Look For A Down USD On Depressed Business Confidence Data

USD/JPY has been stuck in a very tight trading range for the past 2.5 weeks and this morning's trade balance report failed to have much impact on the greenback. The U.S. trade deficit widened from -$40.3B to -$42.2B in October compared to expectations for a decline to -$42.7 billion. Although the increase was in line with expectations and the weakness seen in manufacturing activity -- the largest drop in exports in nearly four years -- is bad news for the U.S. economy. Slower global growth hit trade activity hard in the three largest parts of the world -- U.S., China and Germany (EZ) -- but for the U.S. specifically, exports received additional pressure from the droughts in the Midwest. Imports also fell to its lowest level since April 2011 as demand at home slows alongside demand abroad. The USD/JPY should be trading lower given the weaker trade numbers and the slump in small business confidence but risk appetite is holding the currency pair steady. According to the National Federation of Independent Businesses, confidence saw its largest drop ever, reflecting the ongoing challenges of doing business in the U.S. economy.

Up North, Canadian economic data continues to surprise to the upside with the country's trade deficit narrowing to a mere C$169 million in October, down from C$1.01 billion in September. Despite a sharp pullback in manufacturing activity, exports rose 1% while imports fell 1.2%. This third straight month of improvement in trade should fuel further gains in the Canadian dollar.

Meanwhile most of the major currencies are higher against the greenback this morning thanks to better-than-expected European data and the Wall Street Journal's reports of "progress on the Fiscal Cliff talks." A sharp rise in the German ZEW survey, decline in Spanish / Italian bond yields and rise in European equities lent support to the euro. Part of the reason why investor sentiment in Germany turned positive in the month of December is because of the strong performance in German stocks. This morning, the DAX reached a fresh four-year high easing tensions and boosting optimism in Europe. As for U.S. Fiscal Cliff talks, we haven't heard any new comments out of Washington but the WSJ argues that the strict moratorium on public comments is considered sign of progress at bargaining table.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management