With the U.S. equity and bond markets closed for trading, it has been an exceptionally quiet day in the foreign exchange market. Any volatility was limited to the European trading session, where the dollar sold off aggressively against many of the major currencies. Between 8am and 4pm NY time, there was virtually no movement in the foreign exchange market. 

The dollar ended the day higher against the euro and Swiss Franc but lower against all of the other major currencies.  Based upon the lower highs and lower lows in USD/JPY and other price action, investors remain cautiously optimistic at best.  This caution is understandable considering the risk of disappointments.  There are three areas of possible disappointments this week that could trigger a wave of risk aversion that could strip away the recent gains from many of the major currencies:

1.     U.S. Data – Recent U.S. economic reports have fallen short of expectations including last week’s retail sales report. Although the manufacturing sector has been performing well, no one expects any major upside surprises in this week’s reports. Tuesday’s Empire State manufacturing survey could rebound after a particularly brutal November but the Philadelphia Fed survey, which is set for release later in the week, could pull back. The housing market numbers on the other hand are not expected to be pretty. Even though permits could rebound, starts should be weak and no major improvement is expected in builder confidence. The Treasury International Capital flow report will also be released tomorrow and analysts believe that foreign purchases of dollar denominated securities increased in the month of December. This could be due in part to the dollar’s recovery that month. 

2.     Chinese Data – The big disappointment however could come from Chinese economic data. Fourth quarter GDP will be released along with retail sales, industrial production, consumer and producer prices.  In October and November, the Chinese economy performed very well with the trade surplus increasing and retail sales edging higher. Consumer prices also rose to its highest level in 2 years, prompting the People’s Bank of China’s decision to raise the reserve requirement ratio by 50bp. The momentum is expected to have eased in December with all of the major indicators pulling back. Softer economic data would also give Chinese President Hu reason to fend off U.S. President Obama’s calls for more currency flexibility. Most investors expect U.S. economic data to be weak but not everyone has discounted weaker growth in China. As a result, disappointments in Chinese data could trigger a wave of risk aversion that drives investors back into the safety of U.S. dollars. 

3.     Eurogroup / Ecofin Meeting - The final area of possible disappointment comes from the Eurogroup / Ecofin meeting that is underway. This will be discussed in further detail in the euro portion of our commentary but the most likely outcome of the meeting is nothing. The mere possibility of this happening has driven the euro lower and if no concrete details are announced after the meeting, market pressures could rebuild, resurrecting concerns about the countries on the Iberian Peninsula requiring aid and sending the euro back towards 1.30.

If none of these disappointments transpire, then the rally in the currency market could continue but the risk is certainly skewed to the downside.