US Dollar

The performance of the US dollar has been mostly mixed against the majors.  The Euro gave back some of last week’s gains as trading continues to remain very quiet.  The dollar gained strength after the surprisingly sharp rise in leading indicators for the month of January.  Expected to only increase by 0.6 percent, leading indicators jumped 1.1 percent with an additional upward revision for the data released the previous month. 

Last week’s list of stronger economic data including retail sales, manufacturing sector surveys and a low jobless claims report continue to support the case for solid first quarter GDP growth and possibly even a nice revision to the weak number that we saw last month.  However, the dollar rally was limited as the FOMC minutes created an air of uncertainty.  Even though the Federal Reserve was optimistic on growth and confirmed that “some further policy firming may be needed,” outgoing Fed Chairman Greenspan did take this opportunity to warn that the housing market poses a risk to demand and that monetary policy “seemed close to where it needed to be” and as a result, “rate moves can’t be prejudged with past confidence.”  This slight tinge of neutral-ness threatens expectations for a May rate hike, but given that these opinions reflect the FOMC under Greenspan and not Bernanke, the market is not entirely convinced that the March rate hike will be the Federal Reserve’s last. 

Thankfully today’s consumer price inflation report has the potential to stir up the markets a bit.  After the sharp rise in producer prices reported last week, the market is now anticipating a nice jump in CPI.  If the report fails to meet expectations for higher inflation, the dollar could continue to give back some of its gains.  On the other hand, if headline consumer price inflation grows by more than 0.5 percent and core inflation grows by more than 0.2 percent, then we may finally see the dollar resume its rally.

Euro

Despite another dose of mostly better economic data, the Euro failed to register any gains against the dollar. The Eurozone reported a narrower trade deficit of -EUR 900 million compared to the market’s forecast of –EUR 1.9 billion for the month of December.  The deficit for the month of November was also revised lower.  Meanwhile France also grew by 0.2 percent in the fourth quarter, which was right in line with expectations, but consumer prices fell by a less than expected 0.1 percent last month. 

ECB officials continued to call for a rate hike in March with both Garganas and Wellink chiming in today.  Wellink’s comment was probably the clearest, as he said that “monetary policy should be proactive” in the current environment of “ample liquidity, low interest rates and persistently high oil prices.”  Yet even though we know with near certainty that the European Central Bank plans to raise interest rates in March, the Federal Reserve is also expected to do the same and then possibly tighten again in May.  Therefore at this point it seems unlikely that for the ECB’s interest rate hikes to give much momentum to the Euro unless the Fed stops raising rates, leaving the ECB as the only hawkish central bank of the two.  This shift in dynamic is probably not expected until the second half of this year.

British Pound

For the third consecutive trading day, the British pound strengthened against the dollar and completely decoupled from trading in tandem with the EUR/USD.  Mergers and acquisition flows are helping to keep the pound bolstered, but most of the careful upward momentum has stemmed from expectations that the Bank of England minutes due for release tomorrow could be a bit more neutral than the previous release. 

Economic data has been very mixed, but as we mentioned yesterday, although the BoE voted to keep interest rates unchanged for yet another month, the balance of the votes could very well shift this time around.  At the last meeting that the minutes were published for, BoE member Steve Nickell was the only voter to favor an interest rate cut.  For this meeting, forecasts are very divided with some analysts calling for more members to vote in favor of a rate cut while others predict that Nickell could have voted to leave rates unchanged at the time, which would shift the vote for no change from 8-1 to 9-0.

Japanese Yen

Once again the dollar continued to rally against the Japanese Yen despite a 450 point rise in the Nikkei overnight.  After two days of back to back losses, last night’s rebound was certainly encouraging.  Convenience store sales were the only economic data released last night and for the 18th month in a row, store sales printed negative.  With no end in sight for the tug of war between the Bank of Japan and the Japanese government, there seems to be little that can help the Yen in the immediate future other than a breakdown in the US dollar component of the pair.  Of course, an end to quantitative easing or rumors of an economic outlook upgrade by the Japanese government could help the Yen a tad, but probably not enough to cause a complete reversal in trend.  Improving economic data is something that we have been seeing for weeks and the Yen has reacted little. 

Kathy Lien