Record Breaking Day for the Dollar, Euro and British Pound
It has been a record breaking day in the currency market for the US dollar, Euro and British pound. Despite a stronger than expected service sector ISM report, the US dollar fell to an all-time low against the Euro while the Euro climbed to an all-time high against the British pound. It has been a volatile day in the currency market and even though service sector ISM rebounded, activity in both the manufacturing and service sectors are still contracting. The same can be said for the employment components of these reports, which is extremely worrisome ahead of Friday’s non-farm payrolls release. Not only could there be another month of job losses, but the job losses could be big. The ADP employment survey reported that 23k jobs have been cut from US payrolls in the month of February, the first net job loss in 4 years. The main reason why we think that non-farm payrolls could be very bad is because the last time service sector ISM contracted for 2 months in a row was back in late 2001. For those of you who remember, that was a particularly difficult time for the US economy. There were actually 15 consecutive months of job losses between 2001 and 2002 with -300k being the biggest monthly job loss during that period. The Beige Book report confirms that economic activity is weak across the nation. Two thirds of the areas surveyed reported softening or weakening activity and almost all areas reported higher material costs. As for the labor market, there have been pullbacks in hiring by some firms and increased layoffs, reduction in work hours or hiring freezes by others. The stronger ISM surveyed has pushed rate cut expectations back up to fifty-fifty for a 50 versus 75bp rate cut. Friday’s non-farm payrolls report could change those expectations dramatically as the fate of the March 18 Fed rate cut hangs in balance.

New Zealand Keeps Rates Unchanged, AUD and CAD Rise on Gold and Oil Prices
The Australian and Canadian dollars were the most market-moving currencies today as oil and gold prices hit record highs. This was largely due to the weakness of the US dollar, but oil prices have also been pressured by legal actions between Exxon Mobil and Venezuela. The continual rise in oil prices has now pushed gas prices to a record high in many states. A local news station in California is even reporting that the Americo gas station in Gorda, just south of Big Sur is selling regular unleaded gas for $5.19 a gallon. If this trend continues, there is a decent chance that gas prices could hit $4 a gallon nationwide by this summer. The rise in gold prices is causing another rush. Prices are so high that regular people around the world are digging up their scrap jewelry to be melted and sold on the open market. Sooner or later, this may cause a flush of inventory that could trigger a reversal in oil prices. The growth in the Australian economy is beginning to moderate with fourth quarter GDP and service sector PMI in February falling short of expectations. Meanwhile the Reserve Bank of New Zealand left interest rates unchanged at 8.25 percent. Even though the statement highlighted risks to both growth and inflation and the central bank said up that they will keep rates on hold for a significant period of time, RBNZ Governor Bollard warned that the New Zealand dollar is exceptionally and unjustifiably high against the US dollar. Does this mean that they will intervene in the NZD? Maybe, but as we have seen from their past intervention, there should not be a lasting impact on the currency. Australia will be releasing their trade data tonight and Canada will be releasing IVEY PMI tomorrow; expect more active trading in the commodity currencies.

ECB Trichet Expected to Keep Interest Rates and Bias Unchanged
The European Central Bank is not expected to alter interest rates at tomorrow’s monetary policy meeting. Stronger economic data and continued inflationary pressures should also keep the tone and bias of Trichet’s post meeting press conference unchanged. Retail sales rose 0.4 percent in the month of January while service sector growth accelerated in both France and Germany during the month of February. The continual rise in oil and food prices is boosting inflationary pressures and the risk of second round effects, which is the ECB’s greatest fear. They need interest rates and their currency to remain high in order to have any chance of bringing inflation back down to their target. Therefore comments from Trichet could drive the EUR/USD even higher.

Bank of England: Still Dovish
Like the European Central Bank, the Bank of England is expected to leave interest rates unchanged tomorrow. Although they face inflationary pressures like the ECB and recent economic data including today’s service sector PMI was stronger than expected, their monetary policy statement should still contain a tinge of dovishness. UK growth faces more immediate risks than Eurozone growth which is why their bias should be different from the ECB’s and why the EUR/GBP hit an all time record high today. We expect this trend to continue as we believe that the monetary policies of the ECB and BoE lead to further EUR/GBP strength. As for the GBP/USD, the anticipation of a weak non-farm payrolls report on Friday could help keep the GBP/USD near its year to date highs.

Japanese Firms Hit by USD/JPY Weakness
All of the Japanese yen crosses are up strongly today thanks to a recovery in US stocks. The price action in the yen crosses suggest that we could see a more meaningful rally which is supported by the stories in today’s Wall Street Journal. According to the financial paper, Japanese firms are beginning to suffer as a result of the dollar’s weakness against the yen. In the fourth quarter for example, Toyota Motor Corp approximately $194 million in currency related losses. We expect this trend to continue.

Kathy Lien is the Chief Currency Strategist at FXCM.