• Dollar Rallies on Carry Interest and Corporate Repatriation
• First Germany, Now Italy - Italian Political Crisis Weighs on Euro
• Japanese Yen Under Water Following Smaller Trade Surplus

US Dollar
The mighty dollar continues to soar despite Hurricane Rita blowing closer and closer to the coastal parts of Texas as well as weaker economic data.  The only explanations for the latest bout of strength still lies in the age old argument of increasing carry for the dollar and tax incentives for US companies to repatriate overseas earnings as a part of the Homeland Investment Act.  The Act provided a one-time tax break for US corporations by applying a 5.25% effective tax rate on repatriated dividends instead of the usual 35%.  Companies had the option to either apply the tax break to their 2004 fiscal year earnings or their 2005 fiscal earnings.  This means that repatriation back into the US could still be a big wildcard for the remainder of the year.  As for carry, it was only 2 days ago that the Fed injected some optimism into the markets by being more hawkish than most traders had anticipated.  With at least one more rate hike in the pipeline, carry traders still have interest in the US dollar.  Yet, this does not mean that the US economy is performing all that better.  Today, we saw jobless claims reach 432,000 last week, slightly better than expected, but it was still the worst reading in two years.  Adding salt to the wound, the jobless claims report for the prior week was revised from 398k to 424k.  Leading indicators fell 0.2% in the month of August, which was slightly better than expected, but like jobless claims, the previous figure was revised downwards from positive 0.1% to negative 0.1%.  Overall we are beginning to see the softer economic numbers filter in and this should continue to be the trend going into October.  On a brighter note, commodity prices have also softened a bit following news that Hurricane Rita was downgraded from a Category 5 to a Category 4 storm. 

Euro
The Euro fell over 130 pips today against the dollar, erasing most of yesterday's gains.  These days it seems to really be a matter of who is facing a more dire fate - the US or Europe.   First Germany was plunged into a political crisis when there was no clear winner following the German elections this past weekend.  Now, Italy faces its own crisis following the surprising resignation of Domenico Siniscalo, Italy's finance minister.  Even though Italy the was worst performing major economy within the Eurozone this year, Siniscalo's determination to tackle Italy's economic problems provided a glimmer of hope.  He also stood strong against Antonio Fazio, the Bank of Italy Governor who attempted to impede the free movement of capital.  Siniscalo resigned in protest to the government's failure to penalize the central bank governor following a banking scandal.  However it doesn't end there * the situation got even more uncertain when Italian Prime Minister Berlusconi requested for the resignation of Antonio Fazio.  There is no word yet from Fazio, who is on route to Washington to attend the G7 meeting this weekend.

British Pound
The British pound was the biggest loser today, falling 270 pips before settling 235 pips off of the high.  The currency pair slid easily below the psychologically important 1.80 level, which not only erased yesterday's gains, but also plunged the currency pair down to the lowest level since the beginning of the month.  Even though the CBI manufacturing orders index improved from *29 to *27 for the month of August, the IMF cut its growth forecasts for the UK from 2.6% for both 2005 and 2006 to 1.9% and 2.2% respectively.  The agency is worried that high oil prices, a slowing housing market and still lofty interest rates could take a big toll on growth.  The IMF also warned that the government's tax revenues may be too optimistic and that they should probably curb spending growth.  Aside from fears of slowing growth, rumors of mergers and acquisitions activity also pressured the pound.  There is talk that British Petroleum may have an interest in bidding for Spain's Repsol. 

Japanese Yen
A smaller trade surplus for the month of August as well as broad dollar strength has sent the USDJPY currency pair higher once again.  The trade surplus shrank 80% in August as higher oil prices outweighed export growth.  Even though Japan has become much more energy efficient and along the same lines more resilient to higher energy prices, the latest trade data indicates that the economy has not been completely immune to the rise in oil.  Although the yen strengthened throughout the month of August and into the first week of September, economic officials have continued to warn about the negative implications that it has for the economy.  Although the impact has been felt, it should be limited. Meanwhile shifting over to politics, Koizumi's strong win has given him a solid platform to push forward on privatizing the financial system, starting off with restructuring or in some cases even elimination of eight state owned banks.  This should be really positive for the private banks who are frequently undercut by the government owned banks.  Meanwhile, in revaluation news, Zheng Xinli, China's Deputy Minister for central policy research was caught saying that investments in US Treasuries is "not worthwhile" on a long-term basis.  He also hinted said that equity investments, particularly that of overseas energy resource companies would be a much better investment.  Over the medium term, China's decreasing appetite for US Treasuries should be negative for the dollar.

Kathy Lien is the Chief Currency Strategist at FXCM.