The week started exactly as the last week ended with the dollar being liquidated across the board. The euro set a new high at 1.3847 before dipping lower on some profit taking. The pair now stands within reach of the psychologically important 1.40 level and may well make a run at that target especially if US housing data later this week shows further deterioration in the sector. With market sentiment so strongly dollar bearish and advantage clearly with the euro bulls, any downward surprise in Existing and New Home Sales could push the EURUSD above the 1.3900 level and beyond. If the pair breaks the 1.3900 figure, the temptation to run stops and take out the exotic option barriers at 1.4000 will be so overwhelming and the unit could rally to that level on sheer momentum alone.

However, the move to 1.40 is not pre-ordained. Event risk could tilt dollar’s way, especially if the IFO report prints lower than expected as fears of higher exchange rates damped sentiment amongst German manufacturers. The producers in the EZ have been surprisingly effective in coping with the competitive pressures of a strong currency however such efficiency cannot last forever and the effect of a strong euro is likely to dampen demand sooner rather than later. Nevertheless, for the time being the negative effects of high exchange rates appear to be minimal and few European monetary officials express any serious concern with the current environment. Given these dynamics, the market could well follow the path of least resistance and take the pair to 1.40 before the end of the week.

Much like the euro, cable was also strong taking out the 2.0600 figure in early London trade. Speculators continue to bet on the possibility of another rate hike from the BoE to 6% as early as August, but we believe there is little chance of that occuring. Higher rates are already starting to take a bite out of UK consumption as evidenced by last week’s sub-par UK Retail Sales. Today’s marked decline in the appreciation of housing prices as reported by Rightmove is further proof that demand is starting to slow down. The Rightmove survey registered a rise of 10.3% versus 11.2% expected. While housing prices continue to record double digit year over year gains, today’s sharp pullback from the stratospheric levels of the past few months indicates that the BoE policy of tightening is taking effect. Therefore, the UK central bankers are far more likely to remain neutral and observe the data for next few months before initiating any new actions.

In the short run however, none of the economic and monetary considerations may matter. At this point dollar trading is driven mainly by speculative sentiment. News of sub-prime woes have increased fears of a broader slowdown in the US economy that could in turn lead to a shaper decoupling in economic performance between US and the rest of the world. Presently, the majors are trading more as proxies for anti-dollar sentiment

Boris Schlossberg is a Senior Currency Strategist at FXCM.