US Dollar (USD) Rally Now Contingent Upon Retail Sales (page 1 of 2)

US Dollar

It has been a very exciting trading day today and for once, the news flow was not dominated by US data. Everyone in the FX market was focused on the developments across the Atlantic, which we cover in more detail in our Euro commentary. In the US, we look ahead to the retail sales report on Friday, which is probably the single most important piece of data this week. After the strong non-farm payrolls report last week, many economists have revised their retail sales forecasts upwards on the belief that a strong labor market should translate into healthy holiday spending. Given the lines that we have seen in late November, December and even January for hot items such as the new game consoles by Sony and Nintendo, we doubt that consumer spending during the holiday season could have been that weak. In addition, the stabilization in the housing market and the warm weather should also help to fuel spending. Import prices are also due for release with a projected up tick due to a rebound in oil prices. One way or the other, tomorrow's economic releases will probably not do much to sway the Federal Reserve from their stable monetary policy. Even though Federal Reserve Presidents Bies and Geithner refrained from speaking directly about interest rates, they were both fairly optimistic about the economy. According to the Fed fund futures, the odds are next to zero for a first quarter rate cut at the moment and there is still a less than 50 percent chance of a cut in the first half of the year. The sharp drop in jobless claims below 300k confirms the health of the labor market, which is helping to boost the US dollar. All the market needs now to take us back into the summer of 2006 trading range is a strong retail sales report.

Euro

So far, it has been an extremely difficult month for the Euro as the currency pair makes yet another year to date low against the US dollar. Traders were hoping that ECB President Trichet would reassure the markets by remaining committed to their aggressive plans to raise interest rates. However besides leaving rates unchanged, which was expected, Trichet introduced a bit of doubt into the market about a February rate hike. Originally the market was expecting a hike in next month, but now, a move may not come until March. Trichet also clearly pointed out that his statement no longer includes the words strongly vigilant which suggests that he is attempting to prepare the market for some sort of shift. By doing this, he is either telling us that he will delay a rate hike to March so that they can digest incoming data or that he is planning to raise rates in February, but put the end to their tightening cycle after that. Either way, this is not particularly good for the Euro, especially after the Bank of England surprised with an interest hike this morning. Do not be mistaken, there will still be one more rate hike from the ECB, but with four weeks to go until to the next monetary policy meeting, the Euro could remain weak. German retail sales were pretty disappointing last month which could have influenced Trichet's comments. We will probably need to see some positive reports before he can justify a February hike.

British Pound

The British pound was the story of the day after the Bank of England surprised with a quarter point interest rate hike this morning. This is not the first time that the central bank has chosen to catch the market off guard by delivering a premature rate hike. According to the central bank statement, fear that inflation could accelerate to their fastest pace in 10 years as measured by money supply growth has forced them to accelerate the timing of their rate hike.