Dollar: No Slowdown in Sight
The greenback continued its winning ways for the second week in a row, at least against  all the majors save for cable, as US economic news negated all of the bears’ doomsday fears. Retail Sales increased a respectable 0.9% while  the Trade deficit improved for 2nd consecutive month as lower oil prices and better growth in exports brought the figure  below -$60 Billion once again. As many analysts have pointed out ex-oil the US Trade deficit has basically stabilized over the past year as exchange rate differentials have started to favor the exporters while import  demand  has been curbed.  In and of itself of course the Trade deficit carries little import  to currency trading. The market cares only if the TICS flows will be enough to offset the gap. To that end,  Wednesday’s report could prove market moving if the capital inflows miss to the downside.  But if the data meets expectations of $82 Billion providing ample coverage for the against the –58 Billion figure, January will be yet another month where concerns about US Balance sheet issues will fall by the wayside.

Aside from TICs, the other focus of the week will be on the housing sector as traders will look for signs of a bottom. NAHB Housing survey, Housing Starts and  Building Permits all hit the tape by mid week and if the data shows even small signs of improvement, the greenback could get another push higher. However, a further decline in housing values, could be the factor that stops this dollar rally cold. US capital markets have been rising on the assumption that growth remains steady and wealth creation continues to build. But if the housing data points to further deterioration of asset prices, the fears of US contraction could quickly return despite the relatively rosy US economic data so far.

Euro Tripped by Trichet
After month of sounding uber hawkish Jean Paul Trichet suddenly appeared quite reticent on the subject of future rates hikes offering no assurance that the Central Bank will raise rates by 25bp in February. As a result the EUR/USD plunged further breaking the 1.2900 barrier for a few hours last week as traders readjusted their expectations to March. No doubt the ECB is troubled by the lackluster consumer demand in the 12 member region as German Retail sales actually contracted –0.3% versus an expected 1.0% gain.  The ECB is caught in a tough balancing act as it tries to nurture the nascent recovery that has taken unemployment rates to 3 year lows, and at the same time contain the swelling pools of liquidity that saw M3 balloon to near double digit rates on a year over year basis.   As we noted on Friday, “unless the region suddenly hits a massive slowdown, the trend in rates in EZ remains to the upside and that in turn should provide long term support for the unit.” Furthermore, this week Barron’s notes that the free cash flow yield for EZ equities is 6.5% while the cost of credit is 5% presenting many buyout specialists with attractive M&A targets which is yet another factor that should prove supportive to the currency but  as longer term factor rather than an immediate trigger to buy.

Next week EZ Industrial Production could offer a small boost  to the euro as it is expected to rebound to 0.8% from –0.1% the month prior and the ZEW survey is forecast to improve as well. Overall however, the EZ economic calendar is decidedly second rate this week as trading will most likely ricochet between those traders who bet that the next ECB rate hike comes in Februray and those who will argue that nothing will happen until March.

Another Ugly Week for the Yen
One step forward two steps back. That seems to be the pattern for yen trading these days as the unit was reversed its gains, trading bove the 120 level for the first time in 13 months. Carry trade flows were relentless as Japanese economic data continued and hopes for a BOJ rate hike in January began to fade.  Commentary from Japanese fiscal officials do not help matters either as both FinMin Omi and EcoMin Ota appeared to be jaw boning for BOJ to hold off on any further tightening until consumer demand improved.  That lackluster consumer demand was in evidence late in the week when Eco Watcher survey printed a very disappointing 48.9 registering second consecutive month below the critical 50 boom/bust level.

Next week the yen drama may well be the most interesting story of the week as the BOJ finally meets to decide the fate of short term rates. Although there is serious speculation that BOJ will do nothing, the Japanese central bankers may surprise  and begin to normalize rates at the start of the new year. However, even if they do raise rates, the market will want to see some assurances that this is a genuine start of the tightening process rather than just a hike and stop action like the one in July. Nevertheless, with positioning so grossly skewed against the yen and carry traders exhibiting virtually no fear in the actions, the sense of complacency has grown immense and the pair could be vulnerable to a sharp sells off is the rate hike comes and BOJ strikes a hawkish posture.

Cable Rocks off BoE Hike
No doubt the key event of the week was the surprise rate hike by the BoE which pushed UK rates by 25bp to 5.25% and catapulted cable to the best performance of the week against the greenback.  On Thursday we wrote that “Today's shocker should prove beneficial for the pound especially against the yen - where expectations of any rate hike by the BOJ have been put on hold. “ By end of the week, GBP/JPY was trading at 8 year highs breaking the 236.00 barrier.

Sunday Times speculated that the BoE may have been prompted to move sooner rather than later on rates because of their advance knowledge of UK inflation data which may be far hotter than the market expects.  Talk is now circulating in the markets that cable rates could  eventually go to 6% . Should that be true 2.000 GBP/USD exchange rate will not be far behind.

In addition to inflation releases UK calendar is very busy with critical eco data.  On Wednesday the market will get a peak at the labor market and Friday brings the important Retail Sales data. Overall  as we wrote many times before the UK economy shows remarkable resiliency that is likely to continue in H1 of 2007.  With the big monetary event behind it, price action in the currency may cool somewhat this week, but if the data continues to be supportive cable could easily extend its gains.

Unemployment Data Unable to Slow Swissie Declines
The Swiss Franc fell for the third consecutive week, as relatively impressive employment numbers were unable to stem broader Swissie weakness. In fact, declines were enough to leave the European currency 5 percent below its December highs. Over the past two week most FX traders have been unabashedly dollar bullish, leaving the Swiss Franc in the dust. A relatively unchanged outlook for the Swiss economy could soften the USD/CHF uptrend through the medium term, however, with this week’s data predicting continued strength. Swiss officials said that seasonally adjusted unemployment levels fell through the month of December, leaving the headline rate at 3.1 percent.  Though this was technically below consensus estimates, the robustness of the labor market cannot be denied. Given a relatively sparse economic calendar ahead, however, the CHF will most likely trade off of developments in the US as well as in other parts of Europe.

Looking to the coming week, traders await Thursday’s Retail Sales figures to gauge the strength of Swiss consumer demand. As the sole significant fundamental data for the week, however, price action could be relatively slow from a domestic standpoint. The next significant economic data will come on the week of January 22nd, with inflation data to dominate outlook on Swiss interest rates. In the meantime, Swissie traders should closely monitor key inflation numbers out of the US, as well as a similar report out of the United Kingdom.

Loonie Fights Despite Crashing Crude
Under normal circumstances, a severe drop in crude prices would cause loonie bids to quickly dry up and shorts to flood the market.  However, this past week, as oil prices slid to a fresh 19-month low, the Canadian dollar held its own against the greenback. This may be due to the pervasive belief that the closely watched energy product cannot fall too much further. For one thing, the weather is taking a turn towards chilly temperatures. In the US, Los Angeles received near-record low temperatures with freeze warnings circulating on weather stations. Skipping to the other coast, the Northeastern states left 70 degree weather behind for more customary temperatures on the 40s. With crude inventories falling 6.3 million barrels in the past two weeks, it may not take much to encourage a rush in bullish speculation. Even if natural market forces can’t rouse the necessary resource, OPEC could offer a safe backup as rumors of another emergency production cut spreads.

Though energy prices undoubtedly dominated price action last week, fundamentalists were still finding fodder for their valuations. Housing was the theme of the week, though it was not to the economy’s benefit. December housing starts slipped to 211,500 on an annual pace for the slowest rate of groundbreakings in three months, while November residential permits dropped 2.2 percent and prices for newly finished homes accelerated little from its 15-month low set in October.

In the week ahead, several releases are on deck, though few seem to hold the potency needed to define a trend for the currency.  Not even a rate decision will likely move the market, barring any unforeseen surprise such as a rate hike or a substantial change in the statement. Noting the response to the economic indicators, the loonie may once again find its baring from major support levels and volatile energy prices. If the Canadian currency can stand up to the pressure forced upon crude over the past two weeks, it will be interesting to see how it will react when the contract finally turns upward.

Aussie Employment Revives Rate Hopes
Last week’s Aussie price action would seem rather uneventful if viewed on a high frequency bar charts. However, when the granularity is increased, it was obvious there was scuffle between the bulls and the bears. Considering the economic releases hitting the wires over the period, the bears had an upper hand until the end of the week. November housing permits slipped 0.4 percent through the year, retail sales grew far slower than had been expected and the trade deficit held at its second level in six months. The pressure this dour data heaped on the currency was quickly erased, though, when the most important indicator on the docket answered with a far stronger than expected read. Proving employment remains a pillar of strength for the consumer and the economy, employers hired 44,600 new employees – nearly three times what was expected. This addition helped keep the jobless rate at the 30-year low 4.6 percent rate. Whether or not this will translate into increased spending while interest rates hover at 10-year highs or not remains to be seen.

Looking ahead for the Aussie dollar, there are only a few indicators on deck, but they could retain the potency needed to put AUDUSD through 0.7750 or otherwise put the pair on its way for a heavy retracement of its earlier losses.  Monday opens with TD Securities’ proprietary measure of consumer inflation for December. While there are no expectations for the release, price components of both the services and manufacturing surveys hovered near relative highs. Furthermore, consumer confidence over the same month reached a 17-month high to keep consumer spending fueling price growth. On the other hand, the proprietary nature of the report will likely supersede its timeliness. The opposite will be true of the fourth quarter price indices due Friday. Import inflation for the final months of the year will offer the best look into policy defining CPI read (due the following week) available to the market.

Kiwi Awaits Critical Inflation Report
The Kiwi remained largely rangebound through recent trade, as a sharp rebound from last week’s tumble was met with equally intense selling. The reasons for losses were mixed, with the early week declines attributed to pronounced US dollar strength, while poor economic data sparked weakness through Thursday price action. Outlook for the broader New Zealand economy grew a tinge more bearish due to the recent fundamental news release, with domestic building permits plummeting 12 percent through the month of November. Though expectations were riding low ahead of the data, markets had not priced in such a pronounced downturn in domestic real estate. Given the countervailing forces of a souring economy and high interest rates, outlook for the Kiwi dollar will hinge upon significant fundamental news due in the coming week of trade.

The New Zealand currency will see an atypically busy week of domestic economic releases, with important CPI figures on the 16th to be followed by Retail Sales just two days later. Fourth quarter Consumer Prices will likely steal the show, as the carry trade sensitive Kiwi dollar places tremendous pressure on inflation data. Markets predict that price pressures moderated through the final quarter of the year, bringing the headline rate to a 2.8 percent through 2006. Given that the Reserve Bank of New Zealand aims to keep inflation with a 2-3 percent comfort range, a below 3 result will effectively rule out any further monetary policy through the medium term. As if this were not enough event risk for one week, Thursday’s Retail Sales survey may likewise cause a jump in volatility for Kiwi pairs. If consensus estimates prove accurate, we could see the NZD decline further off of recent yearly highs.

Boris Schlossberg is a Senior Currency Strategist at FXCM.