The dollar was little changed
against the Euro on Tuesday in market volumes sharply below normal as there was
no trading in London. The dollar… … edged marginally stronger, but was unable to
break any major technical levels and was close to 1.1830 against the Euro in New
York. The Euro pushed significantly stronger in early Europe on Wednesday and
pushed above the 1.19 level.

Yield considerations will remain
important in the short term, especially as the US yield curve briefly inverted
during Tuesday with the 10-year bond yield lower than the 2-year yield. The
effect of inverted yield curves on the dollar has been mixed in previous
economic cycles, but the overall implications are likely to be dollar negative
in the short term as it will fuel speculation over an end to Fed tightening and
a slowing US economy. It is also the case that the US yield spreads over German
bunds narrowed and this unsettled the US currency slightly. Interest rate
considerations will remain extremely important in the first few weeks of 2006
and will set the tone for dollar trading with the US currency vulnerable if the
US-German yield spread drops significantly below the 100 basis point level. the
gap had closed to 103 basis points in early Europe on
Wednesday.

Confidence in the Euro-zone economy
should remain firmer in the short term, especially with evidence of a recovery
in German retail sales, and there will expectations of an ECB interest rate
increase early in 2006 with ECB members indicating a tough stance on rates. The
ECB expectations will offer near-term Euro support.

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