According to the LA Times:

Top Justice Department officials have drafted a legal challenge asserting that Arizona's controversial immigration law is unconstitutional because it impinges on the federal government's authority to police the nation's borders, sources said Wednesday. At the same time, the government officials said, the department's civil rights section is considering possible legal action against the law on the basis that it amounts to racial profiling of Latinos who are legally in Arizona but conceivably could be asked to provide documents proving their citizenship.

According to the article, AG Holder met with 10 police chiefs Wednesday who object to the Arizona legislation, & he promised them he would act on their recommendations soon. The chiefs urged Holder and the Obama administration, to stop the law, which they said would seriously hamper local police work.

Another problem with the law is that it would shatter trust between the police & immigrant communities. From the article:

One of the attendees was Los Angeles Police Chief Charlie Beck, who said afterward that he told Holder that "legislation like this inhibits us from doing our jobs" and would deter immigrants from reporting crimes, either as victims or witnesses. "The fear of the police already inhibits immigrants from coming forward to a certain extent," Beck said. "But if you add this, you increase the reluctance tenfold. "People should remember that undocumented immigrants are witnesses in all kinds of crime, and this does not just affect them. If people don't come forward to help the police solve and protect against crime, no matter what their status, then we are doomed to failure. It threatens to destroy a lot of the work that has been done."

While no final decisions have been made, DOJ's chief spokesman Matthew Miller confirmed that Holder told the police chiefs that a decision on federal action would come quickly. We shall see.