US Dollar
The lack of a significant reaction in the US dollar following the dollar positive economic releases that we have seen over the past few days suggests that traders may have already discounted the return of the Goldilocks economy. We have now seen evidence of strength in consumer spending, the labor market, manufacturing, inflation and housing.  This morning, the much awaited consumer price report revealed the fastest pace of growth since August while annualized headline prices increased from 2.5 percent to 2.6 percent due to a pickup in gasoline, fuel and utility prices.  Core price rose by 0.2 percent, which was in line with the market’s expectations. This kept annualized core price growth steady at 2.6 percent.  Housing starts also increased for the second month in a row by a whopping 4.5 percent, which confirms the pickup in home builder sentiment that we saw yesterday. As for manufacturing, not only did the Philly Fed index rebound from -2.3 to 8.3, beating the market’s 3.0 forecast, but it also hit the highest level since August.  The subcomponents only reported mild improvements, but overall, today’s data continues to give the Federal Reserve reason to keep interest rates at 5.25 percent.  The Bank of Japan’s surprise pause last night will also keep USD/JPY carry trades in play.

Euro
The Euro remains very strong in the face of healthy US data. The ECB monthly report released this morning remained essentially unchanged from the prior month.  The report indicated that there were still upside risks to inflation and improving prospects for growth. The comments from EU’s Alumnia today are a great reflection on how the ECB probably felt at their last monetary decision.  Alumnia said that the Euro’s appreciation has been moderate and the recent strength of the currency has helped to push down inflation.  Between November 21st and December 2nd, the EUR/USD appreciated from 1.2860 to 1.3367.  This rapid acceleration pushed down inflation at a time when oil prices tumbled, giving the ECB plenty of room to delay an interest rate hike.  As much as foreign exchange traders like to see higher yield, central banks do not, especially for a region that is still struggling to grow.  Each rate hike tightens the economy and crimps growth.  The latest drop in Euro will still validate another rate hike in March, which may explain why ECB members still feel that rates remain accommodative.  Meanwhile Switzerland reported improvements in both retail sales and the ZEW survey of analyst sentiment.  Consumer spending increased by 3.3 percent in the month of November while the ZEW survey rose from -23.7 to -10.8. This gives the Swiss National Bank reason to lift interest rates again despite muted inflationary pressures.

British Pound
The British pound continues to be the most consistently performing currency pair, as it strengthens against the US dollar, Euro, Swiss Franc and Japanese Yen.  The strength against the Yen was the most notable since the Bank of Japan’s decision to leave interest rates unchanged makes the divergence between UK and Japanese monetary policies even clearer.  Comments form Bank of England member Besley further solidified the overall hawkish stance held by the central bank.  He said that the service sector continued to be a source of inflationary pressure due to its tight labor market and lack of spare capacity.   The British Chamber of Commerce’s Q4 survey also reported the fastest price growth in the service and manufacturing sector in 9 years.  Tomorrow we are expecting retail sales and money supply data.  Given the strength of PPI and CPI, money supply growth should also be robust.  We also believe that retail sales should remain strong since there is little chance the BoE would have raised interest rates is consumer spending was floundering. 

Japanese Yen
The Bank of Japan delivered by a big surprise last night by keeping interest rates unchanged at 0.25 percent.  Although the futures market was pricing in a 30 percent chance of a rate hike yesterday, the day prior, it was pricing in an 80 percent chance.  For the first time since the last interest rate hike in July, the decision was not unanimous.  Six out of the nine members voted for unchanged rates while 3 voted for a rate hike.  Concerns about economic growth seem to be weighing on the central bank despite the potentially stimulative impact of a weak Yen.  According to their monthly report, the “developments in the Japanese economy have deviated slightly downward” from their October report which can be backed up by the recent deterioration in economic data.  Last night, leading indicators dropped from 20 percent to 18.2 percent while the tertiary activity index came out weaker than expected.  The latest decision by the central bank keeps carry trades in play, but at the same time, it also pushes the market’s expectations for a rate hike out to February.  Overnight index swaps are currently pricing in a 70 percent chance of a February hike.  Whether or not the central bank delivers that will depend on how economic data fares over the next month.  If the data does not reflect improvements in the economy, the central bank may have to delay a rate hike once again.

Commodity Currencies (CAD, AUD, NZD)
Despite a drop in commodity prices, the commodity currencies are all stronger against the US dollar as yield driven demand drives those currencies higher.  Gold and oil prices are lower on the day with oil prices having broken below the $50 a barrel intraday. However stronger economic data from Australia and Canada are keeping those currencies lifted.  Australia reported a record high in commodity prices while Canada reported a huge surge in foreign demand for Canadian stocks and bonds.  In fact, November’s C$10,998 billion in net purchases was the strongest in 3 years and almost 1000 percent higher than the 3 month average.  The Canadian manufacturing shipments report also increased by 2.3 percent, which was over double the market’s 0.9 percent forecast.  Tonight we have New Zealand retail sales.  A drop is expected given the recent weakness in the economy as a whole.  There is a small possibility that the strength in the housing market could spur a bounce however.  Australia will be reporting import and export prices while Canada releases their wholesale trade and inventories data.

Kathy Lien is the Chief Currency Strategist at FXCM.