FOREX ASIA UPDATE - USD

USDJPY broke 120 yesterday and has traded to a high of 1.2065, while EURUSD has traded to a low of 1.2882 in response to a less hawkish than expected ECB.

With central banks around the world prepared to surprise the markets, implied volatility for currencies should be higher.

The very low volatility in the currency markets over the past year is linked to both very low levels of macroeconomic uncertainty coupled with very high levels of liquidity, squeezing out returns wherever they appear.

However, liquidity and volatility are jointly determined in that a rise in volatility can trigger a reduction in liquidity and likewise a reduction in liquidity can trigger a rise in volatility.

The decline in oil prices (Nymex benchmark crude is trading at US$52.07) has many scratching their heads, with many analysts attributing the decline to warm weather conditions.

However, that doesn't explain the simultaneous decline witness in other commodity markets, and a more likely joint explanation is stop-loss selling by the hedge fund community.

Over the first two weeks of 2007 we have had both an increase in policymaker uncertainty and some tentative signs that liquidity could be reduced, but despite that currency vols have headed lower.

Retail sales are released later today and could have a fairly influential impact on Fed expectations for this year.

The link between the housing market and the broader economy is via the consumer, so while the improvement in payrolls last week raises hopes for the US economy, it will be consumption data where the debate over the US outlook is settled.

Looking ahead, and retail sales for December are due at 1330 GMT. The market expects a rise of 0.6% m/m, following the 1.1% m/m rise in November.