• Dollar Shrugs of Strong TIC Report in Thin Holiday Trading
• China Sees Declining Purchases of US Debt as a Solution to Reducing Surplus with US
• Japanese Officials Continue to Be Concerned With Rising Long Term Yields

US Dollar
With volatility compressing significantly last week, we took the opportunity on Good Friday to talk about the important crossroad that we are standing at in many of the currency pairs and how this week could prove to be a major turning point in the market.  We also indicated that a break or a big move was imminent and to our pleasant surprise this was exactly what unfolded when we walked into the office today.  With most of Europe still closed for Easter Monday, Japanese and US traders took the opportunity the push the dollar lower against all of the majors.  Trading was extremely erratic as Japanese traders initiated the first wave of dollar selling in the Asian trading hours as dollar bulls take profit ahead of the US Treasury International Capital (TIC) flow report.  When US traders joined the market, they were surprised to see the breakout and responded by exacerbating the sell-off.  What we found the most interesting however was the market's lackluster response to a very strong TIC number.  Net foreign inflows to the US increased by a whopping $86.9 billion, to the highest level in 3 months.  This was not only far above the same month's trade deficit, but also far above the market's forecast.  The details of the report indicate that the US' aggressive interest rate hikes have attracted strong interest in the country's bond market investments.  OPEC, China and Japan were all buyers while hedge funds located in the Caribbean were sellers for the third consecutive month.  Overall, this report was very strong and will push back fears for a growing current account and trade deficit for the time being since the number indicates that we are seeing funding sufficiency rather than deficiencies.  Although technically, today's break lower in the dollar appears significant against most of the major currency pairs, the fact that the move happened during thin trading conditions makes its sustainability questionable.  Looking beyond the TIC report, dollar bulls still have a cause for concern. The manufacturing sector continues to show signs of weakness as the Empire State manufacturing index falls from 29.0 to 15.8 in April.  This is the lowest reading we have seen since last October and is consistent with the weaker ISM report released two weeks ago.  Fears of a possible US military action on Iran has pushed oil prices to a new record high of $70.36 and gold prices to a 25 year high.  The rapid rise in energy prices over the past two months should raise concerns around the world.  Even though heating needs are behind us, we are moving into the busy summer driving season.  Gasoline prices have already creeped above $3 a gallon in many states and if they continue to rise, it could pose a bigger drag on growth as business costs increase and consumers end up with less money for discretionary spending.  It will also push global inflation higher, leaving many central banks with no other option than to either keep monetary policy tight or in some cases, tighten them even further.  Though this could mean a more aggressive Fed, it ultimately means greater risks to the economy.  This week, we are expecting inflation figures starting with tomorrow's producer price index.  Given the sharp fall in the February figures as well as the rise in energy prices, PPI should come in stronger, which could help the dollar recuperate some of today's losses.  

Euro
Even though the Euro broke higher, European markets were still closed for holiday which means that it will be interesting to see how European traders will respond to the breakouts that we saw today.  We are sure that at bare minimum, the European Central Bank is probably not very happy with the Euro's rise.  We are not far from the EUR/USD's year to date highs, which means that should we push above 1.2350, the next level of major resistance will not be until 1.25, a level that we suspect is the ECB's pain threshold.  Further gains would threaten the region's growth and recovery and force the ECB to be even more nimble with interest rate hikes than they have already proven to be.  Like the US, the most anticipated pieces of data from the Eurozone this week are inflation figures.  As we mentioned Friday, based upon the French and German consumer price figures that already have been released, it seems that the annualized pace of inflation growth in March is expected to slow modestly.  Italy reported its own CPI numbers this morning, which reflected a bit more acceleration in prices than expected.  Therefore any downticks in Eurozone CPI should be mild.

British Pound
After consolidating for the past three months, we have finally seen a meaningful breakout in the GBP/USD.  Unlike the EUR/USD, the breakout is cleaner and out of a tighter triangle consolidation, which means the possibility of it holding is stronger.  Merger and acquisition news continues to fuel gains in the British pound.  After Nasdaq's announced stake in the London Stock Exchange last week, there is now talk that the NYSE wants to take a stake in the LSE as well.  As we have repeatedly said, increased protectionism measures in the US have made the UK's business friendly  market  more attractive to international investors. Continued interest in UK based entities will spur further gains in the pound even if the Bank of England continues to leave monetary policy unchanged.

Japanese Yen
The Japanese Yen rallied against the US dollar but lost ground against the other major currencies.  The Japanese government continues to be concerned with the rise in long term rates and is showing no signs of backing down on their intentions to keep their zero interest rate policy intact for a while longer.  Economic data released out of Japan last night was mixed with a fall in consumer confidence but mild upward revisions to industrial production.  This week's focus will be on Chinese President Hu's visit to the US.  We already heard from one Chinese policy official that the solution to reducing the country's large trade surplus with the US may be through an increase in imports as well as decreasing purchases of US debt.  The second point is probably the most important as Hu may become even more convinced that this is the way to go by Bill Gates, who has been a big dollar bear since January of last year.  On the President's first evening in the US, he will be having dinner with Gates before making way to Washington to meet President Bush.

Kathy Lien is the Chief Currency Strategist at FXCM.