US Dollar

The US dollar traded higher against most of the majors yesterday, but the rally occurred primarily during the European trading session before the US market open.  Interestingly enough, even though the consumer price inflation report came in stronger than expected, the dollar actually dropped, which suggests to us that traders may have been looking for a really explosive number.  Headline inflation jumped 0.7 percent compared to the market’s forecast of 0.5 percent but the real sucker was the core CPI report.  Even though core prices grew by an as expected 0.2 percent last month, it was revised lower by 0.1 percent for the month of December.  

With big hopes for yesterday's release, the market could do noting but be disappointed with the downward revision.  After the somewhat more neutral Federal Reserve minutes released yesterday, the fact that the end is near has become even more glaring.  Five percent rates are still possible, but anything beyond that is extremely unlikely.  This means that even though another rate hike could still come after the March meeting, the tone of the FOMC statement in next month’s meeting will probably be notched down significantly. 

One of the biggest news yesterday was the surprise resignation of Federal Reserve Vice Chairman Roger Ferguson.  One of the most respected Federal Reserve Governors, Ferguson was once thought to have what it takes to succeed Greenspan.  As the only central banker in Washington during 9/11 while Greenspan was in Europe, Ferguson has often been credited for steering the Fed through the crisis.  However, Ferguson has often bumped heads with Bernanke as he opposes inflation targeting, arguing that it limits the Fed’s flexibility.  With his departure, Ben Bernanke’s board of governors now consists of all Bush nominees.  This shock to the market will once again bring back concerns about how well Ben Bernanke’s team will respond to any crisis that may fall upon the economy.  

Euro

As the major currency pairs continue to trade within a tight range, the Euro ended the day virtually unchanged. According to this morning’s GDP release, Germany failed to grow in the fourth quarter and instead underwent a period of stagnation in the last 3 months of 2005.   However GDP is a number of the past and Euro bulls have not been stifled given the strength of recent data. Positive confidence and consumption data released in France and Italy also helped the Euro fight back earlier losses.  France’s Business Confidence Indicator jumped to 105 as consumer spending expanded by 0.9 percent in January, a reversal of December’s 1.0 percent contraction. 

Consumer confidence in Italy came in stronger than expected at 110.0 in spite of consumer price inflation of 0.2 percent, indicating that growth on the shoulders of spending may take form in spite of higher prices.  The European Central Bank also revealed that the Euro-Zone current account deficit fell to 5.3 billion euros in December, making the total deficit for 2005 29.0 billion euros.  Positive data in France and Italy combined with the current account data may be enough to push the EURUSD out of a sideways pattern in coming weeks.  This may be the push the Euro needs to initiate momentum toward the upside that could continue with ECB rate hikes later in the year, which have already been priced into the market.  

British Pound

Even though the British pound ended the day weaker against the dollar, it staged a nice recovery from earlier weakness during the US trading session.  The much awaited minutes from the most recent monetary policy meeting showed no change in the balance of votes.  The committee voted 8-1 to leave interest rates unchanged with MPC Nickell once again being the only dissenter who favored a rate cut.  If you recall, the forecast ranged the gamut from 9-0 to 7-2, so the fact that no one changed their minds made the release of the minutes essentially a non-event.  The BoE was slightly more optimistic however, as they cited stronger GDP and consumption growth.  The CBI industrial trends survey also came in stronger than expected, rising to -18 from -28, which has helped pare back expectations for another rate cut in the near future.  

Japanese Yen

After three days of solid gains, the Japanese Yen has actually strengthened against the dollar.  In fact, the Yen strengthened against all of the major currencies as the Japanese government upgraded its outlook for the economy.  With recent economic data showing strength, the government opted to drop the words slowly or gradually from their assessment of economic growth.  For the most part, they agree with the Bank of Japan that the recovery should continue but still feel that according to the fourth quarter GDP deflator, deflation is still prevalent.  Therefore even though USD/JPY gave back some of its recent gains today, the overall uptrend remains dominant.  Meanwhile we are expecting the trade balance and the tertiary activity index later tonight which could grant the Yen a bit more volatility.  

Kathy Lien