US Dollar Breaks Down on Signs of Softer Inflation and Weak Housing
It has been a tough day for the US dollar with softer inflation, housing and capital flow data triggering a wave of dollar selling. After the weaker producer price figures released last Friday, traders really needed to see stronger growth in consumer prices to believe that the Fed is doing the right thing by putting inflation ahead of growth. Unfortunately not only did today’s releases fail to give them that confirmation, but the housing data also suggested that the US economy could face even more difficult times ahead. Yesterday, we talked about how foreclosures were going for less than market value in San Diego and indicated that this was extremely worrisome for the housing market as a whole. Today, the National Association of Home Builders reported the lowest level of confidence in 15 years. If home builders are this pessimistic, there is a very slim chance that they are going to applying for new building permits. This is a good sign that we could see disappointing housing numbers tomorrow which would exacerbate the slide in the dollar. The state of the housing market is far more worrisome than the level of CPI and Treasury International Capital flows. Gasoline prices did not start hitting record highs until late April, early May. Therefore, the up tick that the Fed expects in inflation could appear next month. So even if the EUR/USD continues to rally, gains should be capped below 1.37. Yesterday, the US postal service announced an increase in stamp prices. Companies like Federal Express and DHL have also been quietly increasing their fuel surcharges. We expect this to become a trend in many ancillary services, which will drive consumer prices higher on both a headline and core basis next month. Interestingly enough, capital flows into the US were also pared back in March. Higher interest rates abroad and the risk of further dollar weakness have deterred foreign investors from buying US securities. Meanwhile the only piece of dollar positive news today was the Empire Manufacturing survey, which jumped from 3.8 to 8.5. The weakness of the US dollar should continue to help the manufacturing sector recover but housing is still the bigger focus.

Euro Rallies Thanks to Strong Growth
The Euro staged a very strong rally today thanks to the growing dichotomy between US and Eurozone growth and monetary policy. In contrast to the slowdown that we have been seeing in the US, Eurozone growth is holding very steady at enviable levels. In the first quarter, the Eurozone grew by 3.1 percent which compares to the 1.3 percent growth in the US on an annualized basis. Germany continues to remain immune to the strong Euro and the recent Value Added Tax Increase. The government must be applauding themselves for a job well done. French and Italian growth unfortunately did not fare as well with deceleration seen in both countries. Nonetheless the first quarter growth numbers indicate that the region is healthy enough to handle an interest rate hike by the European Central Bank next month. Consumer price figures are due for release tomorrow along with French non-farm payrolls and wages. French data could be softer given the recent slowdown in growth while the strength of the Euro should cap any major increases in consumer prices. Meanwhile Swiss retail sales were much stronger than expected in the month of March as consumer spending jumped by 7.6 percent year over year. The market was actually looking for softer spending but the resilience of the Swiss consumer should pave the way for a rate hike this year.

British Pound: Quarterly Inflation and Employment Reports Due for Release
As we expected, the softer PPI numbers from yesterday correctly foreshadowed the weaker CPI numbers today. The strength of the British pound is clearly driving inflationary pressures lower throughout the UK which explains why the Bank of England failed to notch up their degree of hawkishness at the last monetary policy meeting. With both PPI and CPI falling, the BoE could very well skip raising rates next month. Whether or not this may be true will partially be contingent upon the Bank of England’s Quarterly Inflation report tomorrow. If there are any signs of serious hawkishness in that report, then traders may still believe that the BoE could raise rates next month. Aside from the Quarterly Inflation report, we are also expecting UK employment data. The sharp deterioration in the current account reported last week is a clear indication that UK industry is suffering from the strength of the British pound. Therefore we expect hiring to be pared back as well.

Japanese Yen: Bank of Japan Rate Decision Could Lead to Hawkish Comments from Fukui
Weaker Japanese machinery orders should have exacerbated the rallies in the yen crosses today but on a day with so much volatility in the Dow, we actually saw limited activity in the yen crosses. At one point, the Dow Jones industrial average was up as much as 135 points, but it ended up giving back close to 100 points to end the day up only 37 points. Perhaps traders are worried about the Bank of Japan rate decision tonight. No interest rate hikes are expected, but the prior record in the Japanese current account surplus and jump in CGPI suggests that growth may be enough to warrant tighter monetary policy in the near future. The 4.5 percent drop in machinery orders is worrisome, but the number tends to be very volatile.

Canadian Dollar Hits 11-Year High, Closing in on 29-Year High
Once again, the Canadian, Australian and New Zealand dollars are stronger across the board. In fact, the Canadian dollar hit a new 11-month high today and is closing in on its 29 year high. Both Canadian manufacturing shipments and new motor vehicle sales were stronger than expected in March while a jump in consumer prices also contributed to the move. It is hard to fade the strong move in the Canadian dollar since data has consistently surprised to the downside. So far, the data suggests that Canada has been relatively immune to the strength of the Canadian dollar, even though analysts have been touting this potential drag on growth for months. The strength of the CAD should keep foreign investors very interested in investing in the loonie and we expect that to be reflected in tomorrow’s data. Meanwhile New Zealand will be reporting producer prices. The strength of the kiwi is expected to have driven inflation lower.

Kathy Lien is the Chief Currency Strategist at FXCM.