US Dollar
The larger US trade deficit has helped to contribute to the US dollar’s weakness, but most of the sell-off in the greenback today was triggered by positive Eurozone data and the continual liquidation of short Yen trades. The trade deficit broke back above the $60 billion mark to rise to -$61.2 billion in the month of December. Imports increased due to rising oil prices and demand for foreign autos and apparel. The deterioration in the trade balance in the last month of the year suggests that fourth quarter GDP may not be as strong as initially reported. Back in January, the advance release of fourth quarter GDP was 3.5 percent. This estimate was based upon a far smaller trade deficit and now that the deficit has widened, fourth quarter GDP growth may be much closer to the 2 to 2.5 percent range. Tomorrow we have the marquee events of the week, namely US retail sales and Federal Reserve Chairman Ben Bernanke’s semi-annual testimony on the economy and monetary policy. Consumer spending accounts for 70 percent of US GDP and how it fared last month will determine whether the market continues to give weight to the effects of today’s trade report on fourth quarter GDP. Incoming weekly and private sector spending data has been strong but the weakness in auto sales could hold back overall spending. Gas prices did not change much in January which means that it will have little impact on the overall release. Instead, we are watching gift card purchases since it was a big contributor to the retail sales report last January. As for Bernanke, odds are in favor of more optimistic comments from the Federal Reserve Chairman. He will most likely pat himself on the back for the rebound in growth. Inflation will continue to remain a concern for the central bank but at the same time, the housing market is only beginning to stabilize and they may signal that they need more time to review incoming data before considering raising interest rates.

Euro
Strong GDP numbers has pushed the Euro back towards the upper part of its month long range against the US dollar. In fact, the currency pair is now trading within 30 pips of its range high. As we speculated, analyst sentiment was not as optimistic as the consensus forecast for the month of February with the ZEW survey rebounding from -3.6 to a lower than expected 2.9. However, the market chose to place more weight on the sharp upside surprise to more backward looking GDP data. Fourth quarter growth accelerated by 0.9 percent on a quarterly basis and 3.3 percent on an annualized basis, which compares to the market’s 0.6 percent and 3.0 percent forecasts. Strength was seen all around with stronger growth reported by Germany, France and Italy. In fact, Italy produced the biggest upside surprise. Such strong numbers encouraged ECB Weber to talk up the outlook for growth and he even indicated that lower oil prices will help to minimize the impact of Value Added Tax increase. Looking ahead, the latest GDP data continues to suggest that the ECB will be raising interest rates next month. There is no significant data from the Eurozone Wednesday and Thursday, but there are a number of policy officials speaking including Trichet and their comments should continue to be supportive for the Euro.

British Pound
The British pound lost value against the Euro and struggled to rally against the US dollar today after consumer prices fell short of expectations. Consumer prices dropped a more than expected 0.8 percent in the month of January, while core prices increased by a more than expected 1.6 percent. This follows yesterday’s disappointment in producer prices and suggests that the Bank of England Governor could lean towards a more neutral take on inflation. However before jumping into a short pound trade, it is important to note that even though inflation is lower in the month of January, it could rebound in the coming months. In addition to the BoE Quarterly Inflation Report, employment data is also due for release. The labor market has been very healthy and we expect both the claimant count and the unemployment rate to continue to drop. Should average earnings rise, it may be a good leading indicator of what to expect from the BoE Inflation Report an hour later since wage pressure is also an inflation indicator.

Japanese Yen
The Japanese Yen continued to quietly strengthen against all of the major currencies except for those in the Commodity Bloc. News that North Korea may be willing to abandon their nuclear program has been exceptionally positive for the Yen. The Japanese were very concerned when recent tests suggested that North Korea’s missiles could reach Japan. As the country’s whose currency is the proxy for the entire Asia region, signs of geopolitical stability was taken favorably. The Yen also benefited from a jump in the stock market. The Nikkei hit a seven year high when it surged at the market open. Economic data was mixed last night with the CGPI index, which is an inflationary indicator falling short of expectations while consumer confidence beat expectations. GDP is the most important release from Japan this week and that is not due until Thursday.

Commodity Currencies (CAD, AUD, NZD)
The commodity currencies were the day’s best performers thanks to the rise in gold and oil prices. Both the Australian and New Zealand dollars were up over 1 percent against the US dollar while the Canadian dollar was up over 0.75 percent. Economic data was mostly encouraging. Australian NAB business confidence increased from 11 to 17 while the Canadian trade surplus hit a nine month high. Australian consumer confidence is due for release tonight and a similar rebound is expected. Canada on the other hand has no data on the calendar. Even though the New Zealand dollar was the day’s best performer, it was primarily led higher by Aussie strength after producer prices disappointed with input prices falling by 0.3 percent in the fourth quarter while output prices fell 0.5 percent. New Zealand retail sales are due for release tomorrow and given recent data, chances are more in favor of weaker rather than stronger spending numbers.

Kathy Lien is the Chief Currency Strategist at FXCM.