US Dollar Sinks on Weak GDP and Uncertainty about Non-Farm Payrolls
The US dollar weakened against every major currency with the exception of the Japanese Yen. Two factors contributed to the dollar’s decline today, namely weak GDP growth and resurgence in carry trade demand. As we said in our Special Report yesterday, carry trades will die when the Dow dies. With the Chinese stock market bouncing in reaction to yesterday’s record high in the US stock markets, carry traders have also returned, triggering impressive rallies in the high yielding Australian and New Zealand dollars. This strength, which is predominately against the Japanese Yen has also helped to drive Euro, British Pound, and Aussie strength against the US dollar. Top that off with the weakest level of GDP growth since December 2002 and this explains why the dollar sold off today. In fact, USD/JPY was the only currency pair to remain stationary which confirms our thesis that carry is driving overall market activity. The 0.6 percent GDP number is very troublesome, but the weakness of the US dollar should help to boost growth in the quarters to come. Personal consumption was strong so the revision came primarily from weaker inventory and trade. Both the Monster.com online job index and the employment component of the Chicago PMI report suggest stronger job growth. But the payrolls derivatives auction settled at 121,300, which means that traders are expecting a weaker number that is more in line with the ADP survey. Job growth is key to the sustainability of the US economy. We have long said that even though the housing market is weak, as long as people have jobs, they will be able to service their mortgages. Therefore weak job numbers could be what topples the US stock market and the US dollar. The odds are in favor of a stronger report however given the extremely low levels of jobless claims last month. Our Non-Farm Payrolls Outlook contains more details on the potential outcome for NFP while traders may be interested in our Trade the News: NFP Focus Report. Aside from payrolls, we are also expecting the National ISM manufacturing index. The weak dollar should continue to help manufacturing conditions nationally, just as it has in the Chicago region. Should the outcome of NFP and ISM be aligned, then Friday could be a big breakout day.

Euro: Stuck in a Range Ahead of German Retail Sales
Even though the Euro is stronger today, it is still stuck in its week long trading range. Economic data was mixed once again. The German ILO unemployment rate dipped and Eurozone consumer confidence increased, but at the same time the number of unemployed people increased in Germany. This data does little to clarify the air on what the European Central Bank will do beyond June which is capping gains in the Euro. Traders are holding back from selling the Euro aggressively on the expectation that the ECB will be increasing rates next month but they are also holding back from buying it ahead of German retail sales and PMI manufacturing numbers tomorrow. The retail PMI numbers were very weak and this suggests that we could also see softer consumer spending in Germany. Manufacturing PMI has a greater chance of disappointing as well with corporate profitability likely to be impacted by the strength of the Euro. Meanwhile over in Switzerland, GDP growth in the first quarter was the strongest in seven quarters. This is a testament to the overall health of the Swiss economy and supports the Swiss National Bank’s desire to raise interest rates. The government has been very unhappy with the weakness of the Franc and the growth data indicates that the economy will be able to weather tighter monetary policy.

British Pound: Weak Data Will Postpone Any Further Rate Hikes
Softer economic data has not stopped the British pound from rallying. Money supply, house prices, mortgage approvals and consumer confidence were all weaker than expected. Even though the CBI distributive trades survey was firmer, it still dropped significantly from the prior month. Incoming economic data from the UK has been weak which indicates that even though the members of the monetary policy committee debated between a 25 and 50bp rate hike, they do not have the fundamental reason to lift rates again over the next few months. After the hawkish MPC minutes, traders were expecting another hike as early as July, but with the economy clearly weakening, the central bank may be forced to hold off until September, which has led to the pound’s under performance against the dollar and Euro.

Japanese Yen: Drop in Labor Cash Earnings Adds to Yen Weakness
With the Dow holding steady and the Chinese stock market rallying overnight, the Japanese Yen is weaker across the board. Carry continues to be the only thing that is driving the Yen. Economic data released overnight was hardly impressive. Housing starts and construction orders were stronger, but still at very low levels. Labor cash earnings were much weaker than expected indicating that corporations are still not passing any increases in profitability onto their workers. Despite hawkish comments from Bank of Japan Nishimura, weak earnings will continue to prevent the BoJ from lifting rates. Watching the Chinese stock market and US stock market performance is extremely important for carry traders. The Chinese government will not be happy with the recovery in the markets. If stocks do not turn down once again, they will be forced to make another change to policy. As a result, a free float may not be out of the question, see our special report for more details.

Commodity Currencies: Australian and New Zealand Dollars Soar on Acquisition News
The Australian, New Zealand and Canadian dollars all performed very well today despite mixed economic data. The strength was driven by acquisition news from Morgan Stanley Group who snapped up Investa Properties for AUD 4.7 billion. The Canadian dollar benefitted from stronger annualized growth in Canada as well as weak US growth. Australia reported a smaller improvement in the trade deficit but strong growth in capital expenditures. New Zealand on the other hand reported a sharp drop in business confidence.

Kathy Lien is the Chief Currency Strategist at FXCM.