The dollar's dramatic slide this week will ensure US data remain the prime focus for the currency market, especially now the outlook for US monetary policy is a lot foggier than in other regions.
The euro rose above the $1.30 level on Friday, soaring to its highest against the dollar since April 2005. A combination of healthy economic data out of the 12-nation bloc and a clearing of dollar holdings earlier in the week ahead of a US holiday battered the greenback across the board.
The US economy itself is at a tipping point - some data suggest growth will moderate and bring the economy to a soft landing, while others suggest the gentle slowdown the Federal Reserve projected could in fact end in a hard landing.
"The reason the market is more sensitive to what is being released from the US is because the interest rate cycle in the US has reached a fork in the road, in contrast to euro land where the overriding consensus is that the data is strong enough to force rates to go higher," said Standard Chartered currency analyst Mike Moran in New York.
The dollar has shed over 10 percent of its value against the euro since the start of the year, over 12 percent against the British pound and 6 percent versus the Australian dollar.
This week the greenback haemorrhaged due to position-squaring ahead of the end of the month and a media report citing a Chinese central bank official as warning Asian countries against holding too much of their reserves in dollars.
Making matters worse was a sharp drop in interest rate differentials, one of the key factors shielding the dollar from worse losses. The gap between US and euro zone 10-year government bond yields shrank to its narrowest in nearly 18 months, dipping briefly to 79 basis points from about 89 a week ago before rising to 85 basis points.
Euro zone GDP has come in lower so far in the third quarter, but Credit Suisse economists point out in a research note that revisions to growth for the region have tended to be upward.
However, the latest round of data suggests 2006 is a robust year for the euro zone economy, thanks in large part to the resurgence of the region's largest economy Germany.
Indeed, data on Friday showing German inflation ticked up last month encouraged investors to price in a greater chance that the European Central Bank may keep raising rates into 2007, beyond the current benchmark rate at 3.25 percent.
The ECB is already expected to tighten to 3.50 percent when it meets in December, but financial futures reflect investors are fully prepared for an increase to 3.75 percent early next year.
The Fed now is widely expected to cut US rates in the first half of 2007 by a quarter of a percentage point to 5.00 percent. In Japan, which has the lowest interest rates in the industrialised world, economic growth has outstripped forecasts, adding to the case for another rate hike by the Bank of Japan, which some believe could come as early as December.
British interest rates are now at 5.00 percent, just a quarter of a percentage point below the US federal funds rate, making this difference the narrowest it has been since January this year. But the Bank of England has been quick to hint it is happy with the current state of policy and this may well mark the peak in its rate-hiking campaign.
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