US Dollar
Even though softer first quarter GDP growth drove the US dollar to a fresh record low against the Euro, the greenback ended up staging a very impressive intraday reversal. There was little to drive the dollar’s rebound aside from option expirations, rumors about a hedge fund cutting US dollar shorts to raise cash and optimism about the arrest of top al Qaida leaders in Iraq. We believe that the reversal is more technical in nature as the EUR/USD refuses to make hitting all time highs a new trend, like we have seen in the Dow. The details of the GDP report indicate that consumers are carrying the economy. Residential, private investment, defense and exports were all negative while the GDP price index grew by the fastest pace in 16 years. Weak growth but high inflation is the definition of stagflation – we just need see whether these conditions last. This puts the Federal Reserve in an exceptionally difficult place as the correction of one problem would worsen the other. Back in the late 70s, early 80s, Volcker defeated stagflation by raising interest rates sharply. When Bernanke took office, he promised to be an inflation fighter. However at this point, it is highly unlikely that he will follow in Volcker’s footsteps since it is unclear whether stagflation is here to stay. Instead, this only further confirms the notion that the Federal Reserve will keep interest rates unchanged for the remainder of the year. Looking ahead, next week will be all about jobs and manufacturing. We are expecting Chicago PMI, manufacturing sector ISM, service sector ISM, factory orders and non-farm payrolls. For the longest time, the argument for economic growth has been that as long as US consumers have jobs and are able to pay their mortgages, they will continue to spend. However the most recent consumer confidence report revealed that consumers are worried about their jobs. If this concern is validated by the non-farm payrolls report on Friday, then the EUR/USD could resume its climb towards 1.40. We argued in previously that the recent rise in jobless claims, signals that we could see payrolls below 110k, but payrolls can be very erratic and revisions could sharp, therefore we do not rule out the possibility of a stronger release, which would surely take the EUR/USD below 1.35.

Euro
he Euro hit a new record high today, but the currency was unable to hold onto its gains amidst a wave of profit taking. In contrast to the usual unambiguously strong Eurozone data that we have become accustomed to, this morning’s economic releases were mixed. Eurozone retail PMI accelerated, German consumer prices increased more than expected and French consumer confidence improved, but the current account balance worsened significantly. Originally expected to print at 1.1 billion, the surplus turned into a deficit. The strength of the Euro most likely contributed to the deterioration and we expect the balance to only worsen in the months ahead. Meanwhile comments from Sarkozy are keeping traders hesitant about buying more Euros. Even though he has yet to become the President of France, his persistent criticism about the exchange rate suggests that if he does become President, his immediate actions will be Euro bearish. Furthermore, he added that Junker has threatened to resign as head of the Eurogroup if Trichet fails to halt the gains in the Euro. With the Euro at such elevated levels, traders have looking for any hint that policy makers may be uncomfortable with the currency’s rise. We are beginning to see a whiff of that, but not from the ECB, who are only the ones that can truly induce Euro weakness. In the meantime, the central bank is still on track to raise rates in June and that is the only thing that matters. Over in Switzerland, KoF leading indicators surprised to the downside, sending EUR/CHF back towards its 8 year highs. It appears that SNB President Roth is incredibly uncomfortable with the recent weakness in the Swiss Franc. He said that the markets are completely ignoring the “very favorable” economic outlook, which suggests that the central bank head will be looking to raise interest rates in the near term.

British Pound
The British pound is stronger across the board today despite the lack of economic data. The price action is more a reflection of dollar weakness and Euro underperformance than pound strength. The British pound has had trouble staying above the 2.0 mark and next week’s UK data is not likely to help much. We are expecting mortgage approvals, house prices, consumer confidence, consumer lending, money supply, manufacturing, construction and service sector PMI. All of the housing market data should be positive and the market expects. Consumer confidence should hold steady while we could see mild improvements in service PMI. There should not be much of a surprise in terms of UK data and most of the releases will support the need for another rate hike. Whether or not the GBP/USD will be able to break and remain solidly above 2.0 will be determined by US data.

Japanese Yen
The Japanese Yen is weaker across the board after mostly disappointing Japanese economic data. Household spending, the job-to-applicant ratio, industrial production, retail trade, and construction orders all fell short of expectations. The only improvement that we saw was in housing starts. Tokyo reported slightly faster CPI growth, but not enough to indicate that deflation has been beaten. As expected, the Bank of Japan left interest rates unchanged at 0.50 percent. The semi-annual report indicated that the central bank also revised their CPI forecast lower. This confirms that the BoJ will remain on hold for some time and explains today’s sharp rally in carry trades. Next week is Golden Week in Japan, which means that most Japanese are on holiday so no significant data is due release.

Commodity Dollars (AUD, NZD, CAD)
After yesterday’s sharp slide, the commodity currencies rebounded today with the most meaningful reversal seen in the Canadian dollar. Despite the best levels in business confidence since the fourth quarter of 2004, USD/CAD is flirting with its 7 month lows. The demand for the CAD has been primarily driven by M&A flows. Norway’s Statoil agreed to purchase Canadian based North American Oil Sands for $2 billion cash. Looking ahead, the only events on the calendar are the RBA rate decision, monetary policy statement, Canadian GDP, industrial product prices, IVEY PMI and New Zealand building permits, money supply and commodity prices. The RBA is not expected to raise rates, while most Canadian data should print positively.

Kathy Lien is the Chief Currency Strategist at FXCM.