• Dollar Collapses as Bernanke Talks of a Pause in Rates
• Strong Eurozone Data Continues to Bolster Euro
• Yen Has a Big Night Ahead; China Raises Interest Rates

US Dollar
On what was suppose to be a quiet day with little data, the US dollar took another beating as Federal Reserve Chairman Ben Bernanke raised the possibility of a pause in the FOMCâ�,��"�s tightening cycle.  This is as dovish as we could expect from the central bank at a time when inflationary pressures are indeed building and recent economic reports have been showing signs of growth.  Furthermore, the Fed is acknowledging these upside risks by saying that even â�,��"if its objectives are not entirely balanced,â�,� they may decide to â�,��"take no action at one or more meetings,â�,� which is their way of saying that they may not be phased by the recent reports. It is quite clear that the cards are stacking higher and higher against the dollarâ�,��"�s favor and Bernankeâ�,��"�s latest comments may indeed be the straw that breaks the camelâ�,��"�s back.  This is in line with our expectations for interest rates to be capped at 5 to 5.25 percent. We are already above the psychologically and technically important 1.25 level, which means that there is room for more strength.  The persistence of the Fed has been the main factor that has kept dollar weakness against the Euro relatively tame compared to its weakness against the Yen, but now that they have for the first time introduced the possibility of a pause, we could see the support beams give way.  Dollar bulls will now have to contend with the world calling for more strength in Asian currencies, reserve diversification, geopolitical risks and a possible end to the Fedâ�,��"�s tightening cycle.  Such grave risks could scare many bulls out of the market even if we get a strong GDP report tomorrow.   The market has already shrugged off many pieces of good data so we would not be surprised if it did the same for GDP, especially since it is commonly seen as a lagging indicator.   We have been saying all week that the latest shift should not be taken lightly since it is a result of many different yet serious fundamental factors.  Next week, we will have a lot more data to contend with including non-farm payrolls and judging from Bernankeâ�,��"�s comments, the Fed will be watching the reports very closely to determine when this potential pause may come.  Most analysts still believe that we will see a May rate hike, but the June interest rate hike is much more up in the air at this point.  The only saving grace for the dollar against the Euro will probably come from the ECB.  If the central bank becomes concerned about Euro strength and begins to talk down the Euro or delay further the need for continued rate hikes on their part, we could see a much needed retracement.

Euro
The Euro skyrocketed today on comments from Bernanke, marking the fifth consecutive day of strength for the currency against the US dollar.  Eurozone economic data continues to come in strongly with German unemployment falling by a more than expected 40k in the month of April.  This brought the unemployment rate down to 11.3 percent from 11.4 percent.  Italian business confidence also picked up, rising from 94.5 to 96.1.  The strength of data has prompted some central bankers to remain hawkish with ECB member Garganas saying that interest rates remain very low and â�,��"we need to expect more rate increasesâ�,� in the future.  Admittedly rates are extremely low and do need to be increased, but the question lies in he timing of the increase.  With the EUR/USD trading above 1.25, the currency is tightening the regionâ�,��"�s economy without the central bankâ�,��"�s help.  The 500 pip rise over the past month will certainly have an impact on exports, which will filter into weaker economic reports for the month of May and June if the currency remains at current levels.  This is a cycle that we have seen often and it could be a good reason for the central bank to hold back a bit longer and wait to see how the economy responds.  The latest surge in Euro should erase any lingering speculation for the ECB to raise rates next month.  The June rate hike however is still a possibility and with the USâ�,��"� June rate hike now in question, the first month of summer could prove to be anything but dull.

British Pound
The British pound strengthened against both the US dollar and Euro today despite the weaker house price report from the Nationwide Building Society.  The market shrugged off the report as nothing more than a retracement off of stronger numbers seen the previous month.  Broad dollar weakness pushed the pound higher but against the euro, the move was likely due to a retracement from five days of consecutive strength.  Aside from the Gfk Consumer Confidence report due tomorrow, we are done for the week.  Consumer confidence is expected to improve modestly, rising from -7 to -6.  As indicated by Bank of Englandâ�,��"�s Barker yesterday, data has been mixed and as such, the central bank will probably continue to stand on the sidelines until we get clearer signs of where the economy is headed.

Japanese Yen
The Japanese Yen strengthened against the dollar today, but weakened slightly against the other major currencies.  There was no economic data released last night, but the Ministry of Financeâ�,��"�s Watanbe was on the wires talking down the yen.  He said that the market misinterpreted the G7â�,��"�s comments on imbalances and that it did not mean that an adjustment in the value of Asian currencies against the dollar was needed.  We beg to differ since the G7 finance ministers said specifically that more flexibility was needed in exchange rates. Tonight will be a big night in Japan with CPI, unemployment, retail sales, industrial production, personal consumption expenditure, personal income, PMI, housing starts and construction orders all due for release.  In addition, the Bank of Japan is holding a policy meeting and will also be releasing their semi-annual outlook on the economy and inflation.  This is all being done ahead of the Golden Week holidays in Japan next week.  With so much data on tap, it would be a surprise if we didnâ�,��"�t see decent volatility in the yen tonight.  Meanwhile, it is worth noting that China increased its interest rates last night for the first time since October 2004 from 5.58 to 5.85 percent to cool the economy.  This is yen positive since it suggests that they are taking yet another subtle moves to increase the value of their currency.

Kathy Lien is the Chief Currency Strategist at FXCM.