FOREX EUROPE UPDATE - USD

The dollar was little changed amid a quiet Asia session, remaining soft against the EUR in a 1.3270-1.3291 range, while holding ground against the JPY in a range of 118.67-118.86.

It is interesting to note the dollar's inability to rebound in the final weeks of the year given the sharp retreat in Fed easing expectations and the strong environment for carry trades.

Indeed, the implied yield on the December 2007 eurodollar contract rebounded 30bp over the course of December, and key carry trades such as AUDJPY, NZDJPY, and GBPCHF surged to new highs.

Against this, EURUSD retreated only marginally after setting new highs for the year in the first week of December, and even USDJPY has been unable to sustain upside momentum.

The dollar's failure to thrive in what should be a healthy cyclical environment for the US currency suggests heightened concern about structural vulnerabilities heading into the new year, and associated focus on diversification by Asian and petro economy reserve managers.

Should current dollar weakness and worries regarding the US economy persist, it is unlikely that reserve managers, especially in developing nations (which now hold 57.5% of the world's reserves), who are increasingly under pressure to obtain higher returns for state welfare, will start looking elsewhere.

The Q4 data will provide an interesting read to see whether the Thanksgiving dollar sell-off prompted a surge in diversification effots.

We think the dollar is likely to remain vulnerable to these themes, and its downside will accelerate once markets begin to price Fed easing more aggressively again.

Looking ahead and we expect today's ISM at 1500 GMT to post a still-lacklustre 50.0 headline, up only slightly from the prior month's 49.5 reading.

The FOMC minutes to the Dec 12 meeting are due at 1900 GMT.

The ADP Employment Report at 13:15GMT will also be assessed as an (albeit imperfect) signal of how payrolls will fare relative to forecast on Friday.