US Dollar - 2007 has started with a bang even though the US equity markets were closed for the National Mourning Day. After at...

... least a week of compressed volatility, we have finally seen a breakout in the currency market as the US dollar came under severe selling pressure.

Traders are telling the market that they do not want to be long
dollars ahead of the busy data week. There was originally a lot of important data
due for release today, but that is now pushed out to Wednesday. Tomorrow we are
expecting not only the manufacturing ISM survey, but also one of the leading
indicators for December payrolls, which is the ADP Employment index. ISM and
payrolls are this shortened trading weeks most important economic releases. The
ADP report is projected to forecast a smaller payroll gain in December than in
November. The size of the surprise, if any could set the tone for trading until we
see the actual payrolls report on Friday. We would need to see very strong payroll
growth to reverse the hold that dollar bears have on the market right now. The ISM
report could help as traders are forecasting for a rebound in the month of December.
The strong Chicago PMI print last week suggests that we could actually see the
index rebound, especially since the ISM adjusted Philly Fed index increased in the
month December despite the drop in the headline index. Traders will also be paying
very close attention to the prices paid component since inflation is still the
Federal Reserves top priority. Growth in the prices paid component could drive
talk of hawkish FOMC minutes later in the afternoon. With so much data due for
release, tomorrow should not be a boring trading day one way or the other.

Euro
The Euro is up strongly today despite weaker economic data. The Eurozone
manufacturing PMI index dropped from 56.6 to 56.5. Even though Germany and France
saw improved activity, weaker performance in France dragged the overall index lower.
On the most fundamental level, the fact that the US ISM index has a possibility of
remaining in contractionary territory while the Eurozone PMI index remains solidly
in expansionary territory explains the reason why the market was able to shrug off
the report. In addition, there was more speculation of central bank buying for
reserve diversification purposes along with hawkish comments from yet another ECB
member this morning. This time Liikanen warned about the second round effects of
higher oil prices. The biggest uncertainty in the Eurozone is Germanys value
added tax increase which went into effect yesterday. The VAT tax rose from 16
percent to 19 percent and was originally expected to have a huge drag on the
economy. However the most recent IFO report suggests that businesses are not
worried yet. Interviews with a bunch of German retailers suggests that even though
the VAT tax will have a meaningful impact on the economy, that may not be until
February or March when January discounting comes to an end. German unemployment is
due for release tomorrow. Another improvement is expected, which should have kept
retail sales healthy last month.

British Pound
Like the Euro, the British pound also rallied strongly on the first trading day of
the year. Manufacturing PMI fell for the third month in a row even though the
market was projecting for an improvement. The index fell from a downwardly revised
52.5 to 51.9, the lowest level since last March. Despite the drop, the Bank of
England is still on track to raise interest rates again early next year. We will be
watching tomorrows money supply data for more direction. Faster acceleration in
money supply growth could push the central bank to move faster with interest rates.
There will also be a number of housing market reports tomorrow. The sector has
shown impressive strength throughout the second half of 2006 and the data is
expected to continue reflect that. With a booming housing and stock market, there
is little chance that consumer confidence will not tick higher.

Japanese Yen
The Japanese Yen has weakened significantly against all of the majors except for the
US and Canadian dollars. The weakness was so pronounced that it drove EUR/JPY to a
fresh record high, AUD/JPY to a fresh 8 year high, GBP/JPY to a fresh 7 year high
and NZD/JPY to a fresh 1 year high. With the Japanese markets closed until
Thursday, there was no economic data released overnight. The biggest question on
the minds of yen traders is still when the next Bank of Japan interest rate hike
will be. Yomiuri newspaper reported on Monday that the central bank could raise
rates as early as this month. They have a monetary policy meeting scheduled for
January 17 to 19. The JiJi News Agency repeated their prior call for the BoJ to
discuss the possibility of a half point hike. BoJ member Mutos comments this
morning that rates will be increased gradually are probably the most accurate
projection of what to expect. We think that the BoJ will raise rates by a quarter
of a point and then pause for 3 or 4 months before changing rates again.

Commodity Currencies (CAD, AUD, NZD)
The Commodity Currencies were all stronger against the US Dollar today. The biggest
mover was the AUD/USD which hit a 21 month high. Aside from dollar bearishness and
continued demand for carry trades, there is nothing behind the move. The futures
market closed early today with gold and oil prices ending slightly higher.
Australian PMI actually dropped from 54.4 to 52.4. The only other Australian and
New Zealand data due for release this week will be on Wednesday night. Canada has
no data out tomorrow but there are a number of key releases on Thursday and Friday
to watch.


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

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