Stalling output in the tri-state area surrounding New York saw the dollar slide on Monday after the New York Federal reserve reported a third monthly contraction in the level of manufacturing activity. The dollar softened in early-going on Monday as corporations made new partnership arrangements, stoking further gains for equity markets around the world. The water feels warmer after a rebound at the back-end of last week. The safe haven units of Switzerland and Japan came under further pressure as investors felt less anxious, while the risk of intervention appeared to loom larger in the background. A Swiss news service claimed that the government and central bank where at the stage of "intense" talks over setting a target rate for its franc. Dealers are acting as though something magnanimous was about to be rolled out. Meanwhile Japan's Finance Minister Noda speaking on public television said that he's again prepared to take bold and decisive action to stem the strengthening yen.

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Japanese yen - The Japanese economy shrank less in the second quarter than was expected surprisingly most economists. Most agree that growth will resume in the current three months. The aftermath of the devastating earthquake and tsunami that plagued Japan in March hindered output as supply chains faced severe disruption. Economists had projected a contraction of 2.5% in the three months through June but were pleasantly surprised by an annualized pace of decline of just 1.3%. The outlook is brighter but remains obscured by the clouds of a stronger currency. Intervention has restrained the unit thus far, although the yen remains close to an all-time high. Finance Minister Noda speaking on a weekend talk-show that he was watching closely and stood prepared to take further bold and decisive action. Diluting his words were those of his rather successful predecessor Eisuke Sakakibara, whose legendary jawboning earned him the nickname of Mr. Yen. "Intervention, in order to be effective, needs to be persistent and continuous and needs to have the understanding" of other authorities. The yen is once again rallying on Monday against a weakening greenback and recently traded at ¥76.71.

U.S. Dollar - Bets the dollar would weaken fell by the most on record according to CFTC data revealed late last week. The size of last week's financial market disruption was so large that it caused significant demand for U.S. treasuries and the dollar forcing currency futures speculators and hedgers to abandon short bets against the dollar. Through the week ending August 9 investors cut almost exactly in half the amount of outstanding short wagers against the dollar to 153,216 contracts. While last weekend's S&P downgrade for the U.S. shocked the world into a state of heightened recession watch, it bolstered demand for the dollar by shoving down the yield curve. That could be a factor arguing against further quantitative easing since the aim of such a policy is to spur lending by leaning on yields. The dollar lost steam at the start of the week with its index against a basket of trading partners losing 0.5% to a three-day low at 74.26 after the New York Fed's index of manufacturing activity in the tri-state area fell and remained in contraction territory for a third straight month.

Euro - Hopes are for some reason running high that tomorrow's Franco-German summit will produce further steps towards resolving the European sovereign debt crisis. The meeting was announced by Paris at the heart of last week's drama when French banking names were coming under further investor scrutiny. It's hard to understand what fresh impetus the duo can agree upon that hasn't already been signaled to the market with limited impact. The euro is, however, firmer in anticipation and as some of last week's pressure on financial markets continues to unwind. The euro ran up to its session high at $1.4379 in the half-hour after the New York Fed signaled the regional economy was faltering in August.

British pound - The pound also advanced against the dollar despite a rocky start, rebounding from $1.6258 before trading at $1.6373 after dealers picked on the dollar after the New York Fed report. The pound slumped by 0.4% per euro as dealers' recent view towards the pound has changed. Despite a still red-hot debt crisis across the English Channel, investors surveying the impact of Britain's harshest austerity measures since the Second World War are growing increasingly concerned by the impact on growth. They still expect stronger growth in the Eurozone. Last week in parliament Chancellor Osborne told lawmakers that going back on austerity measures was the wrong thing to do despite fraying social fabric in Britain that had resulted in several nights of riots and looting across the nation. The euro rose to buy 87.87 pence.

Aussie dollar - Despite a surge in the value of the euro per dollar, investors still seem wary over jumping back in to the growth-sensitive units of Australia and Canada. We'll learn more about the thinking of the central bank on Tuesday when the minutes from the RBA's latest monetary policy committee are released. While the European units rebound against the dollar, the Aussie seems to have lost some of its shine after most analysts started to predict the central bank would be forced to cut interest rates going forward in order to couch a global downturn for growth. The unit recently bought $1.0434 U.S. cents but has yet to move beyond its earlier session highs.

Canadian dollar - The same nervousness kept the Canadian unit confined to a narrow range against the dollar and recently traded at $1.0130 U.S. cents. The earlier Empire State manufacturing index that weighed on the dollar is equally negative news for the Canadian unit given the fact that some three-quarters of its exports wash-up on American shores. The Canadian unit remains above parity despite having revisited that point in the heat of last week's breakdown. For now it looks safe above there but as the week draws on this could be a key relationship to watch should investors force equity prices back to the point of "where next?"

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com       

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