US Dollar
Recovery was the main theme in the foreign exchange market today as the yen crosses saw their biggest one day rally since the unwinding began last Tuesday. Stronger unit labor costs contributed to the gains, but the rebound was already in place by the US market open. China continues to the puppet master of the global markets as the Shanghai and Hong Kong stock indexes lead the gains in equity markets worldwide. Whether USD/JPY is able to hold onto its gains may be partially dependent upon whether the Chinese stock market continues to rebound. Both non-farm productivity and unit labor costs continued to rise in the fourth quarter, but the optimism from these reports were limited by the sharp decline in factory orders and pending home sales. These two reports confirm prior weakness that we have seen in durable goods orders and new home sales. The manufacturing sector has been struggling for some time despite the reported up tick in the ISM manufacturing report last week. The housing market however is still at a tipping point as analysts gage the potential damage of the problems in the sub-prime lending sector. Either way, the US economy is still very vulnerable at the moment and the 157 point rally in the Dow today will not be enough to erase the 750 point drop that we have seen over the past week and a half. Looking ahead, the ADP employment report and consumer credit are the only two pieces of US data due for release. Payroll agency ADP has made significant changes to their sampling methodology which they claim will increase the accuracy of the ADP forecast significantly. For this reason, the ADP number could still be reliable. We also have the release of the Fed’s Beige Book report and comments from Fed President Moskow, who will most likely attempt to pacify the markets.

Euro
Despite significantly weaker retail sales in the region during the month of January, the Euro managed to end the day higher against the US dollar. Over the past few days, the Yen has dictated the movements of many of the other currencies around the world and today is no different. The rally in the Euro can be attributed to the larger gain in EUR/JPY over USD/JPY. Compared to the 595 pip drop in USD/JPY since February 23rd, the 890 pip drop in EUR/JPY helps to explain the currency pair’s sharper rebound. After the surprising drop in German retail sales, the market had already been expecting a 0.4 percent drop in Eurozone retail sales, but the actual decrease of 1.0 percent in the month of January was over double market expectations. Meanwhile no changes were made to fourth quarter GDP and aside from German factory orders, the Eurozone economic calendar is completely empty tomorrow. Switzerland on the other hand reported slower growth in the fourth quarter, triggering a sell-off in the Swiss franc against the Euro and US dollar. Consumer spending and growth did accelerate, but traders were looking for a far faster growth given the strength of prior releases. The Swiss National Bank is still on track to raise interest rates in the next few weeks.

British Pound
The British Pound is higher against both the Euro and US dollar. Like the movements in the Euro, the rally in the pound is partially or even mostly driven by the sharp rebound in GBP/JPY. Next to AUD/JPY and NZD/JPY, the GBP/JPY is the day’s best performing currency pair. Having fallen 1,630 pips since February 23rd, the 433 pip rally represents a 25 percent rebound in the currency pair. The stronger 3.3 percent rise in the BRC retail sales monitor contributed to the overall bullishness in the British pound. The market was originally looking for sales growth to slow from 3.1 percent to 2.3 percent. This upside surprise suggests that we could also see stronger consumer confidence in tonight’s Nationwide confidence report. However it will not provide enough reason for the Bank of England to raise interest rates this week. Whenever they leave rates unchanged, there is no accompanying statement, which means that the rate decision will be a nonevent.

Japanese Yen
The rebound in the Chinese stock markets have led to a correction in the Japanese Yen. There was no Japanese data released last night which indicates that the latest move in Yen was driven by market flows. The move represents a long overdue correction for the Yen crosses, but before getting too excited, it may be premature to look for a major reversal. There has been widespread debate on whether the recent move in the Japanese Yen was a result of the liquidation stopping out carry traders or carry traders actually unwinding their leveraged bets. Either way, with the market so short Yen over the past few years, we are certain that more people have been burned in this latest move than the people who profited. Therefore, they will be far more reluctant to jump back into the market and take the currencies back to pre February 23rd levels. Risk aversion has put an abrupt stop to the party and it is unclear how quickly the partiers are willing to come back. In the long run however, the sharp rally in the Yen will force the Bank of Japan to delay their plans for further tightening.

Commodity Currencies (CAD, AUD, NZD)
The Commodity Currencies managed to ebb higher today as Aussie and Kiwi – the whipping boys of the recent carry trade liquidation – bounced from Asian session lows ahead of potential monetary policy action this week while USDCAD worked down from the 1.1800 level. The Australian trade deficit for January narrowed much more than expected to A$876 million on export growth and a slowdown in imports, which propelled the AUDUSD pair back above the .7700 level. In New Zealand the calendar was empty but the run up to the RBNZ’s monetary policy decision could find Kiwi bid as a hike to 7.50% is widely expected and would put the recently-taboo carry trade significantly in the New Zealand dollar’s favor. Canadian data has been quite strong over the past week, and today was no exception as building permits surged 11.3%. However, the marquee event for Loonie was the BoC decision. Although the central bank stayed pat at 4.25%, the statement accompanying the decision had a slightly hawkish leaning with Governor Dodge and Co. citing underlying strength in the economy and “roughly balanced risks” to inflation projections.

Kathy Lien is the Chief Currency Strategist at FXCM.