Death of Housing Market Leads to Further Dollar Weakness
The housing market is in big trouble. Not only did sales of new homes drop to a 7 year low last month, but the median price of a home sold also fell by the largest amount in 37 years. This follows an already abysmal report of existing home sales released earlier this week and collectively they provide strong evidence that the US economy is in trouble. For the past few years, the inflated value of homes helped to fuel aggressive consumer spending. Now that house prices and demand are falling while inventories are rising, people will start to become more conservative about their spending habits. The US dollar hit a new record low ahead of the new home sales figures as the record amount of subprime adjustable rate mortgages due to reset next month raised big concerns about the possibility of increased foreclosures. With non-farm payrolls due for out next Friday, the state of the labor market is coming back into focus. Jobless claims were surprisingly low last week, but help wanted ads last month fell to a record low. The market is looking for a 100k rebound in payrolls following last month’s drop. We think this is a bit overly optimistic especially considering the fact that many financial companies have announced fresh layoffs in the past month. Although we don’t expect job growth to be negative for the second month in a row, we also do not expect a significant recovery. Meanwhile there is a tremendous amount of US data due for out tomorrow. We are expecting personal income, personal spending, the PCE deflator, Chicago PMI, Construction spending and the final University of Michigan consumer confidence report for the month of September. The odds are skewed towards stronger rather than weaker data because most of these reports are either tied to inflation or the manufacturing sector.

Euro Closing in on 1.42
With the Euro closing in on 1.42, ECB President Trichet has finally buckled down and talked about the currency’s recent moves. Unfortunately he didn’t deliver much when he tempered his comment about excess volatility with the reminder that their baseline views on Eurozone growth remain intact. What Trichet is trying to tell us is that he doesn’t like the fact that the Euro is rising, but at the same time, he doesn’t think that it is a major problem. One of the main reasons why he is able to remain hawkish is because the German labor market has been healthy. The unemployment rate dropped from 8.9 percent to 8.8 in the month of September. The amount of unemployed people also fell by a larger than expected 50k. Not all data was good however; retail PMI in German deteriorated. It seems that Germany is having a much harder time with the recent Euro strength than France. French data has actually been decent. For example, French retail PMI in the month of September increased from 51.1 to 54.2. Tomorrow, we have German retail sales and French producer prices. Sales are expected to slow but inflation could surprise to the downside. Meanwhile the Swiss franc continues to ignore optimistic comments from the Swiss National Bank. According to the latest SNB report, the economy is strong and they expect 2.5 percent growth this year.

Australian and New Zealand Dollars Race Higher
The Australian and New Zealand dollars continued to perform extraordinarily well. The Aussie has rallied for the eighth consecutive trading day and is within a whisker of its .8873 July high. The New Zealand dollar has also finally broken out despite mixed economic data. Business confidence improved, but the current account widened while building permits and money supply grew at a slower pace. Gold and wheat prices remain high which is keeping the commodity currencies bid. Although the Canadian dollar is also stronger, it has been mostly stuck in a range ahead of tomorrow’s GDP, industrial product price and raw material reports. The moves of all three of these currency pairs have become overextended and each pip rise raises the risk of a reversal. However when it comes to the currency market, trends can last far longer than most people would expect. Therefore it is more prudent to wait for a reversal to occur than to try to time one.

Stronger UK Economic Data Erase Losses in the British Pound
The British pound broke higher today on the back of stronger UK economic data. House prices increased 0.7 percent in the month of September, bringing the annualized pace of growth up to 9 percent. The July index of services also increased by 1.0 percent compared to the market’s 0.8 percent forecast. There were disappointments as well, but that was offset by evidence of stability in the UK housing market. The CBI distributive trades survey dropped to 12 from 15, which was in line with expectations while the BBA loans for the month of August fell from 66.9k to 61k. Gfk consumer confidence is due for release tomorrow. We expect confidence to deteriorate given the recent Northern Rock debacle.

Japanese Yen Crosses Continue Higher Ahead of Big Data
The Japanese Yen continued to weaken against every major currency except for the Swissie despite stronger Japanese economic data. Small business confidence increased from 47.4 to 49.1 and BoJ member Suda also attempted to calm the markets by saying that subprime woes have receded slightly. Tonight is a big night in Japan with a lot of economic data due for release. This includes the jobless rate, overall household spending, consumer prices, industrial production and retail sales. Most of these releases are expected to be weaker, reinforcing the factors driving the current recovery in the Yen crosses. The Dow wants to test 14k and if it does, the Yen crosses will continue higher as well.

Kathy Lien is the Chief Currency Strategist at FXCM.