The US currency could be vulnerable to heavy selling pressure if there is a forced capitulation in carry trades, although the underlying yield structure will help cushion the dollar if risk tolerances stabilise. The key factor is still that the dollar is liable to see strong selling pressure on any significant recoveries.

The dollar strengthened to near 1.2760 against the dollar on Friday, but was unable to make further headway and weakened in US trading as poor data and market rumours undermined the US currency. The US currency weakened to lows near 1.2845 before stabilising as the currency was also undermined by an unwinding of short positions in the yen and Swiss franc.

The US housing data was weak with a 14.6% drop in starts for October to a six-year low with an annual rate of 1.49mn while permits fell 6.3% to 1.53mn. The data will revive concerns over the housing outlook and the potential for a deterioration in the wider economy. The dollar was initially resilient after the data, but weakened sharply after rumours that a major hedge fund was in serious trouble and was selling the dollar to cover losses incurred in the commodity markets.

Data influences will be reduced during this week with trading also dampened by the US Thanksgiving holiday and this may encourage narrow ranges. Markets will, however, need to be on high alert over the risk of increased volatility.

The ECB has maintained a tough stance with bank member Papademos calling for extreme vigilance on inflation and these comments were reiterated by Chairman Trichet. Euro gains will still be restrained by the potential for warnings over currency strength from European officials.