The greenback see-sawed indecisively Friday after gaining over the three preceding days, on good US data. The market now awaits additional U.S. data and a Federal Reserve meeting next week to provide further confirmation of a recovering economy.The markets will have plenty of fresh data to digest in the week, including GDP, inflation and non- farm payroll reports.The currency market continued to react to the dismal tone of theTreasury bond market, as yields pushed back up to late-summer highs this week.In general the feeling is that the market was far too aggressive in thinking that the US is in for a (rate) cut.
Yet because the bond market’s reaction to Friday’s data was relatively muted, the currency market - which has been heavily focused on the bond market since Thursday - was provided with little direction. New-home sales had finished 2006 on a positive note, rising a second straight month in December, though demand for the whole year took its biggest tumble since 1990. Sales of single-family homes increased by 4.8% to a seasonally adjusted annual rate of 1.120 million, versus an expected increase of only 1.2%. But without seasonal adjustment, new-home sales fell 17.3% in 2006 to an estimated level of 1.061 million, the largest drop since 17.8% in 1990.
Meanwhile, durable goods orders climbed in December in a broad-based increase that included higher spending by businesses on capital goods. Orders for durables advanced by 3.1% last month to a seasonally adjusted $221.87 billion. Meanwhile emerging market currencies largely stabilized following Thursday’s sell-off of the Mexican peso, South African rand, and Turkish lira among others.
The sell-off was initially triggered by a slip in dollar-yen, suggesting the unwinding of some carry trades, but was sustained by the jump in treasury yields Thursday as investors increasingly worry that recent U.S. data could push the Fed toward a tougher stance on interest rates.
“The peso, which was one of the hardest hit currencies Thursday, having had slipped to a two-month low against the dollar, closed weaker against the dollar Friday. The Mexican currency was quoted closing in Mexico City at MXN11.0620 to the dollar.
On the USD interest rate front, U.S. Federal Reserve officials are more comfortable about inflation than they were two months ago but the Fed is likely to reaffirm its “bias” toward raising interest rates
The Fed is “almost certain” to leave its target for short-term interest rates unchanged at 5.25 % at the end of the two- day meeting, which ends Jan. 31, the newspaper said, citing unnamed officials. But there are several reasons the Fed is likely to signal inflation concerns for at least one more policy meeting. Even if underlying inflation is slowing, some officials believe it is still unacceptably high.
Because there is uncertainty about how much further inflation will fall, officials believe the Fed should be biased toward raising rates to keep the public from expecting higher inflation. Short-term interest rate futures prices trading during the day implied that the Fed will keep rates steady for much if not all 2007. Earlier this month futures priced at least 50 basis points in cuts for the year.
Data out this morning showed that Japanese retail sales fell 0.3 % in December from a year earlier, a sign of sluggish goods consumption that could make it harder for the Bank of Japan to raise interest rates next month. A median market forecast had been for a 0.5 % fall.
On the EURO ZONE- front, ECB President Jean-Claude Trichet said on Sunday there were risks of an inflationary spiral resulting from higher energy prices. Trichet said housing prices had to be followed very closely in France and in other countries in euro zone. On Saturday, Trichet said inflation was still a major global risk and central banks around the world had to remain “very, very alert” on price risks.
The ECB raised interest rates to 3.5 % in December and markets were expecting rates to rise to 3.75 % in March. Turning to exchange rates, Trichet repeated the Group of Seven mantra that excessive volatility and disorderly moves in exchange rates are unwelcome”.
“(The euro) is strong. It must inspire confidence and it is inspiring it,” he said. Trichet also said the levels of government spending, the public deficit and taxes were too high in France and other euro zone countries compared to what would be the optimum level for economic growth and job creation. However, with the Oil prices coming down as we have seen for the last few months, EURO zone inflation could be expected to wane and along with that the EURO Zone rates. Our analysis of the 5 year swap rates, indicates that it may soon peak for a dip into the rest of the year, indicating that inflationary pressures might ease.

W ee k : January 29 - February 02 2007