US Dollar
Foreign exchange traders are so hungry for yield and carry that they completely shrugged off today’s batch of US data. Carry traders received a burst of confidence after the Group of Seven left the language in their communiqué about currencies unchanged. Their lack of official concern for yen weakness or euro strength was just what the market needed to push EUR/JPY to another record high and the EUR/USD further towards its 1.3667 all time high. Even though the US economic calendar is chock full of data over the next few days, the US dollar may not be the story of the week. We all know exactly where the Federal Reserve stands on rates, but what we do not know is how much further these carry trades can extend. As we near 100 in AUD/JPY, 120 in USD/JPY and 240 in GBP/JPY, the one way moves are becoming exhaustive, luring in many top pickers in the process. Carry has been and will continue to remain the main focus of the market as each piece of incoming US data does little to sway the Federal Reserve’s stance on interest rates. Higher inflation will prevent the central bank from cutting rates while risks of a housing market slowdown will prevent them from raising rates. This explains why the dollar barely budged after today’s economic releases. Retail sales were stronger than expected, but the strength contained underlying weakness as higher oil prices drove up gas station receipts. Meanwhile the Empire State manufacturing survey reported a far smaller improvement in the month of April, suggesting that the manufacturing sector is still struggling to recover. The Treasury International Capital flow data reported softer demand for long term US securities ($58.1 billion compared to $98.8 billion in January) due to the pullback in the stock market in February and concerns about the sub prime sector, however the data was not as bad as the headline number suggests since China, the UK and Japan were big buyers. Finally, we had the NAHB housing market index, which dropped to 33 from 36, reviving concerns about the housing market. Looking ahead, we are expecting consumer prices, housing starts, building permits and industrial production tomorrow. Like today, the reports are expected to be conflicting with consumer prices accelerating due to higher oil prices in March while the housing market and industrial production see slower growth. These reports should give the Fed further reason to stand pat and keep the dollar vulnerable to the demand for carry.

Euro
The Euro continued to charge higher as stronger economic data and hawkish comments from ECB officials continued to fuel demand for euros over dollars. The market’s demand is mainly focused on countries that are looking to raise interest rates and the Eurozone fits the bill nicely. Overnight, consumer prices increased by 0.7 percent, which was more than the market expected while French business sentiment climbed to 112 from 110. ECB members Weber and Quaden were both optimistic about economic growth with Weber openly contemplating raising their GDP forecast for Germany and Quaden confirming that a further increase in interest rates is very likely. Tomorrow we are expecting the German and Eurozone ZEW survey of analyst sentiment. The consensus forecast is calling for an increase in analyst sentiment thanks to recent upside surprises in growth and rally in the stock market. However since analysts are always forward looking, we could actually see a downward surprise since the strong Euro and outlook for higher interest rates could crimp growth in the months to come. Meanwhile Swiss National Bank President Roth signaled the possibility of further rate hikes this year. With the unemployment rate below 3 percent and the weak currency driving import prices higher, he indicated that the SNB has to be “vigilant.” The Swiss franc has not reacted to his comments because the strong demand for long EUR/CHF carry trades have kept the CHF pressured, but further gains could be limited.

British Pound
The British pound registered gains against the US dollar for the fifth consecutive trading day thanks to a stronger than expected rise in UK producer prices last month. We actually believe that the British pound will be one of the major stories this week as the much awaited release of the minutes from this month’s monetary policy meeting is expected to reflect a more hawkish voting record. What this means that is that it should pave the way for the Bank of England to raise interest rates in May or June. The growth of producer prices on both a core and headline number was faster than expected in the month of March. Housing market reports also revealed increases in house prices. This suggests that we could see a rise in consumer prices tomorrow as well. All we need is for employment to be hotter on Wednesday and consumer spending to increase strongly on Friday and we could see the GBP/USD rise to 2.00.

Japanese Yen
Stronger Japanese industrial production did little to stem the slide in the Japanese Yen. The currency pair extended to fresh lows against the Euro after the G7 meeting. Adding salt to the wound, US Treasury Secretary Paulson said that it was “not his job to comment on the carry trade,” while Finance Minister Omi said that no one felt that the Yen was a problem. The Japanese are enjoying the benefits that a weak Yen brings to their economy and with growth still struggling to improve, we doubt that they will do anything to stop it. Expect strong earnings from Japanese exporters like Toyota and economic data to surprise to the upside in the months to come.

Commodity Dollars (AUD, NZD, CAD)
Even though the Canadian and New Zealand dollars continued to rallied today, we are beginning to see a turn in the Australian dollar. Interestingly enough, oil prices are lower while gold prices are higher. The Canadian economy has been performing well and we are finally seeing the CAD reflect that strength. Meanwhile the market is snapping up New Zealand dollars ahead of tomorrow’s consumer price report. CPI is expected to jump back into positive territory in the first quarter after dipping in the fourth. This will raise speculation of whether the RBNZ will need to hike rates again this year. The rally in the Australian dollar is simply getting exhausted. With no major data this week, the fate of the Aussie could be dependent on the overall demand for high yielders.

Kathy Lien is the Chief Currency Strategist at FXCM.