• A Possible Early End to Rate Hikes Sends Dollar Tumbling
• Will Higher Oil Prices Tempt Europeans to Look For Euro-Denominated Oil?
• Yen Rallies on Growing Demand for Japanese Equities

US Dollar
The US dollar sold off strongly today as the market begins to consider the possibility that the Fed may not even raise rates to 4%. Greenspan spoke to the President in Washington about the potential economic impact of Hurricane Katrina.  The Fed Chairman will have to walk a fine line between keeping growth steady while battling inflation pressure.  Although Katrina would be a good reason to halt rate hikes, we suspect that Greenspan will stick to his view that the rise in energy prices is temporary and for the time being, go ahead with a quarter point rate hike later this month.  The November decision on the other hand remains more uncertain.  The outlook for the dollar at this point is not good.  There are gas stations running out of gas down south while others have hiked prices to as high as $6 a gallon.  As of 1pm EST, our FXCM Speculative Sentiment Index remained in net short territory for the EURUSD and net long territory for USDCHF - supporting the case for a further rally in the EURUSD (the SSI is a contrarian indicator).  The data that was released this morning was very disappointing, with the ISM survey printing at 53.6 versus expectations of 57.0.  Construction spending was flat compared to the market's forecast for 0.5% growth.  Personal spending and income data indicated that incomes continue to grow at a slower pace than spending.  Although the market will be turning its attention to tomorrow's non-farm payrolls report, we doubt that a good number could do much to help the dollar since the following month's NFP report could be very bad.  Jobless claims have not really flowed in yet from Katrina because most people are still focused on basic survival, but once everything clears up over the next few weeks and unemployment offices reopen, we expect jobless claims to explode as people rush to apply for benefits.  Generally speaking, with hurricanes, we usually see a sharp drop off in payrolls the month of the hurricane with a strong recovery over the next few months. However the dollar's sell-off today has been particularly strong, so we would not be surprised to see a bit of consolidation, but unless the government finds a resolution to this oil shock, traders coming back from their summer or Labor Day holidays could send the dollar even lower.

Euro
As expected, the ECB left interest rates unchanged today at 2%.  With oil prices soaring, the central bank has become increasingly concerned with inflation.  However even if they are concerned and seem to be sending out hawkish comments, we doubt that the central bank would really consider raising interest rates, especially since today's reports indicate that the manufacturing sector is really suffering from the higher price of oil.  The manufacturing PMI survey for Germany dipped back into contractionary territory while Italy's manufacturing sector faced stagnant growth.  The only shining light was in France, which saw a modest expansion in its own manufacturing sector.  The continual rise in oil prices, which is traditionally priced in dollars, may make euro-denominated oil even more attractive for European importers who are looking any edge in cutting costs.  At bare minimum oil priced in euros would cut out the conversion cost, which can be considered a hidden tax.  This could be a big opportunity for Iran, who plans on selling oil quoted in Euros next March. 

British Pound
Rocketing higher, the British pound soared approximately 360 pips during the session with traders bidding the Queen's currency on inflation fears.  Disregarding the fact that housing valuations growth is the slowest in nine years, declining 0.2 percent in the month of August, traders saw potential in up ticks in manufacturing.  Released by the Chartered Institute for Purchasing and Supply, the index rose to a reading of 50.1, capping four straight months of contraction in the sector.  Last month's was slightly below at a reading of 49.5.  With that said, speculation has now risen that the Bank of England will maintain their tone and not succumb to recent pressure for additional interest rate cuts.  Subsequently, the release showed that consumer goods production drove up the overall figure with the new orders component rising sharply over the previous number.  Confirming this notion was a radio interview held before the release where BOE Governor Mervyn King decided to highlight optimism in the industry commenting that “good manufacturing firms are prospering” and that policy officials currently see “a growing world economy that is helping firms that are exporting.”  Subsequently, the release showed that consumer goods production drove up the overall figure with the new orders component rising sharply over the previous number.  With that said, market players are now growing ever confident that interest rates will remain at the 4.50 percent with, what seems to be, a pickup in productivity.  For now, only time will tell.

Japanese Yen
With no economic data, traders bid the Japanese currency higher on growing interest in Japanese equities and talk of more Chinese revaluation in the pipeline.  In this case, attention once again turned to foreign interest in domestic equities.  According to a report released by the Ministry of Finance, foreign buying in Japanese stocks rose to 383 billion yen for the previous week.  This now brings the monthly interest to more than 1 trillion yen.  With expectations that the world's second largest economy will soon prosper, foreign investors are trying to be beat the crowd.  However, domestic investors still remain net sellers of domestic equities and may ultimately turn their sites home once considerable interest prompts such a move.  As a result, both Nikkei and Topix benchmarks hit fresh four-year highs at the close.  Ultimately beneficial for the economy, foreign interest may be bent on future expectations as we close in on the September 11 elections.  This is a considerable implication as a hung election or subsequent situation may leave Japanese investments out in the open, especially the underlying spot currency.  Subsequently, market participants will await next week's data for further direction from here when both consumer confidence and capital investment will play the spotlight.  Our readers will remember that capital expenditures contributed substantively to the rise out of recession we saw late last year.  This time around, although not as popular as household spending, the figure will still be scrutinized.

Kathy Lien is the Chief Currency Strategist at FXCM.