By DailyFX - US Dollar - The US dollar's performance this week is shaping up to be very different from last week, when we saw...

... the dollar sell off across the board against the majors.


Today,the dollar strengthened against all currencies expect for the British pound and the
Japanese Yen. In fact, no one currency has seen a clearer trend against the dollar
with virtually no retracements than the Yen. Carry trade liquidation remains the
predominant theme, which also goes to show the importance of interest rates for the
year ahead. The dollar's mixed performance has to do with two conflicting global
developments. Geopolitical risks remain on the forefront as Iran defies the United
Nations by breaking their seals and restarting their nuclear program. With the
mounting possibility of this becoming a deeper crisis, oil prices have remained
solidly above $60 a barrel. As OPEC's second largest producer, Iran knows that its
world critics will tread carefully because any sanctions on their number one export,
oil, would only further raise the price of oil, which would undoubtedly affect the
world economy. On the flip side, helping to contain dollar bearishness were new
comments from China. Unsurprisingly, China has come back to "reclarify" their
recent comments on reserve diversification. This seems to be something they do quite
often * which is introduce an idea, watch the market react and then take back their
comments if the reaction is excessive or undesirable. Previously, they have said
that they were looking to diversify out of dollars. Today, they said that their
comments were not directed at current reserves but may be considering options for
new reserves. One way or the other, there is no doubt that central banks in Asia
have seen increasing foreign investment. UBS announced today that they downgraded
their one and three month targets for the US dollar. They blame the expected
weakness on deterioration in the US trade balance, increased uncertainty, central
bank diversification, and properly priced equity and bond market valuations.
Nothing new, most analysts have been calling for the same thing - slower US growth,
higher oil prices and lower house prices. What they don't quite agree on yet is
whether the Fed will stop at 4.25%, 4.50% or 5%.

Euro

Another trend that we have been seeing is stronger Eurozone economic data. The
German ZEW index jumped from 61.6 to 71, which is the highest level that we have
seen since January of 2004. The Eurozone ZEW index increased from 51.2 to 66.1. More
investment is occurring in the Eurozone and we are beginning to see economic
recovery that may very well be fueled by more than exports alone. Yesterday's
larger trade surplus already illustrated this possibility which as we have said will
become even more important as the Euro continues to rise. French and Spanish
manufacturing activity also improved with industrial production increasing by 3.1%
and 0.8% respectively. Overall, the evidence continues to stack up in favor of
another rate hike by the European Central Bank. If the current trend continues, it
will be a move that the ECB cannot avoid. In the shorter term however, even though
the ECB is not expected to raise interest rates on Thursday, there is a very good
possibility that we will hear some hawkish comments from ECB Trichet, which could
help the Euro regain some upside momentum. Meanwhile, the Avian flu epidemic is
still hitting headlines. There are 15 people in Turkey who have tested positive for
the virus while Greece is on alert for contamination. For the time being, there
have been no human to human transmission, but it is at least a reminder that it may
be too early to forget about the Avian flu virus.

British Pound

Strong retail sales has helped the British pound hold onto its gains against the
dollar. Retail sales jumped by 2.6%, the largest amount in 18 months and double
market expectations. December has proved to be a great month for retailers which
going into Thursday's Bank of England rate decision only further solidifies the
already consensus expectation that the BoE will refrain from lowering rates once
again. Recently, we have seen more people jump over to the neutral camp from the
rate cut camp. Economic data has been very mixed which certainly doesn't help the
BoE's decision making process. Even though the retail sector has been improving,
the manufacturing sector has been soft. The Trade Congress Union called for another
rate cut as higher unemployment and lower growth could be a big risk for the sector.
As we stand, the BoE is still on rate cut watch, but in the past week, they have
certainly inched closer to neutral.

Japanese Yen

The Japanese Yen strengthened significantly against all of the majors expect for the
Canadian Dollar. Household spending was weaker than expected and Economic Minister
Yosano warned about excessive fluctuations, but both did little to stifle the Yen's
gains. The trading range remains tight as traders mull over the possibility of
another move lower. Traders are taking the central bank comments with a grain of
salt since the likelihood of Japanese intervention still remains low. According to
our proprietary sentiment index, more losses could be in store for USDJPY. For the
time being, most traders are still favoring a downside bias the currency pair.


Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com
By DailyFX

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