US Dollar
With European markets closed for May Day and Japanese traders out for Golden Week, most of the action in the foreign exchange market was concentrated in the US trading session. The drop in the Chicago PMI number yesterday followed by the soft Empire State and Philly Fed numbers earlier this month had most traders looking for a weaker ISM report. However instead of falling or remaining steady, manufacturing activity nationwide accelerated by the fastest pace in 11 months. The ISM manufacturing index jumped from 50.9 to 54.7 in April with the prices paid component surging 7.5 points to 73.0. The employment component also rebounded back into expansionary territory, which indicates that job losses in the manufacturing sector may be coming to an end. The unambiguously strong US ISM number triggered a sharp rally in the dollar with traders completely ignoring the 4.9 percent drop in pending home sales. As a lending indicator of the housing market, the number of contracts signed in March has a strong correlation with existing home sales in the months ahead, so be careful of todays weakness becoming tomorrow housing market collapse. Looking ahead, the number one focus for traders is of course, the labor market. Tomorrows Challenger Layoff report, ADP Employment Survey and Thursdays service sector ISM number will be closely examined for clues on how Fridays non-farm payrolls release will fare. Job growth is important because as long as US consumers have jobs, they will be able to afford to pay their mortgages. The moment they have problems doing so, it becomes time to worry. Tomorrows data will instrumental for traders looking to lay on non-farm payroll positions. Expect some aggressive positioning on the back of any big data surprises.

Euro
Three consecutive days of lower highs and narrower trading ranges paint the picture of a currency pair that is having an exceptionally difficult time holding near its record highs. In our weekly Commitment of Traders report, we talked about how Euro net longs hit an all time high for a third week in a row and whenever sentiment is this one-sided, the risk of a reversal is extremely high. Technically, the appearance of RSI divergence on the daily charts and MACD turning negative in the same time frame also supports more Euro weakness. All we need to see now is softer Eurozone manufacturing PMI numbers and German unemployment figures. On Monday, we already had a sharp turn in German retail sales. At that time we reminded our readers that the EUR/USD peaked in December 2004 on back to back weakness in European data. Should the figures tomorrow disappoint as well, then a turn would be supported by fundamentals, technicals and sentiment. However it is important to point out that the current forecast is for stronger and not softer numbers. With German business confidence accelerating in the month of April, manufacturing conditions should have been decent. It remains to be seen whether or not this translates into an improvement in the labor market. Meanwhile EUR/CHF hit an 8 year high today. For a currency pair that typically range trades, the 500 point near vertical rally over the past 2 months has been one of the clearest trends in the foreign exchange market. Despite comments by the Swiss Finance Minister, demand for carry trades continues to drive the currency pair higher. Swiss manufacturing PMI is due for release tomorrow. Weakness in the currency should spur demand for Swiss exports, which would translate into stronger manufacturing sector activity.

British Pound
Mixed economic data has led to mixed performance in the British pound. The currency lost value against the US dollar but strengthened against the Euro and Japanese Yen. Even though manufacturing sector PMI was slightly weaker than expected, the CBI distributive trades survey hit the highest level since May 2004. The CBI index is a measure of short term trends in the UK retail and wholesale distribution sector, which makes it just as important as the PMI index. Meanwhile tomorrow we are expecting construction sector PMI, mortgage approvals and consumer credit. These numbers should confirm the overall health of the housing sector. As long as it remains stable and money supply continues to grow, the Bank of England is on track to raise interest rates later this month. This should keep the GBP/USD hovering close to 2.00. If data disappoints however, traders will begin to question whether the central bank will really follow through with the May 10th rate decision.

Japanese Yen
The rebound in the Dow has helped to push the yen crosses higher. With most Japanese traders out for Golden Week, the price action in currency pairs like USD/JPY and EUR/JPY was concentrated in the US trading session. Economic data released night supports yen weakness with cash earnings posting the fourth straight decline in March. Finance Minister Omi was on the wires today commenting on the need for the Yen to reflect fundamentals. There was some Yen buying on the back of his comments but the reaction did not last for long. The only piece of data due for release from Japan tonight is the monetary base, which is not a market mover. Expect the Yen pairs to continue to move in lockstep with the Dow.

Commodity Dollars (AUD, NZD, CAD)
The Australian, New Zealand and Canadian dollars all ended the day slightly weaker against the US dollar. All eyes are on the Reserve Bank of Australia rate decision tonight. No changes to interest rates are expected, but after the surprise rate hike from New Zealand last week, there is a minor risk that the RBA could follow in their neighbors footsteps. Remember, whenever rates are left unchanged, there is no accompanying statement or press conference. Prime Minister Howard commented on the booming economy today despite the fact that manufacturing sector PMI dropped to a six month low. Meanwhile USD/CAD touched its seventh month low again today on the back of strong inflation figures. However the currency staged an impressive intraday reversal on the back of firmer US numbers and softer oil prices. The long wick in todays USD/CAD candle suggests that we could see more strength in the currency pair tomorrow, but with no Canadian data due for release, that will continue to be dependent upon oil prices and US data.

Richard Lee is a Currency Strategist at FXCM.