• Dollar Rallies on Holiday Squaring, But the Outlook Is Still Murky
• British Pound Gets Hit by Weak Mortgage Lending Figures
• Yen Slides as BoJ Forces Short-Term Rates Lower

US Dollar
The US dollar climbed its way higher after the market digested the 8:30 numbers as London and US traders began to close their books ahead of the three day weekend.  The US is celebrating Memorial Day while London is celebrating its Spring Bank holiday.  With both markets closed, there should be minimal liquidity and activity in the currency market.  As for todayâ�,��"�s dollar rally, it would be a stretch to credit the dollarâ�,��"�s move to the stronger annualized core PCE deflator since the rally took off a good 45 minutes after the release.  Instead, position squaring and rumors of fixing demand at 11am related to the Morgan Stanley Capital International reweighting is probably the more likely catalyst for the move.  With inflation being one of Federal Reserveâ�,��"�s central focuses, the market was closely eyeing the PCE deflator released today.  Although the numbers were in line with expectations, they represent an up tick in prices from the previous month.  The annualized rate of core PCE growth has moved above Bernankeâ�,��"�s 1 to 2 percent comfort zone.  This level was brought up as a level to watch by Bernanke when he was a Fed Governor.  Meanwhile personal income came in weaker than expected and fell short of spending numbers for the same month.  We are beginning to see gradual signs of consumers cutting back.  With oil prices continuing to remain strong, we would not be surprised to see spending take an even bigger hit.  To the marketâ�,��"�s surprise, consumer confidence ticked higher modestly from 79.0 to 79.1 in the month of May.  Consumers were less optimistic about the current environment but more optimistic about future expectations.  However before getting too excited, next week, we will receive the Conference Boardâ�,��"�s measure of confidence and unlike the UMich survey, the report is expected to show a sharp deterioration.  Furthermore, we are expecting non-farm payrolls for the month of May.  After not being satisfied with last monthâ�,��"�s report, analysts are reaching high once again by predicting very strong job growth.  With expectations so high, they could really be setting themselves up for a disappointment, especially since jobless claims have been increasing while help wanted ads have been falling.  Judging from the trend of US data next week, the risk is to the downside for the dollar.   Meanwhile there has been some chatter about US Treasury Snow leaving office.  Even though the Bush Administration has denied his departure, the market is already talking about possible replacements.  The thought is that a departure by Snow would be seen as dollar bearish because a new candidate may be more aggressive in pressing China and Japan to appreciate their currency and stop paying lip service to what appears to be a non-existent strong dollar policy. 

Euro
Even though the Euro ended the week lower, consolidation has been the marketâ�,��"�s predominant theme.  As expected, consumer price growth in Germany slowed last month from an annualized pace of 2.0 percent to 1.9 percent.  With the busy economic calendar next week, we expect the marketâ�,��"�s price action to be more interesting.  Unemployment data is due out from both France and Germany.  With economic growth improving in the months leading up to April, the number of unemployed people is expected to drop in both countries.  Retail sales in Germany for the month of April are also expected to rebound while GDP for the first quarter comes in firmer than the previous quarter.  However, the more recent releases for the month of May, which includes manufacturing sector surveys, business climate and consumer confidence are not expected to be as strong.  We have repeatedly cautioned about the damaging effects of the Euro on growth and next weekâ�,��"�s May data should begin to provide signs of the Euroâ�,��"�s potential impact. 

British Pound
After a brief recovery, the British pound weakened significantly against the US dollar today and also lost ground against the Euro.  The fall was far more pronounced than the slide in its EUR/USD counterpart because the pair needed to work off the more extended gains it has incurred over the past month.  Weak mortgage lending figures gave sterling bulls a good reason to send the pair lower.  Originally expected to print at 67.3k, there were only 64.7k mortgage approvals in the month of April, which is a 24 percent drop from the number of approvals in March.  This continues to keep the Bank of England firmly at neutral and downplayed the hawkish comments made by BoE member Tucker earlier today.  Like many central bankers from around the world, Tucker was concerned about inflation and said that the BoE has to remain vigilant in face of rising inflationary pressures.  Unfortunately we will not get to see much of evidence of inflationary pressures next week aside from money supply figures as the market focuses on the housing market and consumer confidence numbers. 

Japanese Yen
The Japanese Yen weakened against every major currency expect for the British pound.  The much expected consumer price figures proved to be a non-event.  The numbers were pretty much in line with expectations, indicating that prices rose modestly.  National consumer prices increased slightly less than expected in April, but any pessimism was offset by the faster growth in Toyko core prices in May.  For the time being, the Bank of Japan is still far from raising interest rates.  Any move will not come until the fourth quarter at the earliest.  In fact, the BoJ is extremely concerned about the recent rise in short term interest rates. Yesterday and today, they pumped a lot of money into the money market to keep short term rates near zero.  Since March, they have spent approximately 500 billion yen.  This is a sore point for the BoJ and probably a good reason for them to stand put for a while longer.  Comments from Japanese officials also contain a more subdued tone.  Japanese Finance Minster Tanigaki said that they have yet to abolish deflation and that conditions are simply improving.  Economics Minister Yosano chimed in and said that prices are just emerging from a â�,��"bad condition.â�,�  In the week ahead, we are also expecting a lot of important Japanese economic data.  With oil prices rising and the yen relatively strong, it will be interesting to see how household spending holds up.  The market is actually predicting spending to contract once again, while industrial production slows.  On the bright side, earnings are expected to improve and housing starts are expected to tick higher.

Kathy Lien is the Chief Currency Strategist at FXCM.