US Dollar: Reversals in the Dow and in Carry Trades
We saw major reversals in the financial markets today. Not only did the US dollar erase all of its losses against every major currency with the exception of the Japanese Yen, the Dow also reversed nearly all of its gains. The major volatility in the financial markets has been triggered by one thing and that is fear. In the first half of the European trading session, demand for carry trades returned with a vengeance taking EUR/JPY to a fresh record high and CHF/JPY to an 8 year high. When US consumer confidence came out much stronger than expected, the dollar began to take off. The strength was so widespread that for a brief moment USD/JPY rallied in lockstep with USD/CHF. Unfortunately, the stock market / carry trade relationship is too dominant to suppress. When the stock market reversed its gains around noontime, USD/JPY also reversed, despite the fact that the dollar continued to rally against the Euro and British pound. The trigger for the reversal was another attempt by China to cool the rapidly growing stock market. With the Shanghai stock index hitting another record high last night, the government tripled its stamp tax on stock trading. Having just increased interest rates, widened the Yuan trading band and increased reserve requirements 2 weeks ago, the government is clearly becoming very anxious with the stock market’s unstoppable rise. The hope is that the stamp tax will reduce the amount of trading, but with a tax of 3 in a thousand, the increase may only have a limited impact on the Chinese market in the long term. In the short term however with the Chinese stock market, US stock market and carry trades extremely overbought, this could be a trigger for some further unwinding. This will all depend on how the Chinese markets behave tonight. A big reaction in Asia will trigger a bigger reaction in the US, but at the same time, we need to see that reaction first because the Chinese appetite for risk should not be underestimated. Meanwhile, it is important to point out that the S&P/Case-Schiller house price index dropped for the first time in 15 years, which is further evidence of the vulnerability of the housing market. This week is non-farm payrolls week and tomorrow’s ADP employment index is one of our first leading indicators for payrolls. A strong number could extend the dollar’s rally as well as hawkish FOMC minutes from the March 9th meeting.

Euro: Eurozone Economic Resilience Evident in Current Account Data
Even though the Euro gave back nearly all of its intraday gains, next to the Japanese Yen, it was the best performing currency against the US dollar. This resilience was thanks to the much stronger than expected current account data released this morning. The market was completely caught off guard when the current account shifted from a deficit of -3.7 billion to a surplus of 5.4 billion in the month of March. This is yet another piece of evidence that the strength of the Euro has had a limited impact on the overall economy. Instead, ECB officials continue to remain very hawkish. According to the Financial Times, ECB member Weber said that “the current cycle of interest rate increases has not yet reached its end.” This clearly indicates that the central bank is on track to raise interest rates on June 6. German and French retail PMI data is due for release tomorrow. With business confidence holding steady, there is no reason to expect weak consumer confidence. Meanwhile the Swiss franc has performed extremely well after the UBS consumption index hit a 5 year high. The trade surplus fell short of expectations, but the market is less interested in trade ahead of the GDP and CPI data later this week. We expect the weakness of the Swiss franc to have boosted both growth and inflation.

British Pound: Losing Ground Amidst Lack of Data
With no significant economic data to help boost the British pound, the currency fell quickly and sharply under the weight of the dollar rally. The only piece of data that was released was the BBA loan numbers for the month of April. According to the group, home loans fell 13 percent in the month of April (from 75098 to 64815). The economic calendar is comparatively light for the UK this week, with only Tier 2 data due for release. This includes GfK consumer confidence, mortgage approvals, the CBI distributive trades survey and PMI manufacturing. None of these reports should alter the market’s expectation of another rate hike by the Bank of England this year. Last week, the minutes from the most recent Bank of England meeting revealed that they were debating between a 25 and 50bp rate hike.

Japanese Yen: Carry Trades Refuse to Die
Japanese Yen carry trades were the focus of the day. Many times in the past, carry trades have refused to die despite minor hiccups which explain why we are wary of whether this will happen again. The US stock markets have already recuperated some of its losses and we have key Japanese data due for release tonight, namely industrial production and the Bank of Japan meeting minutes. Overnight, economic data from Japan was very strong with the jobless rate falling below 4 percent for the first time in 9 years. Overall household spending was also robust which suggests that we may finally be seeing some recovery in the Japanese economy.

Commodity Currencies: Canadian Dollar Surges to Fresh 29-Year High
The Canadian dollar surged to a fresh 29 year high today after the central bank signaled that an interest rate hike may needed in the near term. The central bank was widely expected to leave interest rates unchanged at 4.25 percent, which they did on the fear of derailing the economy by pushing USD/CAD closer to parity. However growth has become so substantial that if it does not wane any time soon, the central bank will need to step in and take action. The futures market is now pricing in 2 rate hikes by the end of the year. Tomorrow we are expecting more Canadian data with raw materials and the current account balance due for release. Australian retail sales are scheduled for release this evening. The strength of the labor market should keep consumer spending strong.

Kathy Lien is the Chief Currency Strategist at FXCM.