By DailyFX – Dollar Rallies on Speculation that Fed will Aggressively Tackle Inflation, German ZEW Survey Expected to Rebound, Pound Slides as Deputy Governor Long… … Resigns

US Dollar

The US dollar has gained strength in a relatively quiet day as the market prepares
for tomorrow's heavy dose of global economic data. Here in the US, we are expecting
reports from all facets of the US economy including inflation, foreign appetite for
US securities and the housing sector. Inflation will remain on the top of
everyone's list of things to watch as producer prices are expected to grow just as
fast as consumer prices, if not faster. It is hardly a secret that producers have
borne the brunt of higher input prices over the past few months as they watch their
margins continue to get squeezed. Higher inflation seems to be the market's only
focus these days as the futures market has now fully priced in at least 2 more rate
hikes to 4.25% with a more than 50% likelihood of another rate hike on January 31st
to 4.50%. After last Friday's sharp surge in consumer prices, we saw analysts from
the leading investment banks step out to tout the possibility of 5% rates. Although
we think that this is a bit far fetched given the dark clouds hanging over nearly
every piece of data we have seen over the past few weeks, it does confirm that the
dollar will continue to benefit from higher interest rates and hold onto its title
as the favorite carry trade currency to go long in 2005. With no less than ten Fed
speeches this week, nine of who are voters this year or next, we doubt that the Fed
will let the market forget about how concerned they are for inflation. Therefore
the risk for the dollar this week appears to be on the upside, but we will first
have to see how the results of tomorrow's TIC report of foreign purchases of US
securities fares in the month of August. So far, foreign inflows are expected to
reach $60B, which is less than the previous month, but just about meets the funding
needs for the same month's trade deficit. If the dollar is lucky enough, as it has
been over the past few weeks, the market could shrug off a weak report like they did
this morning and proceed on with its rally. The Empire Statement manufacturing
survey shrank from a downwardly revised 15.6 to 12.1. The dollar barely budged even
though the rise was primarily led by the growth in the prices paid component. The
employment component as well as the outlook component both softened.

Euro

Over the past few weeks, the ECB has been spending a lot of time clarifying their
stance. As a central bank that traditionally likes to prepare the market for any
significant changes to monetary policy, the ECB is doing a good job of confirming
that interest rates are appropriate and if they were forced to make a move that it
would certainly be to the upside at the moment. ECB members Trichet, Issing and
Weber all reaffirmed the central bank's hawkish bias. The highlight of the week in
terms of European economic data will be tomorrow's ZEW survey. The index of
economic sentiment is expected to rebound as the slump that we saw back in September
was primarily attributed to the uncertainty surrounding the German elections.
Consumer prices in the region are also expected to tick higher, validating the ECB's
call for more vigilance when it comes to dealing with inflation. The inflation rate
is now solidly above the central bank's 2% pain threshold so they have no choice but
to stay vigilant.

British Pound

The British pound has taken a nosedive as Andrew Long, Deputy Governor of the Bank
of England bows out of his role to join the private sector. Long will be replaced
by Sir John Gieve, the Permanent Secretary of the home office. As a well-known
hawk, Long is said to have played a big role in the central bank's more conservative
monetary easing policy and more aggressive tightening policy. His departure is
expected to make the Bank of England's monetary policy committee more apt to lower
rates going forward. The inexperience of John Gieve could make him more compelled
to follow the leaders for at least the next few meetings before we can get a sense
of what his true bias may be. As reported in our Morning Brief, house prices rose
by 0.5% according to the October report, which was the biggest jump in 6 months and
the first improvement in 5. However, as has been the recent trend, the outlook for
interest rates dominated this morning's price action.

Japanese Yen

The Japanese Yen shot higher today with a test of 115 now seeming inevitable
especially since we are pennies away from that at this moment. The minutes from the
September 7-8 Bank of Japan monetary policy meeting indicated that the decision to
keep the liquidity target unchanged was 7-2 from 8-1 at the last meeting. The BoJ
is gradually moving towards an eventual departure from their zero interest rate
policy, although this will not be something that we see until next year at the
earliest. Meanwhile at the G20 summit in Beijing, the Chinese Premier pledged to
ECB President Trichet that the Yuan will become more flexible. Although no
timeframe or size of further revaluation was discussed, it validates the market's
belief that China's job is far from over. Of course, we believe that China will
look for another politically opportune moment to make their next move and though it
will be a minor step it will be politically significant.

Kindest Regards,

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

FXCM, L.L.C.® assumes no responsibility for errors, inaccuracies or omissions in
these materials. FXCM, L.L.C.® does not warrant the accuracy or completeness of the
information, text, graphics, links or other items contained within these materials.
FXCM, L.L.C.® shall not be liable for any special, indirect, incidental, or
consequential damages, including without limitation losses, lost revenues, or lost
profits that may result from these materials. Opinions and estimates constitute our
judgment and are subject to change without notice. Past performance is not
indicative of future results