US Dollar
Even though there was no US data to drive market activity today, there was quite a bit of interesting price action. The main event was the press conference after the ECB meeting. Interest rates were left unchanged, but as soon as the words “strong vigilance” came out of Trichet’s mouth, the ECB’s hawkish bias was set and bullishness was instilled in the Euro. The behavior in the British pound however was very different. The currency collapsed after the Bank of England left interest rates unchanged. It appears that more than a small minority may have been expecting an interest rate hike. The Australian and Canadian dollars rallied thanks a rise in commodity prices while the New Zealand dollar collapsed after Finance Minister Cullen said that he was considering imposing a mortgage levy to curb the growth of the housing market. The action has been in the crosses with typically range bound pairs like the EUR/GBP and EUR/CHF seeing unusually large moves. The Tier 2 US data released today pretty much offset each other. Wholesale inventories fell short of expectations while wholesale sales were stronger than expected. Jobless claims were slightly higher, but remained at levels that were indicative of limited job losses. Tomorrow’s market activity should continue to be driven by factors outside of the US since no economic data is due for release. We expect the most interesting movements in the Japanese Yen as traders adjust their positioning ahead of the G7 meeting.

Euro
Thanks to the comments from European Central Bank President Trichet, a March interest rate hike is a near guarantee. The central bank President was far more hawkish this morning than he was at the last monetary policy meeting where he set the market up for today’s unchanged rate decision. Trichet plays his cards well and after the latest pause he is now telling traders to expect one rate hike in March and possibly another one shortly there afterwards. Even though he felt that inflation could slow in the spring and summer, he expects it to accelerate again in the second half since Germany’s Value Added Tax increase has yet to be reflected in consumer prices. The economic expansion also remains solid and the outlook for consumption is promising. Therefore unless we see a material slowdown in Eurozone growth, interest rates could reach 4 percent by the end of the year. Furthermore, Trichet clearly indicated that the ECB is independent and will not be influenced by Eurozone finance ministers. His lack of concern for carry trades suggests that they will not be stopping rate hikes just to stem the rise in EUR/JPY.

British Pound
The Bank of England’s decision to leave interest rates unchanged triggered a major sell-off in the British pound against the US dollar, Euro and Japanese Yen. The most interesting aspect of today’s move is the fact that trader positioning was so misaligned with analyst expectations. Given the narrow vote that supported the last rate hike, there was little chance for a follow-up move today. However the sharp divergence between UK and Eurozone monetary policy has earned EUR/GBP the status as the day’s most market moving currency pair on a percentage basis. The sell-off in the GBP/USD was exacerbated by a report from the Wall Street Journal that UK based HSBC was forced to set aside 20 percent more capital (most likely in US dollars) to cover the delinquencies in the US sub prime mortgage market. The fear that HSBC will struggle to recover from this has sent the company’s shares down to an 8 month low. However the blowup in the sub prime market has even greater significance. We are sure that HSBC, who is the world’s third largest bank, is not the only ones to suffer from the growing delinquencies in the US sub-prime lending market. If this problem exacerbates, it may be the first sign that the US economy is in trouble. The UK trade balance is due for release tomorrow and the strong level of the pound could push the deficit higher.

Japanese Yen
Comments from Bank of Japan member Haru sent the Japanese Yen tumbling today. Haru reiterated the importance of keeping a loose monetary policy and touted the benefits of a weak yen for the economy. The takeaway message from his comments is that they will press hard to defend the recent weakness in their currency and will probably not waiver in the face of European pressure. Furthermore, it is unlikely that they will raise rates until April or June. Nikkei news speculated that weak economic data will prevent the central bank from tightening policy. The BoJ has long said that they need to see improvements in consumer demand and inflation before raising interest rates again. The G7 meeting will be the market’s main focus tomorrow. Even though no official criticism is expected, there could be some position squaring of yen shorts ahead of the meeting.

Commodity Currencies (CAD, AUD, NZD)
Big moves were seen in the commodity currencies today. The Australian dollar rallied for the fifth consecutive day thanks to rising gold prices and underlying strength in last night’s employment numbers. The strength was most pronounced against the New Zealand dollar which suffered from Finance Minister’s Cullen’s open considerations about a levy on mortgages. This is actually an extremely intelligent way of taming the housing bubble. The most common way to tame a housing market is to raise rates, but with interest rates that are already the highest amongst the developed world, the New Zealand government has no interest in spurring even more demand for their currency. A mortgage levy on the other hand not only helps to cool the housing market, but it also helps to cool the strength of the New Zealand dollar. The Canadian dollar on the other hand saw a nice intraday reversal as oil prices continued to climb. Canadian employment numbers are due for release tonight and a strong print could exacerbate the turn in USD/CAD.

Kathy Lien is the Chief Currency Strategist at FXCM.