US Dollar
The big question tomorrow is not whether payrolls will come out over or under but whether it will come out significantly away from the marketââ,¬â"¢s forecast to cause a meaningful reaction in the US dollar.  We, like most traders are hoping for a big divergence since the quiet range trading in the major currency pairs has lasted too long that it has become painful.  Taking a look at what we call the leading indicators for payrolls, the odds are more in favor of a weaker release over a stronger one.  Yet with the short term sentiment in the market at the moment more pro dollar than anti dollar, this suggests that the market is banking on a number that will still indicate decent growth in the US economy.  The Federal Reserve is far from raising interest rates which means that a strong number between 120 and 150 will probably only lead to a dollar rally that tests the currencyââ,¬â"¢s recent highs against the Euro (1.2625) and the Japanese Yen (118.40).  Further strength beyond that may be difficult.  On the other hand, the market is waiting for a sign that could push the Fed to cut interest rates sooner rather than later.  They do not expect to see that tomorrow, which is why the dollar is holding on strong.  However if payrolls sink below 100k, we could see a sharp dollar sell-off that has the possibility of continuing onto the summerââ,¬â"¢s low.  Either way, we are just hoping for a big move that can set the tone for fourth quarter trading.  Meanwhile we want to point out a story in the FT today about Vega Asset Management, which we mentioned yesterday.  The latest report indicates that the hedge fundââ,¬â"¢s assets are now down to $1 billion from a high of $12 billion.  The meltdown of hedge funds is a big reason why we believe that despite what Bernanke and Kohn said yesterday, the Federal Reserve is leaning far closer to an interest rate cut than a rate hike at this point. 

Euro
European Central Bank President Trichet said a lot about very little in his press conference this morning after the ECBââ,¬â"¢s decision to raise interest rates by a quarter of a point to 3.25 percent.  Like his peer across the Atlantic, he neutralized his more cautious comments about growth by reiterating his concern for inflation.  The fact that the word vigilance was missing from any of his comments today may have disappointed some Euro bulls who then bailed out of their long Euro trades.  However, we want to point out that Trichet did say that rates remain very low and monetary policy remains very accommodative indicating that they are still on target to raise interest rates again later in the year.  The drop of the word vigilance may just be their first step to putting a lid on interest rate hikes once they reach 3.50 percent, which would still leave the ECB as the only major central bank to be raising interest rates at the moment.  This will be a big advantage for the Euro if the market finds a reason to believe that the Federal Reserve will need to start cutting interest rates.  We are also watching EUR/CAD as the interest rate spread between these two currencies has now shrank to 1.00 percent in the Canadian dollarââ,¬â"¢s favor.  The closer we get to zero, the more attractive long EUR/CAD may be for traders who want to express short oil trades.  Meanwhile the retail PMI survey for the Eurozone increased from 52.3 to 52.4 in the month of September.  In an interesting twist of fate, the index for Germany and France actually fell but it increased for Italy.   German factory orders are due out tomorrow, but the market will probably trade quietly ahead of the US payrolls report. 

British Pound
The Bank of England left interest rates unchanged at 4.75 percent this morning, which was right in line with the marketââ,¬â"¢s expectations.  The divergence in monetary policies between the ECB and the BoE has come to the aid of EUR/GBP which ended a three day losing streak. Todayââ,¬â"¢s gain in the pair could extend further if tomorrowââ,¬â"¢s industrial and manufacturing production reports come out weaker.  With the ECB the only one of the two central banks to be raising interest rates, any sort of dollar negative reaction to the payrolls will probably lead to a more exaggerated reaction in the Euro over the British pound.  

Japanese Yen
The Japanese Yen has extended its gains for the second straight day as we begin to hear comments from the Japanese government on the value of EUR/JPY.  More specifically, last night, Japanââ,¬â"¢s Vice Finance Minister Watanabe said to reporters that they are watching to see if the movements in EUR/JPY become too volatile.  Although we still do not expect them to back any concerns with action, Watanabeââ,¬â"¢s comments were enough to tempt yen bears to take profits on their shorts.  Japan is always more concerned with the value of USD/JPY than EUR/JPY even though their trade with the Eurozone is increasing.  The US tends to exert more pressure when they are displeased with the US dollarââ,¬â"¢s value against the Yen and Japan tends to give way easier, especially in times like this when they will need to rely on the US if tensions with North Korea escalate.  Currencies can frequently become political instruments as we have seen with the Chinese Yuan and it is important not to forget that.  Even though the yen linked currency pairs have all turned to the downside, they are all sitting at critical support levels.  This means that it can swing anyway tomorrow depending upon how the US payrolls report turns out.

Kathy Lien is the Chief Currency Strategist at FXCM.