US Dollar
The US dollar is weaker today after the Federal Reserve failed to deliver the degree of hawkishness that the market was anticipating. After a series of upside surprises in US data, many traders had begun to price in the possibility of an interest rate hike by the Federal Reserve later this year. However, what the Fed chose to tell us instead is that even though there are signs of recovery, they need to see at least two more months of data before pulling the trigger. Their concern is that the recent strength may be as much of a fluke as the weather patterns that we have seen so far this year, which is why for the time being, they feel that the housing market is only showing “tentative signs of stabilization.” Since the last quarter point rate hike in June, interest rates have remained steady at 5.25 percent. This morning’s economic numbers were mixed. Fourth quarter GDP was very strong, printing at 3.50 percent compared to the market’s 3.0 percent forecast. ADP employment also rose to 152K compared to a 140K forecast, signaling that we could see strong payroll growth on Friday. However Chicago PMI dropped to 48.8 from 51.6, which is the first time that the index has dipped into contractionary territory since April 2003. With the ISM report on tap tomorrow, we could be looking forward to a weaker number. A dip into contractionary territory is unlikely though since manufacturing in the Philadelphia region accelerated in the month of January. The mixed reports this morning and the Fed’s moderately disappointing FOMC statement have dealt a blow to the dollar’s momentum. We will need a strong ISM number to erase that sentiment. Rate hike expectations have dropped from about 14 percent in December to close to zero.

Euro
Stronger German economic data has helped to take the Euro back above the 1.30 level. Retail sales increased 2.4 percent in the month of December indicating that consumers spent aggressively ahead of the increase in the Value Added Tax. This should be exceptionally positive for fourth quarter GDP and is likely to be the main contributor to the recovery that we have seen over the past 2 months. Looking ahead, even with the tax increase, the economy is starting the New Year on a stronger footing. German unemployment dropped by 106k in the month of January, bringing the unemployment rate down from 9.8 percent to 9.5 percent, the lowest level in over 4 years. The market was only looking for a 40k drop but warm weather and strong consumer demand in the month of January kept more workers on corporate payrolls. However much of this growth was driven by demand in the fourth quarter, so we will need to see at least 2 more months of strong data to determine that the growth is sustainable. Elsewhere in the region, the outlook is not as positive, as consumer confidence in the Eurozone moves deeper into negative territory. The flash consumer price estimate also remained unchanged at 1.9 percent, compared to the market’s 2.1 percent forecast. Germany is clearly the only one providing the boost to growth and inflation while the rest of the region lags. If German data fails to extend its strength, then the next ECB rate hike may be their last.

British Pound
Even though the British pound is slightly stronger against the US dollar today, that strength is mostly attributed to dollar bullishness rather than pound bearishness. The GfK consumer confidence report did come out stronger, rising from -8 to -7 but the outlook component for personal finances deteriorated. This is yet another indication for a potential slowdown in the UK economy in the months ahead. We have already seen signs of slower price growth in the housing market and now the GfK consumer confidence report is signaling that spending could also falter. This gives strong fundamental backing to the latest move in EUR/GBP. Manufacturing sector PMI is due for release tomorrow. The index is only expected to drop modestly which means that the British pound’s value will continue to be dictated by the over or under performance of US data.

Japanese Yen
The Japanese Yen broke higher after comments from US Treasury Paulson. With the G7 meeting scheduled for next weekend (Feb 8-9 to be exact), traders have been looking for clues on whether the US will back Eurozone officials in criticizing the recent weakness in the Yen. Paulson indicated today that the US is watching the Japanese Yen very carefully and said that he was very frustrated with China’s currency regime. Although these two statements do suggests that the US may support critical comments about the Asian currencies, his latter statements still leaves things up in the air. He said that economic fundamentals are driving the yen and that talks with China give the “best chance” for progress. In addition economic data released overnight continues to indicate that the Japanese economy is weakening. The biggest problem in the economy is earnings growth which continues to remain a problem as labor cash earnings fall by 0.6 percent and overtime earnings grow by a paltry 1.6 percent.

Commodity Currencies (CAD, AUD, NZD)
The Commodity Currencies are all stronger across the board thanks to firmer New Zealand and Australian data. The New Zealand trade deficit shrank from -0.805B to -0.785B while the Australian skilled vacancies increased by 1.4 percent and new home sales rose by 6.0 percent. Canadian data was softer, but the Loonie found support from the rebound in oil prices. CAD GDP rose by only 0.2 percent in month of November compared to a 0.3 percent forecast. The Australian and New Zealand dollars appear to be bottoming out while the Canadian dollar is doing the exact opposite.

Kathy Lien is the Chief Currency Strategist at FXCM.