Sharp swings ensued in today's FX trading, as the dollar fell sharply during the Asian session following a spike in oil prices after President Bush announcement to double the Strategic Petroleum Reserve to 1.5 billion barrels over the next 20 yrs. An unexpectedly low inflation report from Australia sharply significantly curtailed chances of a February rate hike by the Reserve Bank of Australia next month and boosted the US currency by a full cent. But the dollar sell-off resumed, especially against the yen, dropping to a 5-day low before recovering on an unexpectedly dovish report from the minutes of this month's Bank of England interest rate decision. (more below)

Does aggressive SPR build-up foretell Iran strike?

Light sweet crude is down 20 cents at $54.80 per barrel, after Tuesday's $2.48 jump to $55.04 on reports that the US Dept of Energy will purchase 100K barrels of oil per day starting next spring. While the decision is part of the Bush Administration's latest commitment to reduce US dependency on imported oil, the aggressive approach on beefing up SPR may reflect heightened possibility of a US military strike against Iran as early as March or April, at a time when US navy ships are piling up in the Persian Gulf. Yesterday, markets were filled with chatter of a Kuwait-based newspaper article reporting that the US will launch a military strike on Iran before April 2007, citing "reliable sources". According to the article, the strikes will be launched from US ships with Patriot missiles guarding all oil-producing countries in the region. The attacks would be planned in April, the last month of British PM Blair in office. The immediate result of such an attack is a protracted run up in oil prices, which could reach the $70 per barrel mark in less than a week.

The recent pickup in FX market volatility to oil price swings reflects the role of energy prices in recalibrating the FX equation. A renewed decline in oil bolsters expectations of a US consumer-led stability to act as a stabilizer to housing's downside risks. The 14% decline in prices so far this year has considerably diminished chances of a March Fed cut and manifested itself across European and Asian currencies. The role of oil's rebound has been such that it took center stage in FX markets, shadowing a string of positive economic data from the Eurozone and the UK. Aside from freeing US consumers' wallets, falling oil prices have reduced the Sep-Nov trade deficit by over 17%, which is likely to contribute as much as 0.7% to GDP.

Kuwait concerned with dollar performance

Less than 1 month after the United Arab Emirates announced it will reduce the amount of dollars in its currency reserve composition, Kuwait, the 3rd Arab oil producer said it may abandon the dinar's peg against the US dollar in favor of a basket of currencies to cushion the impact of a weakening US dollar Kuwait's finance minister Bader al-Humaidhi said in Davos, Switzerland today ``The dollar fell a lot against the euro last year, but if we'd been linked to a basket we wouldn't have suffered'. Kuwait, along with the 5 Gulf Arab monarchies has pegged its currency to the dollar ahead of a planned single currency planned in 2010.

Today's weekly US petroleum inventory figures (10:30 am) are expected to show a an increase of 1.3 million barrels in crude oil, and a drop of 700K barrels in distillate stockpiles (heating oil and diesel).

Cable plunges on dovish minutes

Sterling dropped more than 1 cent to $1.97 after the minutes of this month's Bank of England interest rate decision revealed a 5-4 vote, in favor of the surprising 25-bp rate hike. Markets had expected no more than 2 dissenters at the decision, especially when CPI registered a 3.0% y/y growth, well above the central bank's 2.0% target. MPC members Bean, Blanchflower, Lomax, and Tucker were the dissenting voters, stating that inflation would fall during 2007. The majority said that they did not see risks to inflation falling quickly, and saw little chances of a slowdown from the rate hike. Sterling had already been under pressure ahead of the minutes after a BoE Governor Mervyn King said in a speech late yesterday that the Bank maintained its view that inflation would fall back in H2, possibly quite sharply.

The minutes shadowed the stronger than expected Q4 GDP figures showing a rise of 0.8% q/q and 3.0% y/y, the highest since Q2 2004. It remains unclear whether the vocal doves at the MPC will prevent a rate hike next month.

Cable stabilizes at the 61.8% retracement of the 1.9591-1.9914 move at 1.9710. A break below the 1.97 figure is expected to stabilize at 1.9680. Key foundation stands at 1.9650. Traders must carefully watch tomorrow's IFO survey from Germany and US existing home sales for further action in cable. Upside seen capped at 1.9730, with further gains encountering pressure at 1.9760.

Aussie slumps on weak CPI

AUDUSD dropped more than a full cent to 0.7810 from 0.7935 after Australia's headline CPI slowed to 0.1% m/m in December and 3.3% y/y, against expectations of a 0.2% m/m and 3.6% y/y. Falling prices of commodities were largely attributed to the soft data. The figures slashed expectations of a February RBA rate hike from as much as 80% to 40%.

We expect AUDUSD to stabilize near the 0.7805 support ahead of this morning's oil inventory data from the US, which could fuel the pair back towards the 0.7820s. Upside capped at 0.7840. The daily MACD suggest renewed losses towards the 0.78 figure, but support seen standing firm at 0.7770.

Euro seeks 1.2950 support

The latest drop in EURUSD is expected to stabilize at the 1.2950 support as markets stay aside ahead of the US oil inventory data, which could potentially show smaller than expected builds resulting from the recent drop in temperatures. Nonetheless, the daily MACD suggests further declines to as low as 1.2920.

Buying support should emerge near the figure ahead of tomorrow's IFO survey, which is expected to hit a fresh 15-year high at 109 in January from 108.7. Recall that the figure had been a source of sharp euro gains in the last two months, which makes a retreat very possible.

Upside capped at 1.3050, followed by 1.3080, which is the 50% retracement of the said move.

USDJPY ends little changed after wild ride

A brief exodus from carry trades following the 1 cent plunge in the Aussie triggered a 100 pip drop in USDJPY to 120.67, but renewed pressure on European FX and a brief retreat in oil boosted the USD back above 121.20 and onto 121.60. Markets may be ready to fuel fresh gains in the pair if Friday's CPI release (due Thursday evening) shows another 0.2% y/y increase in January. The upward bias in the pair remains as such that we expect 122 to be a matter of time. Interim resistance stands at 121.80, followed by 122.20. Longer-term resistance stands at 122.60. Renewed losses seen stabilizing at 121.20.