Daily Forex Report - USD higher supported by unwind of dollar carry trades

* USD: Higher, unwind of carry trades sparked by Fed optimism about the US recovery, Greek fiscal problems
* JPY: Lower, Kan welcomes USD/JPY at 90, budget uncertainty
* EUR: Lower, Greek debt downgrade, construction output declines
* GBP: Lower, retail sales decline
* CAD and AUD: AUD & CAD lower, spike in risk aversion, Canada's inflation rises/investment flows strong

Overview
USD surged to a three-month high with the EUR pressured by S&P downgrade of Greece's debt rating and in reaction to Fed optimism about the US economy. S&P lowered Greece's debt rating by a notch. The downgrade of Greek debt generates concern about the EU fiscal outlook. The Fed says that the US economy is picking up and deterioration of the labor market is abating. Although the Fed stopped short of signaling when it will begin to hike interest rates the Fed is moving closer to the end of its ease cycle and the USD is supported by unwind of USD carry trades. Bloomberg reports that unwind of the USD carry trade may be the biggest threat to the global economy in 2010. According to the report everyone is borrowing in USD at zero rates and using the funds to buy higher yielding assets around the globe. As the Fed moves away from zero interest rates the USD may rally as carry trades are unwound and this will reduce liquidity for equities and commodities markets. GBP was pressured by report of unexpected decline in UK retail sales. Commodity currencies traded lower tracking weaker equity markets with CAD trading lower despite report of higher than expected Canadian CPI. JPY trades lower despite weaker equity market trade pressured by a broad USD gains versus Europe and concern about Japan's budget outlook. Today's US economic data was mixed with jobless claims posting an unexpected rise and LEI and the Philly Fed coming in stronger than expected. Today's US data fits with the Fed's forecast of improving US economy with limited jobs growth.

Today's US data:
Initial jobless claims for week ending 12/12 rose by 7k to 480k a reading of 470k was expected. Continuing jobless claims posted a slight rise to 5.19mln from 5.16mln last week. November leading indicators rose by 0.9%, a reading of 0.6% was expected. December Philly Fed rose to 20.4, a reading of 16.5 was expected.

Upcoming US data:
No major US data is due for release Friday.

JPY
JPY traded lower pressured by spillover from broad USD gains against Europe sparked by upbeat Fed outlook and downgrade of Greece's debt rating by S&P. JPY was also pressured by continued uncertainty about the Japanese budget outlook. Japan says that its 2010/11 budget will be at ¥92trln. MOF officials said that Japanese government needs to cut at least 3trln from the budget to keep bond issuance below ¥44trln. The ratings agency Fitch said that Japan's debt rating may be downgraded if bond issuance rises above this level. Japan's national Strategy Minister Kan said that the weaker JPY is desirable and he welcomes USD rise to 90.00. According to Kan 90 is the rate that many Japanese companies assume in their business plans for USD/JPY. JPY downside was limited by gains in cross trade to Europe and the commodity currencies with EUR/JPY trading 1% lower in reaction to the Greek debt downgrade. Focus turns to the conclusion of the BOJ policy meeting Friday. Earlier in the month the BOJ elected to ease monetary policy and provide additional funding to try to weaken the JPY and combat deflation. The trade expects the BOJ to keep monetary policy unchanged. In light of recent weakness of the JPY the BOJ is unlikely to make reference to the JPY.

On December 18th revised October leading indicators will be released expected at 2.5 compared to 4.2 last month.

Key technical levels to watch in USD/JPY include support at 89.35 the December 16th low with resistance at 90.40 the December 7th high and 90.86 the November 6th high.

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EUR
EUR traded at a three-month low versus the USD pressured by S&P downgrade of Greece's debt rating and speculation that upbeat assessment of US economic outlook by the Fed sets the stage for the beginning of the Fed's tightening cycle. General consensus is the Fed will begin to gradually raise interest rates mid 2010. Much of the recent weakness in the USD is attributed to speculation that the Fed would keep interest rates low possibly into 2011. The outlook for low US yields encouraged funding of carry trades in the USD. The change in the outlook for the timing of Fed rate hikes sparked unwind of USD carry trades boosting demand for the USD. EUR was also pressured by report that construction output declined for the six month in a row. November construction output declined by 0.6%. The decline in EU construction output generates concern about the strength of the EU economic recovery and the report may dampen expectations of a more rapid withdrawal stimulus by the ECB. Concern about the deterioration of sovereign debt outlook in the EU will also limit the ECB's ability to tighten monetary policy. There is a clear change in sentiment and focus in Forex trade away from concern about rising US budget deficits and low US interest rates to debt troubles in EU. Uncertainty about sovereign debt risks in the EU generates concern about the stability of European monetary Union and the credibility of the EUR. The EUR looks much less attractive as an alternative to USD as a reserve currency in light of sovereign debt worries in the EU.

The technical outlook for the EUR is negative as the EUR breaks trend line support. Expect EUR support at 1.4175 the September 1st low with resistance at 14531 the December 17th high.

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GBP
GBP traded lower pressured by report of weaker than expected UK retail sales, S&P downgrade of Greece's debt and speculation that the Fed will begin to gradually raise interest rates mid 2010. UK November retail sales declined by 0.3%. December CBI sales were unchanged at +13. The decline in retail sales and lack of improvement and CBI sales generates concern about the outlook for the UK recovery. GBP remains vulnerable to uncertainty about BOE policy outlook. The BOE is likely to be the last central bank to begin to withdraw stimulus and this means that yield differential is moving in favor of the USD. Recent UK economic data however may encourage the BOE to pause in its asset purchase plan and quantitative ease as the UK labor market is stabilizing and inflation rising. Wednesday the UK reported that the job claimant count fell for the first time since February 2008. UK November CPI rose at an annual rate of 1.9% which brings the UK inflation rate close to the BOE's 2% target. Last week the BOE left interest rate policy unchanged and said it will maintain its current level of asset purchases. The BOE left interest rates unchanged at a record low 0.5% and the level of asset purchases at £200bln. The BOE is expected to wait until the release of the February inflation report before it decides to make any adjustments in monetary policy or in the size of its asset purchase plan. The BOE's Barker said the BOE must be cautious of how much farther to expand its bond purchase plan. Today's UK data shows that UK consumer remains retrenched and this suggests that UK recovery will be weak. In light of the Feds upbeat assessment of the US economic outlook growth differential and yield differential are moving more in favor of the USD.

The technical outlook for GBP is negative as GBP trades below 1.6100. Expect near-term support at 1.6020 with resistance at 1.6240.

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CAD
CAD traded lower despite report of higher than expected Canadian inflation and strong net foreign investment flows. CAD was pressured by weaker equity market trade and spillover from broad USD strength against Europe. Canada's inflation rose more than expected and foreign demand remains strong for Canadian bonds. Canada's November CPI rose by 0.5% m/m and 1% y/y with core inflation at 0.4% m/m and 1.5% y/y. Despite the rise in Canada's inflation the BOC is expected to maintain low yields through mid-2010. Net foreign investment flows to Canada rose by 5.81bln in October the trade had expected a 5bln reading. This week's economic data from Canada points towards quicker economic recovery with manufacturing shipments and leading indicators coming in higher than expectation and inflation rising faster than expected. It's not clear whether the improved outlook for the US economy will boost demand for the CAD on speculation that economic growth in North America is starting to accelerate or if as in today's trade the focus is on the prospects for US interest rates to rise sooner than in Europe and Canada. Yield differential is emerging as the key short-term driving factor for Forex trade and the CAD.

The technical outlook for CAD is negative as USD/CAD consolidates trades above 1.0700. Look for near-term support at 1.0552 the December 15th low with resistance at 1.0780 the November 9th high 1.0855 November 3rd high.

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AUD
AUD traded sharply lower pressured by weaker global equity market trade and speculation that US and Australian yield gap is set to narrow as the Fed lays the foundation for future rate hikes and the RBA moves towards steady policy. As noted above the Fed indicated greater optimism about the US recovery and this is seen by many as the beginning of the end of easy Fed monetary policy. The Fed statement generates speculation that the timeframe for Fed rate hikes will be moved forward in 2010. Although the RBA was the first major industrialized central bank to hike interest rates this year recent statements from the RBA suggest that further rate hikes are less certain. Wednesday the RBA's deputy governor Battelino said that Australian interest rates are back in the normal range and he sees less need for a rate hike if loan rates keep rising. His comments follow Tuesday's release of the RBA policy minutes for December. The RBA policy minutes were seen as less hawkish and dampen speculation that the RBA will hike rates aggressively at the start of 2010. The minutes for the December RBA policy meeting said that arguments for a rate hike are finely balanced and that the current rate structure is less accommodative. In addition to Australia's economic data was mixed with industrial activity up 2.2 points to 50.4 and November merchandise imports declining by 2%. Wednesday Australia reported weaker than expected rise in Q3 GDP. There was little reaction to report that the RBA sold A$313 mln in November. This was slightly higher than the is A$307mln in sales in October but the size of the sales does not indicate the RBA is aggressively intervening to try and weaken the AUD. AUD remains vulnerable to diminished RBA rate hike speculation and speculation that Fed is moving closer to the end of its ease cycle.

The technical outlook for the AUD is negative as the AUD drops below above 9100. Expect AUD support at 8755 the October 6th low with resistance at 9004 the December 17th high.

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