• Dollar Shrugs Off Weak Data in Favor of Commodity Slide
• Euro Showing Signs of Making a Turn
• Yuan Makes Yen Rise

US Dollar - The US dollar starts the week on a strong footing as the market shrugs off weak economic data to focus on the deep retracement in commodity prices.  Gold prices have tipped below $700 an ounce while oil prices are broke the $70 level thanks to comments from Saudi Arabia about OPEC possibly adding enough new capacity to meet demand.  Fundamentals have not changed much however as the latest reports signal a gloomier outlook for the US dollar.  The Empire State manufacturing survey dropped from 15.8 to 12.4, which is the weakest reading in 11 months.  Unsurprisingly, the culprit is the rising costs of energy and raw materials.  We have long said that it is inevitable for companies and US consumers to feel the oil pain.  The Philly Fed survey which is a more closely followed report due out later this week should fall victim to the same fate.  The NAHB housing market confidence index also dropped from 51 to 45 in May, the weakest reading in ten years.  Home builders see the outlook for the housing market as "poor" due to higher mortgage costs, high prices crimping purchases and a withdrawal of speculators in the market.  If the housing market goes, the Fed will be forced to cut short their rate hikes sooner rather than later, but it will not be until we see the inflation numbers on Tuesday or Wednesday will we get a better sense of what the Fed will do since it all boils down to which is pressures are more significant * growth or inflation.  Meanwhile the much anticipated Treasury International Capital flow report came in much weaker than expected for the month of March.  Foreigners purchased only $69.8 billion worth of dollar denominated securities in March, compared to the market's forecast for a $79.9 billion rise.  Even though the Fed has been raising interest rates, which should increase the attractiveness of US treasuries and the stock market rallied throughout the month of March, the depreciation in the US dollar is outweighing the possible earnings from the other markets.  Most countries slowed their purchases with the exception of the UK, Caribbean based hedge funds and Mexico.  The biggest red flag in the report was the major selling by Japan, the world's largest holder of US treasuries.  Central banks around the world have been cutting back their purchases.  We have already talked about Sweden, Qatar, the UAE and Russia, but now with Japan selling, the pressures on the dollar are exacerbated even further.  Demand from China also slowed even though they were a net buyer in March.  Central bank reserve diversification is a long term factor that will plague the currency for months or even years to come.  However, we can see today that the US dollar has completely ignored the report and rallied against all of the major currency pairs.  Admittedly, the February figure was revised upwards from $86.9 billion to $90.5 billion, but it was not enough to negate March's downward surprise.  In addition, the TIC, though weak, was enough to cover the $62 billion trade deficit reported last week.  However even so, the dollar's rally today seems more attributed to the sharp slide in commodities as well as a correction after extreme exhaustion.  Although this may last for a few days, fundamentals have yet to warrant a strong shift in trend.

Euro - After such a prolonged period of strength, we are finally seeing a significant day of weakness in the EUR/USD.  There were no economic reports released overnight which indicates that today's weakness was primary a result of dollar strength rather than a shift in Euro dynamics.  As indicated in this morning's brief, the FXCM Speculative Sentiment index has flipped to positive territory signaling a turn in the EUR/USD.  Although this will likely ensue, the fundamental trigger would need be weaker economic reports from the Eurozone.  Officials from the European Central Bank have remained decidedly hawkish, downplaying the potential impact of a strong currency, but we believe that the strength in the Euro will have a dampening effect on economic growth.  First potential evidence of this would be from tomorrow's German ZEW survey of economic sentiment.  We expect to see the fourth consecutive drop in confidence as high oil prices hit discretionary spending.

British Pound - The British pound slipped against the dollar but held ground against the Euro.  Leading indicators dropped in the month of March from an upwardly revised 1.0 percent to 0.6 percent.  House prices according to the Office off the Deputy Prime Minister also increased less than expected in March, rising by only 3.3 percent compared to a 4.0 percent forecast.    The Rightmove report, which is a more current reading on the housing market showed a 2.0 percent rise in contrast to the ODPM report, which suggests that the housing market has improved since then.  The UK economic calendar is fairly busy this week with consumer prices due for release tomorrow.  Like the rest of the world, inflation is expected to tick higher in the month of April.  Core prices however are expected to remain tame.  Overall though, inflation should still remain at or above the central bank's 2 percent target.

Japanese Yen - The Japanese Yen rallied across the board against all of the major currencies except for the US dollar as talk of Chinese revaluation hits the headlines once again.  This time, it has been attributed to the value of the Yuan rather than official comments.  For the first time ever, the People's Bank of China has allowed the Yuan to fall below 8.0 against the dollar.  The market is finding this quite encouraging as it validates the US' claims that the country is taking more currency reform initiatives.  Meanwhile Japanese economic data was firmer than expected with the current account surplus and the consumer goods price index increasing strongly.  However BoJ Governor Fukui believes that the economic growth will slow which suggests that they are becoming concerned about yen strength.  Yet he still hints that the central bank could raise rates soon.  Meanwhile the government is against rate hikes and is already concerned about yen strength as Finance Minister Tanigaki warned again about possible intervention.

Kathy Lien is the Chief Currency Strategist at FXCM.