The FX markets were remarkably quiet for much of the night, though the greenback staged a brief but strong rally as European traders took the stage and sold EUR/USD down more than 100 points for a test of 1.4720 and GBP/USD lower for a touch of 2.06. Likewise, USD/JPY surged to 109.20 before subsequently backing off as lackluster price action in Asian equity markets left carry trades range-bound.

As we’ve seen time and time again, the Japanese yen showed little reaction to regional economy data. Indeed, Japanese retail sales for October rose at a better-than-expected 0.3 percent from the month prior, pushing the annual rate up to 0.8 percent. Gas prices led the index higher, though purchases of autos also contributed to gains. This data comes on the tails of the Japanese Cabinet Office’s monthly economic report, which cut its assessment of the labor market for the first time in three years yesterday, effectively eliminating one of the Bank of Japan’s primary arguments for continuing on with rate normalization. Furthermore, the Japanese Trade Ministry published a survey that showed that 90 percent of small and mid-sized companies were having difficulty passing on higher energy costs to consumers. With inflation unlikely to stem from wage increases or price hikes on consumer goods, there is little impetus for the central bank to increase rates any time soon, and as a result, FX carry trades like USD/JPY and GBP/JPY will likely remain driven by risk aversion trends.

Meanwhile, German consumer confidence for the month of December, as measure by GfK, fell back in line with expectations to an index reading of 4.3 from a downwardly revised 4.8. The decline is not entirely surprising given current outlooks, as the tightening of the credit markets and mounting inflation pressures are likely to quell growth prospects in 2008. Nevertheless, as yesterday's release of the German IFO investor sentiment survey indicated, current conditions remain relatively robust and suggest that consumer and business spending in Q4 should keep expansion on track. Moreover, yesterday’s hot German CPI figures that remain well above the European Central Bank’s 2.0 percent target signal that inflation pressures throughout the entire Euro-zone region are surging. While this would technically give the Trichet & Co. more than enough reason to hike rates in December, the ECB’s claims earlier this month that the “ongoing reappraisal of risk in financial markets has led to continued uncertainty” indicate that they may still prefer to wait and see as the markets have yet to truly stabilize.

The US dollar faces heavy event risk today with durable goods orders, existing home sales, and the Fed’s Beige Book scheduled to be released. Durable goods orders and the housing data are both anticipated to show gloomy results, but the news may not be disappointing enough to spark a drastic dollar selloff. Indeed, the fireworks may not come until the details of the Beige Book report hit the wires as it will allow the markets to gauge the FOMC’s view of the economy. Fed fund futures are fully pricing in a 25bp cut in December but a pronounced focus on inflation may lead expectations to be scaled back, and as a result, the greenback could extend this morning’s gains later on in the day.

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