A Weak US Dollar May Not Be Good Enough
Since the beginning of the year, the US dollar has fallen 5.9 percent against the Euro and 6.7 percent against the Japanese Yen. For many countries, including the US, a weak dollar has caused major problems ranging from deteriorating export growth to inflation. The one good thing that the weaker dollar was supposed to do is to save the US manufacturing sector. Unfortunately, today’s US economic data proved otherwise. Industrial production dropped 0.7 percent in the month of April, manufacturing activity in the NY region dipped into negative territory and even though the Philly Fed index rebounded from -24.9 to -15.6, it still remains deep in contractionary territory. Unfortunately the depreciating value of the US dollar has failed to offset slowing demand. The automobile sector has been the hit the hardest from the double blow of higher oil prices and a weaker labor market. The US economy is continuing to struggle and there is no doubt that the Federal Reserve has a tough task ahead of them. Jobless claims increased last week while the NAHB housing market index fell to 19, one point shy of its record lows. Although foreign purchases of US securities increased $80.4 billion in March, including short term securities like US Treasury bills and non-market transactions such as stock swaps, foreigners were actually net sellers. This reflects the sharp liquidation out of short term securities in the immediate aftermath of the Bear Stearns debacle. Tomorrow we are expecting housing starts, building permits and the University of Michigan Consumer Confidence survey. With many construction projects still underway in big cities New York, a lot of inventory has yet to flow onto the markets. Combined with the uncertainty of the outlook for the US economy, housing starts and applications for building permits should continue to fall. In such conditions, it will be difficult for consumer confidence to improve and as a result, we expect the UMich index to fall to a fresh 26 year low. Dollar weakness should prevail, particularly against the Japanese Yen, Canadian and Australian dollars.

Euro: Looking for Fresh Direction
Euro traders are looking for a fresh direction. Since the beginning of the month, the currency has been trapped within a relatively tight trading range as rising inflation meets weakening economic data. ECB President Trichet lent his weight to the debate last week when he confirmed the central bank’s focus on inflation. Although this has helped the Euro carve out a near term bottom, the tables have recently turned, leaving traders confused about where the Euro is headed next. Commodity prices have tumbled with oil prices off its highs and rice prices declining for the fourth day in a row. On the other hand, Eurozone economic data has been improving with growth in France and Germany rising more than expected in the first quarter. Strong consumer spending and rising trade balances have helped to spur growth in the first 3 months of the year, but it is important to remember that these numbers are backward looking, which is part of the reason why the Euro was unable to hold onto its gains following the report. The Eurozone trade balance is due for release tomorrow along with Swiss retail sales. The Swiss franc looks particularly bearish against the Japanese Yen which correlates with the market’s forecast for weaker consumer spending.

Is the Sell-off in the British Pound Over?
The British pound has finally stabilized after gradually trending lower since the beginning of the month. Coincidently, the currency’s pair’s intraday low was exactly the same price as the low reached on February 20th, leading some technical traders to call the latest recovery a double bottom. Fundamentally, there was no UK data released last night and none are expected tomorrow, which means that there is no major news to drive the British pound lower. The US data on the hand could drive the dollar lower which coincides with the potential for a GBP/USD rally. However even though the currency pair could very well extend its gains over the next 24 hours, the British pound remains vulnerable to further losses especially if the housing market deteriorates further.

Sharp Recovery in the New Zealand Dollar
One of the most interesting stories in the FX market over the past few weeks has been the New Zealand dollar. The currency has been on a one way downtrend since last week, having lost close to 400 pips in a matter of days. Economic data has taken a turn for the worst with retail sales dropping 1.2 percent in March. The drop in visitor arrivals and credit card spending should have been the first clue that consumer spending has been weak. If producer prices, which are due for release this evening, are also soft, the Reserve Bank of New Zealand could actually consider lowering interest rates. Canadian manufacturing shipments fell short of expectations as well, but the sell-off in the US dollar has offset any kiwi or Cad bearishness and has instead pushed all of the commodity producing currencies higher.

USD/JPY: Still Flirting with 105
USD/JPY is still flirting with the 105 price level. Having hit an intraday high of 105.29, the currency pair has failed to hold onto those gains. Japanese economic data was weaker than expected with machine orders falling 8.3 percent in the month of March. GDP, industrial production, and consumer confidence are due for release this evening. Most likely the numbers will be weak because even though consumer spending improved in the first 3 months of the year, trade decreased. All of the carry trades are getting heavier by the day and look vulnerable to further losses.

Kathy Lien is the Chief Currency Strategist at FXCM.