This is article is released weekdays under the heading Daily Fundamentals at 5pm EST on www.dailyfx.com

• Euro Fails on Test of 1.4810 - German ZEW Report on Tuesday
• British Pound Down as Traders Bet on Expansion of Quantitative Easing
• Commodity Dollars Continue to Dominate on Building Risk Appetite

US Dollar, Japanese Yen Pull Back as Equities Rise in Low Volume Holiday Trading

On Monday, the US dollar and Japanese yen retraced much of their gains from last Friday, while US equities and commodities rose amidst light trading volumes on the US Columbus Day holiday. There was also limited news flow, with most market reports blaming the greenback's decline on reserve diversification toward euros and Japanese yen. That said, this phenomenon has been occurring for years as the world's biggest economies seek to make their central bank reserves more reflective of which countries they trade with. Nevertheless, quiet news days make for good opportunities to discuss longer-term trends.

Looking ahead to the rest of the week, a variety of indicators could impact market expectations for US interest rates. As of today, Fed fund futures show that the central bank may start raising rates from 0.25 percent at the beginning of Q2 2010, and Credit Suisse overnight index swaps are pricing in 81 basis points worth of increases over the next 12 months. However, according to comments from St. Louis Federal Reserve President James Bullard, a decline in the unemployment rate is a prerequisite for any rate increase, which runs counter to statements made by Richmond Federal Reserve President Jeffrey Lacker, who said monetary policy may need to be tightened even with unemployment near 10 percent.

On Wednesday morning, the Commerce Department is forecasted to report that US retail sales slumped 2.1 percent in September, after jumping by the most since January 2006 in August at a rate of 2.7 percent. The decline is likely to be due primarily to a drop in auto sales relative to recent months. For example, spending on motor vehicles and parts rocketed 10.6 percent higher in August as the cash for clunkers program came to an end, and demand is likely to have fallen without the government-sponsored incentive.

Then, on Wednesday afternoon, the minutes from the Federal Reserve's last meeting on September 22-23 will be released. Following that meeting, the policy statement initially led the US dollar to sell-off against the most popular currencies as the central bank maintained a neutral tone and repeated that they would keep rates exceptionally low for an extended period. However, the currency subsequently bounced back as the overall sentiment of the statement was optimistic, with the FOMC saying that economic activity had picked up while conditions in the financial markets have improved further. Based on Bernanke's recent commentary, traders will likely be looking for additional signs of when the central bank will start raising rates.

Related Article:
US Dollar Faces Lineup of Major Event Risk from US Retail Sales, FOMC Minutes

Euro Fails on Test of 1.4810 - German ZEW Report on Tuesday

The euro was mostly stronger on Monday, taking EURUSD up for a failed test of last week's highs near 1.4810. Data-wise, there was only the release of the German wholesale price index, which fell 0.2 percent in September, keeping the annual rate negative for the eleventh straight month at -8.1 percent. The news adds to evidence that price pressures remain extremely weak in the Euro-zone, though European Central Bank President Jean-Claude Trichet has already acknowledged that he expected inflation to remain subdued in the medium term. On Tuesday, the German ZEW survey - a gauge of investor confidence - is projected to edge up to 58.8 for the month of October, the highest since April 2006, from 57.7. Such an improvement would be in line with the steady gains we've seen in equities in recent months, but at the same time, the consolidation of the DAX below 5,750 through September and early October suggests any change may be minimal.

British Pound Down as Traders Bet on Expansion of Quantitative Easing

The British pound remained the weakest of the majors on Monday, and though there was no data on hand, the steady decline in the currency indicates that traders anticipate that the Bank of England will expand their quantitative easing program once again at the end of the year. However, we did see on Friday that the producer price index (PPI) that measures input prices slumped 0.5 percent in September, but a 0.5 percent increase in PPI output suggested that businesses have a bit more pricing power these days and may be able to make up for some lost profit margins. Furthermore, the data creates some potential for surprising strong results for the consumer price index (CPI) on Tuesday. At 4:30 ET, the CPI reading for the month of September is expected to rise 0.3 percent, but the more important part of this report is that the annual rate of growth, which is more closely watched by the Bank of England, is forecasted to fall to 1.3 percent, the lowest since October 2004, from 1.6 percent, keeping inflation within the central bank's acceptable range of 1 percent - 3 percent, but below their 2 percent target. If CPI falls more than projected, the British pound could pull back sharply as the markets will anticipate that the BOE will expand their quantitative easing efforts even further before year-end. On the other hand, if CPI holds strong as PPI suggests, the currency could rally in response.

Commodity Dollars Continue to Dominate on Building Risk Appetite

The Canadian dollar, New Zealand dollar, and Australian dollar have been the strongest major currencies over the past week or so, as risk appetite has contributed to strength in commodities, the commodity dollars, and FX carry trades. The Australian dollar received an extra boost last week after the Reserve Bank of Australia surprised everyone and became the first major central bank to raise interest rates after the global financial meltdown. Indeed, the RBA raised rates by 25 basis points to 3.25 percent, as the central bank determined that growth [is] likely to be close to trend over the year ahead [and] inflation close to target, adding that the risk of serious economic contraction in Australia [has] passed. Event risk will be comparatively low for the commodity dollars this week, and overnight, the release of NAB business confidence is likely to reflect robust optimism, as recent increases in employment suggests firms are doing well enough to hire and more households are earning income.

**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar
For the most up-to-date Forex analysis and news, visit: www.forexstream.dailyfx.com

Written by: Terri Belkas, Currency Strategist for DailyFX.com
E-mail: tbelkas@dailyfx.com