This week is set to be crucial for the dollars direction, as we have two very important economic events to look forward to; the ECB rate decision together with Trichet’s speech and the non-farm payroll data.

Let’s start with what happened in the markets last week, as there was a big liquidation on Thursday in all markets, with DOW JONES and NIKEI dropping more than 300 points after Citigroup and several other big companies revealed more than 7000 job reductions. The fact the US economic data was negative for the dollar together with risk aversion hitting the markets; the dollar was driven down against the Euro and carry trades deteriorated.

Last week’s big event was the FOMC rate meeting which returned unchanged as was widely expected; however the statement left traders disappointed as it didn’t deliver any hope for a rate hike in the next meeting. Markets were pricing in that after positive comments from Bernanke and co-members, the bank will be even more hawkish in its policy stance but due to bad economic data and renewed recession fears the bank failed to give a positive message. The dollar was weak after the announcement and EUR/USD pushed higher more than 100 pips in just a few minutes.

The other event of the week was carry trade liquidation, which saw EUR/JPY, GBP/JPY and USD/JPY dropping more than 200 points, following the DOW JONES. The negative sentiment is clearly back in the market. EUR/JPY made new life time highs at 169.50 but the move didn’t find any followers and the pair sold off together with all yen related pairs.

Today, Monday, is the last trading day of the month, and traders are closing their trading books for the second quarter, so volatility is expected to be high, with choppy moves likely as liquidation takes place all across the board. The yen related pairs continue the sell-off, but are rising to strong support levels, USD/JPY at 104.60, EUR/JPY at 165.60 and GBP/JPY at 209-209.30, so a consolidation from those levels might occur before renewed sell moves arise.

Today the economic calendar is quite empty, with only important economic release being Chicago PMI. Analysts predict that data could be negative, which may push the dollar lower once again.

However, all traders think about this week is Thursdays ECB rate decision, which is expected to be a hike of either 12.5 points or 25 points. The fact that Trichet was hawkish in the last meeting, leads everyone to expect a rate increase, but the level of increase is not yet clear. Many believe that the bank might just go ahead and hike 25 points and then pause for a period of time, or hike 12.5 points now and the other half in the next meeting. Whatever the outcome, the Euro will be very volatile on that day and if the bank hikes more than 12.5, we might see break up towards 1.60.

Let’s not forget though, that on the same day at same time as Trichet’s speech, we have the other big event of the week, the non-farm payroll from US. The number is expected again to be negative at -60000 for a sixth consecutive month. The recession bells might start to ring once again, as in the time of recession in the past, we have negative number for 10 consecutive months. A negative number, together with a hawkish Trichet may be the end of any dollar rally in the near term, leading to new highs in EUR/USD. The chance of a positive number is slim, as data so far suggest contraction in the economic figures and jobless claims were high in the last few weeks. It will also be interesting to watch the ISM numbers, which are expected to be worse than previous months, suggesting more dollar weakness in the coming weeks.

EUR/USD still trades within 1.5550-1.5850 and a clear break of the latter may see a move up towards 1.5900-20, potentially setting up resistance before the rest of the week’s data.

GBP/USD is trading just below the $2 level and if the data helps, it may break with 2.0050-2.0100 coming into view. From those levels the Pound could correct as the economic data will not support further appreciation. In King’s speech last week he sent the message that inflation is high and the bank needs to act in order to bring it down. However, this is easier said than done as more negative numbers are coming out daily and therefore the bank will find it difficult to hike more than once.

Let’s see how the markets will move after today’s month end and if the dollar will still manage to surpass all negative sentiment that is built over the last few days. The question will be now; which economy is performing better, Euro zone or America? I think we all know the answer, so let’s trade this information accordingly…for now anyway.