US Dollar (USD) Rises Ahead of Trade Balance Report (page 1 of 2)

By Kathy Lien, Chief Strategist of www.dailyfx.com

US Dollar
It has been a quiet day in the foreign exchange market as the US dollar continues to test the resilience of the 1.30 level against the Euro. The currency market is essentially trading sideways going into the three major event risks this week which are the European Central Bank's interest rate decision, the US trade balance report and the US retail sales report on Friday. The ECB is expected to keep interest rates unchanged at 3.50 percent, which means that the actual interest rate announcement should be a non-event. However EURUSD traders will be watching the accompanying press conference for details on how aggressive the central bank plans to be with monetary policy in the months ahead. As for the US trade balance, after hitting a record high back in August, we have probably seen the worst. The trade deficit is forecasted to increase from -$58.9 billion to -$60 billion due to rising imports. However with oil prices remaining low for most of November and the dollar index falling close to 4 percent that month, the deterioration in the US trade balance should be limited. Import prices, which is an inflationary indicator is also due for release. Prices are predicted to have accelerated in the month of December, which if validated, would be yet another reason to expect the Federal Reserve to keep interest rates on hold at 5.25 percent for a few more months. The weekly indicators released today were also mostly dollar positive. Both the ICSC-UBS and Redbook reported stronger chain store sales in the first week of January. The IBD/TIPP confidence report also rebounded from 53.5 to 53.7 while oil prices eased on hedge fund selling. Dollar bears are struggling to regain control in what may be proving to be a Goldilocks economy.

Euro
Euro traders are hanging tight for the ECB monetary policy meeting on Thursday before deciding whether or not to take the currency below 1.30. It has flirted with that level a thousand times today but dollar bulls retained control of the currency pair. Even though this morning's German data was stronger expected, it was not enough to erase the bearishness that came from yesterday's disappointing retail sales report. The German trade surplus hit a record high thanks to a much smaller than expected drop in exports. Given that domestic spending has been lackluster at best, it seems that foreign demand is behind the surge in business confidence. Industrial production also jumped by 1.8 percent which makes it very difficult to tell whether or not the ECB President will retain his hawkish tone. It is an exceptionally close call, which is why the meeting has the potential to be a major event risk. The right question to consider in the meantime may be whether the economy is able to handle 1 to 2 more interest rate hikes given the increase in Germany's Value Added Tax. In the meantime, we have French industrial production and trade balance tomorrow. Like Germany, France is also expected to report acceleration in its industrial sector activity.

British Pound
As the one economy that is unambiguously healthy, the UK continues to deliver upside surprises in its economic data. Last night, the BRC retail sales monitor increased from 2.5 to 4.4 percent in the month of December, indicating that holiday sales were strong. Even though the market expects the Bank of England to forgo a rate hike on Thursday, the central bank is still expected to lift rates later this year. UK trade data and the BRC shop price index are due for release tomorrow.