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By Andrew Wilkinson at IB:

Bending over backwards to invite anyone else to join in, the euro remains in splendid isolation at its own limbo party as it seems the world has shunned its back on the single currency. Between March and April 2009 the euro rose by four cents from $1.25 to $1.29. So far during May the unit has already shed 3% reaching $1.2936 and dealers are openly questioning the rapidity of a decline to $1.25 as contagion fears spread while the transparency of the not so pretty Greek picture evolves. It’s hardly any wonder that the bears are questioning the potential of a break up of the single currency as a result.

Euro – To be fair in the introductory comment, the euro’s weakness is not isolated but it is absolutely safe and fair to state that it is the root cause of dollar strength. The dollar has surged on a huge risk aversion bid with the weight of fear that contagion stemming from fiscal difficulties has already trumped the rejuvenated earnings season.

That said, the Canadian and Australian dollars are far from multi-month lows and indeed are just pulling back from comparable peaks against the dollar.

The growing toxicity surrounding the euro has resulted in a record number of short futures positions against it and reminds me of any similar unrelenting currency crisis where a stalemate failed to deter negative speculation. With the resolution awaiting ratification it’s worrisome to see that the shorts are in no mood to relinquish their vice-like grip.

Today the market was in no mood to trifle with data showing expansion across the Eurozone implying ongoing service sector expansion and dwelled on the negative connotations of stalled retail sales during April. In a very fluid market the euro has now slipped to $1.2894 and 85.43 against the pound for a five-week low.

Aussie dollar – At the forefront of the cue snookering the Aussie dollar is the fallout from a slumping euro. However, a fresh slide in Asian stocks overnight comes as a second-wave effect of how Eurozone problems may impact the global pace of recovery. China’s own third attempt at curtailing lending is also weighing on prospects for Australian growth. The Aussie is lower on the day at 90.32 U.S. cents despite an embarrassingly robust 15.3% monthly gain for building approvals reported earlier. The figure proved a 51.6% annual gain in approvals and begs the question as to whether monetary policy increases have hit consumers where they should.

Canadian dollar – And while the Aussie can boast a more than 4% yield boost over the U.S. dollar it is faring as badly in this environment as the Canadian dollar. The sprawling European debt crisis is reducing demand for growth sensitive currencies. Commodity prices slid on Tuesday and despite the even more favorable fundamental recovery, not to mention budget deficit position in Canada, the loonie is under selling pressure to 96.97 U.S. cents as safe haven status of the greenback gets an ever-greener light.

British pound – On the eve of Thursday’s British election, little has changed. The Conservatives will likely fail to secure an overall majority but may form a new government. The pound continues to weaken against the dollar to $1.5085, but truth be told, so is everything today. Since January the pound slipped by over 7% against a basket of trading partners as well-founded fears surfaced that Britain’s budget deficit of £167 billion was in dire need of slashing. However, the real threat to an already tall order was the likely to be a hung parliament in which no party captures overall power.

However, it is extremely likely in my humble opinion that most of that political risk has been sufficiently priced into the pound’s value. More to the point it is unlikely that, in light of the escalation of the problems facing the continent, that British politicians of any party will embark on a few rounds of Russian roulette, and not want to openly invite ratings agency downgrades and a visit from the IMF. In other words any coalition formed from this delicately poised election race will probably see through a necessary deficit reduction plan. The leading Conservative party has the most aggressive fiscal plan. The Liberal Democrat leader last week rebuked the notion that politics would stand in the way of fighting the deficit stating that a hung parliament would not be accompanied by Armageddon.

U.S. Dollar – The dollar index is up by more than 1% in this fear-driven environment. There is little else to add to the growing list of a fully fledged currency crisis backed by legitimate deficit contagion threats, slumping stocks, rising bond prices and sinking commodity prices. All we need now is a hedge fund industry dinner outlining winning strategies under this environment. The dollar faces a couple of key data reports midweek. First, the ADP employment report already showed a 32,000 job gain for April and bodes well for Friday’s official report where total non-farm payrolls should expand by a forecast 189,000. The ISM service sector report is also due to show that 90% of the economy continued its healthy expansive recovery.

Japanese yen – Although the Japanese markets remain closed, the yen continues to retain a safe haven bid of its own and rose to a six-week peak against the euro at ¥121.69. But against its most actively traded partner it’s the economic prowess of the dollar economy that is winning through with the Fed far more likely to raise short-term interest rates (at some point) than the Bank of Japan. Dollar-yen is bubbling under at ¥94.73 with the tempting target of ¥95.00 likely to see the dollar accelerate.