US Dollar
The US dollar staged quite a turnaround this week despite the lack of any significant data. Over the past few weeks, other central banks have proven to be less hawkish than the market had anticipated while upside surprises in US data continues to give traders confidence that the Federal Reserve will keep interest rates at 5.25 percent throughout the first half of the year. This is especially important going into next week’s FOMC meeting. The Federal Reserve has good reason to remain hawkish and will continue to warn of upside inflation risks. Even though oil prices have been falling, the labor market and wage growth have been strong, which should boost inflationary pressures. The two sectors of the economy that use to be a problem are now showing signs of stabilization. Durable goods orders increased by 3.1 percent in the month of December. This was only slightly stronger than expected but we had a big surprise in orders excluding transportation. Originally a large Boeing order was expected to skew the report to the upside but today’s release actually showed that demand was more broad based. As for the housing market, the growth in new home sales completely blew past expectations. Sales increased by 4.8 percent last month while November sales were revised from 3.4 percent to 7.4 percent. In the week ahead the US economy has many opportunities to prove its strength. The calendar is packed with important releases including Consumer Confidence, GDP, FOMC, Chicago PMI, Construction Spending, ISM, Personal Income, Personal Consumption Expenditures, and Non-farm payrolls. If we get overwhelmingly positive news, the market could even begin to talk about the slim chances of an interest rate hike over a cut this year.

Euro
Strong Eurozone inflation data was balanced out by even stronger US data, which prevented the EUR/USD from breaking out of its two week long 200-pip trading range. The currency pair came close to testing the bottom of its recent range, but it will need next week’s tier 1 US reports to trigger a break. Money supply growth increased from an annualized rate of 9.3 percent to 9.7 percent in the month of December, which comes in contrast to the slower growth that the market originally projected. The faster inflation growth lends validity to hawkish comments made by ECB officials this past week. ECB member Weber said that inflation has started the year above their 2 percent target rate. Stark added in a separate comment that the central bank needs to take proactive measures to prevent inflation from exceeding far beyond 2 percent. Both feel that interest rates are extremely accommodative which basically ensures an interest rate hike this quarter. Like the US, there is a ton of Eurozone data due for release. This includes consumer price reports, unemployment reports retail sales reports, consumer confidence and regional PMI. Meanwhile in Switzerland, the UBS consumption index increased from 1.889 to 1.896 in the month of December, which supports the optimistic growth comments that we heard from SNB Roth yesterday.

British Pound
After the minutes from the Bank of England’s most recent monetary policy meeting revealed that four out of the nine members of the MPC voted against the interest rate hike, the currency staged a major turnaround. The market went from pricing in another rate hike this quarter to steady rates for the next two months. Having long been the primary driver of growth for the economy, the housing market is beginning to show signs of weakness. According to the British Bankers’ Association, mortgage approvals dropped sharply in the month of December. This follows softer than expected price growth reported by RICS and Halifax earlier this month. Next week we will have a better gage of how the housing market is doing thanks to more reports related to the sector. We are expecting Nationwide House prices, BoE Mortgage Lending / Approvals, in addition to the CBI distributive trades survey, the Gfk Consumer confidence report, and PMI.

Japanese Yen
A softer than expected consumer price report has put a stop to most of the carry trade liquidation. Even though consumer price growth was flat in the month of December, core prices fell 0.1 percent when compared to the prior month. This was hardly surprising given the Bank of Japan’s decision to keep interest rates on hold earlier this month. If inflation had picked up pace, they may have had more reason to tighten rates. There are two major event risks over the next few weeks that the market will be focusing on, which are the G7 meeting and the February central bank meeting. The decision to stand pat this month shifted the market’s expectations for a rate hike to February. The overnight swap rates are putting the odds at 50/50. Originally the fear was that the G7 would criticize the recent weakness of the Yen at their meeting, but to do so would require criticizing the weakness of the Chinese Yuan, which the US may not support at this point. Treasury Secretary Paulson’s buddy versus bully approach seems to be paying off slowly but surely and he may not be willing to risk it. Next week the Japanese economic calendar is quite busy as well. We are expecting spending, labor market, manufacturing and trade data. Unfortunately, none of the numbers are projected to be stellar.

Commodity Currencies (CAD, AUD, NZD)
It has been a brutal week for the Australian dollar after the surprise drop in consumer prices. The currency is trading at a year to date low against the US dollar and this weakness has infected the New Zealand dollar as well. The market has completely shrugged off the hawkish comments from the Reserve Bank of New Zealand after their monetary meeting. The central bank has been confusing the market quite a bit lately. Even though they the RBNZ comments were hawkish, Governor Bollard warned of the possibility for a financial crisis because of the nation’s low savings rate. It seems that every time there is a Kiwi supportive development, that development is tempered. In the week ahead, Australia and New Zealand will be releasing trade data while Canada publishes its report on manufacturing conditions along with the GDP. As usual the trend of commodity prices will also play a role in how these commodity bloc pairs behave.

Kathy Lien is the Chief Currency Strategist at FXCM.