PMI Supports the Euro

European manufacturing showed broad strength with all three major European economies (Germany, France and Italy) registering better results than the month prior. Most importantly the output prices component rose to 53.4 from 51.8 indicating that manufacturers finally have the power to pass on increases in their input costs to consumers.

The data was welcome news to euro bulls who have long argued that ECB will have to assume a more hawkish posture by aggressively raising rates to contain the budding inflationary pressures in the 12 nation region.

Thus far the week belongs to the euro longs as US data has been dour with GDP, Chicago PMI and Existing Homes all coming in below target while EZ eco news has been generally positive. Today, traders will focus on Personal Income and Spending reports and ISM Manufacturing release. Market players will also keep a sharp eye on the PCE deflator - the Fed's favorite gauge of inflation.

If the ISM and Personal Spending data come in soft but the PCE exceeds expectations of 3.1%, the Fed may find itself in the unenviable position of having to control inflation by raising rates beyond 5% level just as overall US economic demand contracts. The prospects for such a scenario especially in an election year cannot be good for the greenback.

On the other hand, if manufacturing continues to demonstrate strength while inflationary pressures accelerate, the market may well move right back into dollar long positions, turning yesterday's breakout in the EUR/USD into a one day wonder.