Forex Market Update

Tight ranges have prevailed in overnight trade, with EURUSD holding between 1.3103 and 1.3131 and USDJPY stuck between 121.31 and 121.65.

The dollar has struggled this week despite a very healthy carry trade environment and a modest paring back of Fed easing expectations.

The implied yield on the December EuroDollar contract is up about 6 bp on net this week, with markets focusing on the firm reading on CPI Tuesday and ignoring Thursday's weaker claims number. Still, at 5.10%, the yield remains well below levels prevailing before January retail sales numbers and Bernanke testimony early last week.

The USD's failure to capitalize on this week's movement in yields suggests market participants remain concerned about structural vulnerabilities. We continue to expect the trend in key data to point in the direction of weakness and Fed easing in the weeks ahead, undermining the dollar further. Having said that, our economists note that they are not yet ready to conclude that the last two weeks of elevated jobless claims mark the beginning of the weakening in the labor market they have been looking for given the possibility that bad weather boosted the numbers. Moreover, they note, on balance, regional Fed surveys so far suggest some recovery in the ISM manufacturing index after the low January reading of 49.3.

Next week, the dollar may face a rough ride as much of Asia will return from holidays and the economic calendar is heavy. The market will be able to turn its eye towards indicators crucial to the Fed outlook such as the ISM and the core PCE deflator. We maintain our cautious 1.32 1-month target for EURUSD and prefer to trade our bearish USD view via USDCAD, with the CAD less susceptible to upside surprises on US data.

Ahead today, are no economic data releases scheduled. Dallas Fed President Fisher will speak about globalization and the US economy at 10:45 am EST and San Francisco Fed President Yellen will talk about the economic outlook at 3:35 pm. Yellen spoke earlier this week and was fairly hawkish, reaffirming her concern on inflation, while Fisher spoke last week of signs that the housing market is bottoming out.