German business confidence improved marginally which should have been bullish for the euro, but unfortunately the most actively traded currency pair in the forex market has remained under pressure throughout the European and U.S. trading sessions. So if the EUR/USD is not responding to economic data then what is driving it lower?

Five factors:

1. U.S. Treasury Auction

One of the big focuses of foreign exchange traders this week is the massive Treasury auction. The U.S. government will be issuing a record $104 billion of 2 year, 5 year and 7 year Treasury notes between Tuesday and Thursday. The reason why currency traders are watching these auctions is because of its scale and also because it will shed some light on investor’s willingness to fund the U.S.’ large and growing budget deficit. The auctions will be a big hurdle for the U.S. dollar this week because if demand comes up short, the dollar could get hit but it is not that simple because at the same time, weak demand could drive up yields, which is dollar positive. Either way, over the next couple of days, there will be a lot of focus on the Treasury auctions.

2. First ever 12 month ECB refinancing

The ECB refinancing is the biggest story for the EUR/USD this week because the 12 month offer is seen by bond traders as a quasi quantitative easing effort by the ECB because the operations are most likely going to be collateralized by government bonds which can then be posted as collateral to the ECB for funding. Although ECB President Trichet warned that their monetary policy actions can be easily unwound if needed, he also said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.”

3. Fears that German Debt Could Explode

As for Germany, Deputy Finance Minister Werner Gatzer said that total new debt could exceed EUR100 billion next year, which would be much larger than this year’s record financing needs of EUR80 billion. Looking ahead, we could see further weakness in the EUR/USD if Tuesday’s PMI figures fall short of expectations. Despite the improvement in business confidence, which was driven entirely by the expectations component of the report, current conditions remain weak.

4. Comments from ECB President Trichet

Although ECB President Trichet warned that their monetary policy actions can be easily unwound if needed, he also said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.” These bearish comments came after ECB member Nowotny said this morning that interest rates could remain unchanged into 2010.

5. Tuesday’s PMI numbers

However in the near term, weaker economic data could keep the EUR/USD pressured. German industrial production, factory orders and retail sales have all declined which could prevent a meaningful pickup and possibly even deterioration in manufacturing and service sector PMI.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.