US Dollar
The price action in the US dollar over the past week suggests that there may no longer be any buyers left in the market.  Nearly every piece of US economic data has surprised to the upside, highlighting the overall strength of the economy. Improvements have been seen everywhere from housing to manufacturing to the labor market, consumer spending and inflation. According to the University of Michigan Consumer confidence report, optimism hit a 3 year high in the month of January.  Comments from Federal Reserve Presidents Hoenig and Bies also continued to confirm the market’s general belief that interest rates will remain unchanged throughout the first half of the year.  Both Presidents felt that improvements in the economy should keep inflation risks skewed to the upside.  All of this should have been very positive for the US dollar, but it wasn’t.  Except for the Japanese Yen, the US dollar either lost value or remained unchanged against every other major currency.  This counterintuitive price action can only be a result of either central bank buying or skepticism about how much longer this dollar rally can last.  Technically, the inability of the EUR/USD to break below last Friday’s low has not helped either.   A quiet data week ahead makes the chance that the US dollar could resume its prior rally even slimmer.   The only major piece of data due for release is durable goods on Friday, but there are 2 wild cards worth watching.  The first is oil.  Crude prices are hovering slightly above the key $50 a barrel mark.  Should it break below that, we could see oil prices spiral lower as stops get triggered, which would also send the US dollar higher.  The second is President Bush.  He will be giving his annual State of the Union Address on Wednesday.  He is likely to pat himself on the back for the improvements in the economy, but without a Republican Congress, it will be interesting to see how he tackles the political and economic landscape going forward. 

Euro
Despite a week of stronger US economic data, the Euro still managed to rally 4 out of the past 5 trading days against the US dollar.  Even though the comments from European Central Bank officials have been moderating which indicates that they could be slowing down their pace of tightening, the latest comments still confirm that they are on track for at least one more interest rate hike.   Nearly all of the Eurozone’s monetary policy members have said that rates still remain low, but Garganas indicated specifically that inflation may increase back above 2 percent or more this year while growth may be near or above potential.  This will force the central bank to act as he said in a “timely, prompt manner if needed.”  He also noted that the futures market is currently pricing in a 100 percent probability of a March rate hike.  Given his verification that the central bank likes to prepare the markets for a move, he would not be making such hawkish comments unless the ECB planned to deliver to the markets what they expected.  Unlike the US, there are a number of important pieces of data due for release next week.  This includes the German IFO report, French Consumer Spending, Business Confidence and Eurozone money supply.  Garganas warned that the ECB is monitoring M3 money supply growth extremely closely for signs of inflationary pressures.

British Pound
It is clear that the rally in the British pound has become very exhausted given the currency’s lack of a reaction to the firm retail sales and money supply figures released this morning.  Retail sales increased 1.1 percent in the month of December, which was close to double market expectations.  Money supply growth was only slightly stronger than expected, rising 0.9 percent versus 0.8 percent expected.  After the surprise interest rate hike earlier this week, these upside surprises have been essentially priced into the market.  There was a very slim chance that the Bank of England would have raised rates if consumer spending was not strong.  Instead, traders paid more attention to the softer mortgage data which points to potential weakness in the housing sector.  After the drop in prices reported by the RICS and Halifax housing market surveys, the market has already become concerned about the stability of the UK housing sector.  The mortgage data only exacerbates this worry and having been the sector that has led the recovery, it’s potential weakness has now become very worrisome.  

Japanese Yen
The Bank of Japan’s decision to leave interest rates unchanged is still resonating in the markets as the Yen extends its slide against the majors.  USD/JPY has hit a four year high while EUR/JPY came with 20 pips of its all-time high on an intraday basis.  The markets are continuing to look to February for a potential rate hike.  Overnight index swap futures which can be extremely volatile pared back expectations from 70 to 56 percent.  Next week’s data will play a major role in clarifying the potential timing of the next rate hike with consumer prices due for release.  Any signs of inflationary pressures will send rate hike expectations and the Yen skyrocketing.  If inflationary pressures continue to subside however, those same expectations could sink towards zero.  The BoJ will also be releasing their minutes from the December meeting while many BoJ officials are set to speak in the week ahead. 

Commodity Currencies (CAD, AUD, NZD)
The commodity currencies are finally responding to the rebound in commodity prices.  They are stronger across the board even though economic data from all three countries disappointed.  New Zealand reported a larger than expected drop in retail sales, which was also the first drop in 7 months. Australia reported a much weaker rise in export prices and a larger drop in import prices, signaling that inflationary pressures are subsiding.  Canada also reported a smaller than expected rise in wholesale sales due to a drop in demand for agricultural and farming products. The Reserve Bank of New Zealand will be conducting a monetary policy meeting next week.  Given the drop in retail sales and the drop in consumer prices we saw earlier in the week, there is little chance that the central bank will change interest rates from their present level of 7.25 percent.  Meanwhile, Australia and Canada have inflation reports due for release; Canada will also be releasing their retail sales report.

Kathy Lien is the Chief Currency Strategist at FXCM.