US Dollar
Throughout the past week, the value of the US dollar was determined almost exclusively by foreign developments. The dollar skyrocketed against the Japanese Yen on carry trade demand and slipped against the Australian, New Zealand and Canadian dollars on rising commodity prices. Against the Euro and British pound, the currency remained virtually unchanged. Even though there was barely any US economic data on the calendar, there was plenty of news that could affect the future direction of the US dollar, the most concrete of which is the potential rise in inflation. Consumer price growth was stronger than expected in the month of January which created a wave of concerns about inflationary pressures. The corresponding rise in oil prices exacerbated that concern as it was the most tangible driver of higher prices in months to come. The potential risk of a major blowup in sub-prime mortgages also sent investors fleeing into safer assets while Iran’s defiance of UN demands raised concerns for geopolitical risks. The pressure on the US dollar could continue to grow as we head into the busy data week. We are expecting durable goods, consumer confidence, existing and new home sales, preliminary fourth quarter GDP, Chicago PMI, personal income and manufacturing sector ISM. Aside from Chicago PMI and ISM, the market is not expecting dollar friendly data, especially at the beginning of the week. A drop in aircraft orders should weigh on durable goods orders while softer inventory data and downward revisions to non-residential and business investment could lead to a significant downward revision in GDP. This supports the technical outlook for the majors, which has turned dollar bearish on the last trading day of the week.

Euro
The Euro ended the day higher against the US dollar despite a softer German IFO report. The drop in business confidence from 107.9 to 107 in the month of February was relatively mild and any bearishness was offset by optimism off of the stronger French consumer spending numbers. The prospect of an interest rate hike in March and the potential impact of the Value Added Tax increase have given businesses reason to be slightly less optimistic about current and future conditions. Looking ahead, the Eurozone economic calendar is just as busy as the US calendar which suggests that we could see a meaningful pickup in market volatility. The Eurozone will be releasing German and Eurozone consumer prices, retail and manufacturing PMI, money supply, German and French unemployment, German retail sales and Eurozone consumer confidence. On balance, the data is expected to be Euro positive. Consumer price growth is forecasted to have accelerated in the month of January, the labor market in both France and Germany are expected to have improved along with conditions in the manufacturing sector. The only uncertainty lies in retail sales. Consumer spending was exceptionally strong in the month before the VAT increase and in response to that, spending is expected to have been pared in January. Switzerland will be releasing their KoF leading indicators report and manufacturing sector PMI report.

British Pound
The British pound is stronger against both the US dollar and Euro thanks to underlying strength in the fourth quarter GDP report. Even though the headline GDP number was not revised, private consumption and exports were. In fact, consumer spending was so healthy that it triggered cautious comments from Bank of England member Sentence who said that it was important for the central bank to keep demand under control, especially since inflation is coming back on-track. With oil prices creeping back up, another rate hike before the summer is not out of the question. In the week ahead, we are looking forward to a number of housing market related reports. This includes mortgage approvals and lending, the Hometrack and Nationwide house price reports, manufacturing PMI, money supply and the CBI Distributive trades survey. The Bank of England is divided on what to do next with interest rates and when. Since the housing sector has long been one of their primary focuses, next week’s reports are extremely important.

Japanese Yen
The Japanese Yen was this past week’s biggest market mover and we expect the currency to continue to be a dominant focus in the week ahead. Traders are getting tired of selling the Yen, especially after the Corporate Service Price index jumped to a 9 year high in the month of January. If US data begins to turn sour, today’s liquidation of short yen trades could exacerbate. Central Bank President Fukui has indicated that interest rates will remain low for sometime and we believe him, but any evidence of stronger inflation or consumer spending will still boost rate expectations. We will get “answers” hopefully next week with the release of retail sales, CPI, unemployment, industrial production and manufacturing PMI. 2007 could be the breakout year for the Yen, to read more about this see our Special Report.

Commodity Currencies (CAD, AUD, NZD)
After a brief pause yesterday, the commodity currencies extended their impressive rally. Gold prices rose by a decent amount while oil prices saw a mild extension above the $61 barrel level. There was no Canadian or New Zealand data on the calendar, but Australia reported an in line leading index for the month of December. The prior reading was revised higher from 0.2 percent to 0.5 percent. At this point, the outlook for the commodity currencies remains bullish. The Canadian economy has been performing very well and we expect next week’s GDP and current account data to continue to reflect that. Both Australia and New Zealand will be releasing trade data. The deficits of both are forecasted to have increased due to the stronger currencies. Australia is also releasing their January retail trade report, which is expected to be strong.

Kathy Lien is the Chief Currency Strategist at FXCM.