US Dollar
The US Federal Reserve has kept interest rates steady for over 6 months now and today’s data releases suggests that they could continue to leave rates at 5.25 percent for another six months.  Not only did producer prices increase more than expected on both a headline and core level thanks to higher oil prices in December, but industrial production also accelerated by the fastest pace growth in five months.  Even though we have seen a slowdown in the regional manufacturing reports, the industrial production report seems to have aligned well with the strength that we saw in the national ISM index.  What is even more encouraging though is the fact that homebuilder sentiment rose to a 6 month high.  The increase in buyer traffic suggests that the housing market may be bottoming.  With inflation remaining high, the labor market improving, the housing market bottoming and consumer spending accelerating, the Federal Reserve has no reason to change their current monetary policy stance.  The only piece of disappointing data released today was the Treasury’s report on net foreign purchases of US securities.  The market was looking for inflow valued at $75 billion, but actual inflow was only $68.4 billion.  The details of the data indicate that the biggest demand was for corporate bonds by private investors.  Central banks continued to be net buyers of dollar denominated investments, but their purchases have been slowing.  Given that the inflow is still in excess of the same month’s $58.2 billion trade deficit, the report was not entirely dollar bearish. The Beige Book report was mixed, though the tone still contained more hawkishness.  Even though the individual districts saw expansions in manufacturing and retail sales along with a tighter labor market, at the same time, they felt that the housing market was continuing to soften.  Looking ahead we are expecting consumer prices, housing starts, leading indicators and the Philly Fed report tomorrow.  We continue to expect more dollar positive news since CPI has a good chance of rising like PPI.  The rebound in homebuilder sentiment also suggests strength in housing starts.  Although it is worth noting that Fed Chairman Ben Bernanke is scheduled to testify before the Senate Banking Committee tomorrow, we doubt that he will veer away from his topic on the “Long Term Fiscal Challenges” that the US faces.  

Euro
The Euro is holding on strong in the face of firmer US data.  This morning’s inflation data was in line with expectations.  Consumer prices rose 0.4 percent in the month of December which left the annualized pace of growth unchanged at 1.9 percent.  The YoY core price growth also remained unchanged at 1.5 percent.  The trade surplus in the Eurozone fell short of expectations, but the revision in the prior month was quite substantial.  None of the European data was market moving, but it seems that Friday’s 1.2866 low is proving to be strong support for the EUR/USD.  Given the strength of today’s US data, if consumer prices also prints strongly, then there is a good chance that the currency could attempt to test that level.  There is no meaningful Eurozone data due for release tomorrow, but the ECB will be releasing their monthly bulletin which could shed some light on the current economic situation as well as the outlook for inflation. 

British Pound
The British pound continues to be one of the best performing currency pairs in the market.  The currency has extended its gains against both the US dollar and the Euro for yet another trading day.  Employment data released this morning for the month of December was stronger than expected thanks to a larger drop in jobless claims.   Wage growth slowed for the month of November however but that failed to undermine the overall strength of the UK economy.  The Bank of England still has reason to raise rates again in the first quarter, which leaves them as the most aggressive central bank in the G7.  Retail sales are due out tomorrow along with money supply and housing data.  It would be surprising if retail sales were not strong because it is unlikely that the central bank would raise interest rates otherwise.  Money supply data, which is another measure of inflation, should also be firm after the rise we saw earlier this week in consumer and producer prices. 

Japanese Yen
The Japanese Yen is the star of the market tonight as traders gears up for what could potentially be the second rate hike in six years.  With as many no rate hike calls as rate hike calls reported by the media, the decision is simply a coin toss at the moment.  The markets went from pricing in an 80 percent chance of a rate hike yesterday to 30 percent today.  Data overnight was yen bearish with the trade balance shrinking and consumer prices dropping.  We continue to believe that if there was a time for the BoJ to lift rates, it would be now.  The Japanese Yen is trading at very low levels against the Euro, US dollar and British pound which is already providing stimulus for the economy.  Therefore a rate hike at this time will probably not deal a significant blow to the economy.  The recent comments from Japanese government officials suggest that they are no longer as staunchly against a rate hike as they use to be.  As a result, we continue to believe that the most likely outcome tomorrow is a 25bp rate hike followed by an attempt to temper the market’s reaction to that move by signaling that another rate hike may be a long way off.  At this point, with the yen continuing to slide and rate hike expectations dropping so significantly, a move by the BoJ may actually still a cause a meaningful rally for the yen. 

Commodity Currencies (CAD, AUD, NZD)
The Australian and Canadian dollars are stronger today thanks to the rebound in commodity prices.  The New Zealand dollar however was not as lucky as a larger than expected drop in consumer prices dragged the currency lower.  For the first time in six years, consumers prices fell 0.2 percent q/q due to an 8.5 percent rally in the NZD/USD in the fourth quarter along with a 15 percent drop in oil prices during the same period.  This should keep the Reserve Bank of New Zealand on hold at next week’s monetary policy meeting.  Retail sales are due out tonight.  Given the recent trend of New Zealand data as well as the overall health of the economy, consumer spending is expected to be weak.

Kathy Lien is the Chief Currency Strategist at FXCM.