬â"¢s booming economy and Chinaââ,¬â"¢s status in the world market. 

Commodity Currencies (CAD, AUD, NZD)
Demand for high yielding currencies have helped to boost the value of the Australian and New Zealand dollars.  Australia reported very strong employment data which confirms the rise that we saw earlier in job vacancies.  The number of jobs added last year was the strongest since 1989 which has helped the unemployment rate remain unchanged at 4.6 percent.  The NZD has done little but ride the wave of the stronger Aussie data.  The Canadian dollar on the other hand did not join the rally as oil prices continue to tumble.  USD/CAD has been trapped in a very tight range for the past week and unless we see a rise in oil prices, the currency could remain weak.  Traders will soon be thinking about the Bank of Canada rate decision next week.  No changes are expected but it will be interesting to see how the central bank feels going forward, which will be revealed in their monetary policy update.

Kathy Lien is the Chief Currency Strategist at FXCM.