Euro Eases After Setting Yearly Highs

German unemployment decreased by -40K against expectations of a -35K drop and the ILO unemployment rate declined to 8.4% from 8.8% the month earlier. The news did not come as much of a surprise to the market as the figures were leaked several days earlier.

The German labor ministry expects employment to pick up especially as better weather creates demand in the construction industry. However, euro bulls should be cautious in extrapolating these results as the ever climbing exchange rate may have a dampening effect on future labor demand in a heavily export depended economy such as Germany.

Improving labor conditions are critical to Euro-zone growth, where the downtrodden consumers have been reluctant to spend for more than 3 years. A robust job market will generate the confidence to increase spending and further fueling gains in GDP. To that end, the rise of the euro , as we've noted in the past, may stand as a critical threat to a sustainable European recovery. At 1.2500 and above many of the European finance ministers are likely to escalate their rhetoric in an attempt to pressure the ECB to maintain a dovish monetary policy.

While recent statements from ECB officials have been relatively hawkish, should the currency appreciate much further, we believe European monetary policymakers may decide to refrain from tightening monetary policy - a move that is likely to surprise the majority of currency traders.

However, given the recent price action , none of these issues may matter in the short term as the market seems intent on challenging the 1.2500 barrier in the pair. In the current market environment all positive US news is ignored or discounted. Yesterday's strong Durable goods orders had only the most fleeting of impacts on the EUR/USD as market players quickly bought the dip, while the huge jump in New Home Sales was dismissed outright by euro bulls for two reasons; the data is subject to massive downward revisions and anecdotal evidence from April suggests a severe slowdown in housing demand.

Today all eyes will be on Chairman Bernarke as he testifies before Congress. The key question for the currency market is will he be a dove or hawk? Given the fact the Fed stressed its 'data-dependency' focus, the reasonable assumption in light of the recent positive US economic news, is that Chairman Bernarke will be hawkish. Whether the market responds to his rhetoric, however, remains an open questions.