For readers of the Daily Currency Focus, it should be no surprise that the dollar has continued to weaken. On Wednesday, we said that the actions by the Federal Reserve have cemented the downtrend in the U.S. dollar. Given how currency traders have responded to previous Quantitative Easing threats and announcements, the EUR/USD could realistically hit 1.40 (see charts). Although equities have given back its gains and bond yields have rallied, the moves in the currency and commodity markets indicate that the Fed’s actions will have a lasting impact on the financial markets. As we look forward to more dollar weakness, it is worthwhile to consider how a weaker dollar impacts the global economy.

Gold prices hit an intraday high of $999.50 an ounce, just a few cents shy of $1000.

Capital flight has driven the US dollar higher. On a day when President Obama signed the Economic Stimulus Package into law, the banking turmoil in Europe and the resignation of Japan’s Finance Minister has turned investors away from other major currencies. Even though the greenback is yielding next to nothing, investors are willing to park their money with the US government as long as they keep it safe. The lack of negative game changing news from the US has been very positive for the US dollar. The greenback and gold prices have been moving in tandem since January 14th. This unusual correlation is actually sending a strong message to currency traders.

The US dollar continues to rise, but the rally is tempering. After sharp losses this past week, the Euro, Japanese Yen and Australian dollar are beginning to stabilize against the greenback. US equities have been in the red throughout the day, which is why most currencies remained negative despite sharp intraday reversals. Over the next week, the US dollar faces 3 big threats that all traders and investors should be aware of – a bad bank plan, central bank intervention and economic data:

For the most part, markets today expressed a tone of relief and satisfaction for global economic events. We have seen the classic pattern of dollar and yen weakness across the board that is quite the mainstay in markets that think the worst is over. However, we are cautioning that this brief level of renewed sentiment may be short lived. In the US the euphoria that was left over from European trading seemed to dwindle in the latter part of the trading day. The Dow finished one of its typical whipsawed trading sessions, falling off of highs of more than 100 to dip in to negative territory. The index did finish in positive ground. This level of uncertainty definitely casts some doubt on the continuation of this renewed confidence in the financial markets.

US Leading indicators shocked to the upside, rising 0.3% against a forecast of -0.2% decline. This was the first positive print for the index in six months as a rebound in financial components outweighed the losses from increased jobless claims and stock market declines.

With most of Asian and Australia out on holiday, the liquidity starved conditions in the currency markets created some exaggerated movements in both euro and pound on the first trading day of the week, as both units fell hard at the start of Asia trade only to stabilize and recover on better risk appetite as the night progressed.

Gold spiked to within two dollars of $900/oz in holiday leaden Asian trading as saber rattling between US and Chinese officials regarding the manipulation of the yuan ratcheted the tension in global capital markets. Last week Treasury Secretary-designate Timothy Geithner stated that China was a currency manipulator sending shock waves through the financial markets as the Obama administration appears to have taken a much more confrontational stance with Chinese authorities than its predecessor.