Risk aversion remains the main theme across the money markets this week with equity market continuing to slide and the safe havens of the US Dollar and Japanese Yen performing strongly. Very positive German GDP yesterday gave the euro a boost in early trading but again developments in Greece have swamped any positive euro related news and driven the euro lower against the Dollar and Sterling.

News of large euro outflows out of Greece by citizens is not helping the nagging feeling that a Greek exit from the eurozone is approaching faster than European politicians would like.

They have desperately tried to manage the situation to ensure that if the worst did happen, Greece leaving could be orderly.

The fear is now that politicians no longer have the ability to manage the situation and a disorderly exit may now be on the cards.

The Bank of England inflation report is due today at 10.30.

We have covered what the Governor is likely to outline, namely lower that expected growth and higher than expected inflation.

The market has already built that into Sterling and the news will probably play second fiddle to news coming from the eurozone for the rest of the week.

A study completed by the National Institute of Economic and Social Research (NIESR) is predicting the UK unemployment rate will rise from the current 8.3% to nearly 9% by the end of 2012. The study blames low growth in the coming two years as the UK steers itself out of this technical recession.

NIESR recognized that later revisions may alter this, but said “small quarter-to-quarter movements of this sort are largely irrelevant to the broader picture of an economy that remains very weak”.

The big ticket data release this afternoon is the US non-farm payrolls.

It’s been a mixed bag data wise leading up to today’s announcement so there is a large degree of uncertainty over the actual number.

Consensus estimates are for 175K jobs created in April, initial jobless claims yesterday came in better than expected which point towards a positive number but at this stage it is difficult to call.

The Dollar has regained significant ground against Sterling in the last week and the risks remain to the downside, however if the number disappoints and we could be trading above 1.62 quite quickly.

The sterling/euro exchange rate has broken its correlation with movements in EUR/USD for the time being, with self-governing Sterling strength evident.

This is been confirmed by the shift in interest rate differentials between the UK and eurozone, a move which has gone in favour of GB Pound strength.

The view now points to some further downside potential in this currency pair, with a test of technical support around 0.8067 on the cards.

A surprise increase in the US ISM manufacturing survey yesterday evening was enough to push the Dow Jones industrial average to its highest level in four years, dragging European bourses higher this morning along with the high risk currencies. Due to the May Day bank holiday in Europe, markets on the continent are playing catch up with the US and UK and are performing very strongly in early trading.

Chinese manufacturing PMI also showed a slight improvement overnight, but is still below the 50.0 level, signifying a contraction in manufacturing output.

This afternoon the ADP employment report is released in anticipation of the non-farm payrolls on Friday with expectations of 175K jobs created in April, not quite the numbers we saw in the first three months on the year but positive non-the-less.

Portugal goes to the market today, issuing six and twelve month treasury bills.

The target amount is only €1.25-1.5 billion, but the auctions will be closely watched as ever and expect overblown hysteria if we any signs of weakness.

Ahead of the auction the spread between the benchmark ten-year bonds is slightly higher, sitting at 902 bps in current trading.

The euro is marginally weaker this morning against the US Dollar and Sterling.

From the data just out, French and German PMI were broadly in line with the flash estimates but German unemployment rose in April and it is this that is leading the Euro weakness this morning.

Fears in Europe have escalated a notch amid growing concern on both economic data and political cohesion.  This morning S&P have taken a negative rating action on 16 Spanish banks, in addition press reports out of Germany suggest that a Merkel-Hollande alliance will not be as straightforward as the Merkozy alliance.

At the moment the euro is holding up fairly well as the market has been selling the US Dollar on sentiment that the Federal Reserve will ease further, however the underlying negative tone will be a concern to the markets.

Later this week the ECB are expected to leave interest rates on hold, however Mario Draghi will face tough questions in the press conference on the strategy for Europe amid growing concerns for a growth compact.

USA jobs data will be a main data point to watch this week.

Friday’s non-farm payroll report will form important sentiment for the pace of the US recovery after last month’s disappointing number which followed a good run of jobs data.

The number is expected to be a good number and the feedback on this data will be a key factor for the Feds future strategy-a bad number and we can expect more easing.

In the UK, attention will focus on the PMI data tomorrow and Thursday which will offer a snippet of growth feedback following last week’s preliminary Q1 GDP which came in negative.

Again if data proves negative it could trip the Bank of England to pump more QE through the system- possibly at the May MPC meeting.

Ben Bernanke head of the US Federal Reserve predictably kept policy on hold whilst reducing forecasts for unemployment and raising expectations for higher near term inflation. The US economy is still expected to grow at a ‘moderate’ pace in coming quarters, with the bulk of Fed members predicting the first tightening in 2014 or beyond.

The one concession to markets was the fact that the Fed is ready to do further in terms of policy development if required.

This helped to boost risk assets overnight leaving the Greenback on the back foot.

Headline releases are thin on the ground today leaving markets to consolidate gains in a relatively ‘risk on’ environment.

Sterling came plummeting down from its summit following yesterday’s news that the UK economy entered a technical recession after GDP unexpectedly contracted by 0.2% in the first quarter of the year.

Nevertheless, the fall was short lived, with Cable improving from its losses, helped by a superb reading for UK Nationwide consumer confidence in March.

However, Nationwide cautioned that the spring in confidence may be brief and therefore cautious of reading too much into this.

Sterling gains against the euro look as though they have reached its limit.

Finally, there was no adjustment in policy from the Royal Bank of New Zealand as expected, with policy rates on hold at 2.5%.

However, governor Bollard did endeavour to talk the kiwi lower while stressing worries about the international outlook.

Concerns about kiwi strength will raise the spirit of FX interference though it may also mean a delay in rate hikes.

The announcement was fairly encouraging on the domestic outlook too.

Even though rates are ‘appropriate’ according to the RBNZ there is a good chance of a rate hike in Q3.

The NZD ignored Bollard’s comments, firming on the back of improved risk appetite.

UK Q1 GDP has come in at 0.2% which means the UK is confirmed in a technical recession (the final GDP figure is out later in the month). The news has trimmed 50 points from Cable and Sterling-Euro in quick time and will keep the Pound on the back foot for the rest of the day.

As we thought it was the construction sector that dragged the number down, showing a decrease of 3% in Q1 2012.

Eurozone data is light today so the focus will remain on the politics of austerity and how it continues to disrupt single currency governments.

With the Dutch cabinet resigning at the beginning of the week, the uncertainty over the outcome of the French election and German Chancellor Angela Merkel facing open rebellion by other European nations over her demand for further austerity, euro sentiment is taking a beating and dragging the euro lower with it.

Today marks the end of the two days FOMC interest rate meeting in the US.

It is expected that the Fed will keep rates and QE on hold, but as ever, it will be what the Fed indicates it will be doing over further easing later this year that moves the markets.

Wording will be key, but we can expect the Fed to continue to the cautious optimism tone of recent meetings.

Also later today is the US durable goods order figure, with consensus estimates showing a decline of around 1.5% in March?

The UK’s Q4 final GDP has come in at -0.3% which is lower than the expected -0.2% and is a disappointing number for the Pound which has faded lower this morning against the euro and the US Dollar.  The number is not a great surprise but more of a disappointment and will heap pressure on the Q1 2012 GDP to come.

The US Dollar remains somewhat on the back foot following Fed chairman Ben Bernanke’s dovish tone earlier in the week with rhetoric suggesting more QE could be required and the loose monetary policy stance is here to stay despite a sustained run of positive economic data.

The USD has managed to claw back a little overnight against the EUR and the GBP- this corresponds to a move out of risk on weaker Chinese data.

Elsewhere risk currencies such as the Australian Dollar have come under pressure overnight as further concerns of a slowdown in China have dampened demand for risk currencies.

February’s industrial sector profit fell 5.2% year to date, the markets will be closely watching the situation in China.

Essentially China and the US are the key drivers behind global growth and any signs of slowing growth will turn the markets into risk off mode benefitting the safe haven shores of the USD, JPY and CHF and weakening risk on commodity based currencies such as the AUD & South African Rand.

Yesterdays appealing comments by Fed Chairman Bernanke, in addition to better than expected results for German IFO business confidence last month, have boosted risk assets whilst weakening the Greenback against Sterling and the euro. Markets appear to have shaken off, at least for now, growth worries stemming from weaker manufacturing confidence surveys in China and Europe last week.

The S&P 500 climbed 1.4% to 1,416.51, its highest close since May 2008.

The Dow Jones rose 1.2%, while the Nasdaq gained 1.8% to close at 3,122.57, its best finish since November 2000.

Ben Bernanke continued his stance that supportive monetary policy is still necessary particularly given worries about the jobs market and additional QE may still be needed.

Today markets will focus on US and French consumer confidence coupled with bill auctions in Spain and Italy. US consumer confidence is likely to slip slightly while the bill auctions are likely to be well received.

Sterling has failed to maintain gains above 1.59 against the Greenback over recent weeks let alone manage to test the key psychologically level of 1.60.

Therefore the current move above 1.59 could be a short one.

For the break above it will require an improved downtrend in the Greenback motivated by a sharp enhancement in risk appetite and/or a drop in US bond yields for Sterling to move much higher.

Both are unlikely.

Sterling will be susceptible to a general stronger Dollar for the rest of this year but could outperform against the euro.

Another expectation beating employment report from the US on Friday has the markets in buoyant mood this morning. The headline number was 227K jobs created in February against a forecast of 210K, with strong upward revisions to both December and January numbers.

This marks the third straight month of strong jobs growth with gains spread across different sectors of the economy.

One negative was that construction jobs showed flat growth for the first time in a couple of months.

Interestingly we have again seen the Dollar strengthen on the back of positive US developments, which flies in the face of the risk-on, risk-off paradigm that has dominated FX trading in the US Dollar over the last few years.

Commodity currencies initially surged on the news but have cooled off as we start the week.

Looking ahead this week we have several big ticket releases to look forward to.

Tomorrow German economic sentiment is followed by US advanced retail sales and the Fed interest rate decision.

The market expects a strong increase in retail sales from last month and Friday’s employment report is fuelling further optimism of a stellar number.

The risk therefore is to the downside in terms of the Dollar if we get a disappointing figure.

The FED meeting should be a non-event, but talk about sterilized QE over recent days by the Fed Chairman will keep market interest high.

Also worth watching is the Swiss Interest rate decision, not for interest rates directly but for chatter over an increase in the Swiss Franc peg which, if undertaken, would cause significant movements across the FX markets.

Encouraging economic developments provided wise money markets with an appetite for risk again. Despite weaker than expected US durable goods orders, a rise in US consumer confidence to its highest since February last year provided stock markets and risk assets with an overall a boost.

It was a similar story in Europe as Italy held a successful auction of 10-year debt at a lower than expected cost at the same time as Portugal approved a third review of its bailout agenda.

However, there was some negative news, with the ECB momentarily deferring the eligibility of Greek bonds as security for its backing and Eire calling a referendum on the European fiscal compact.

Nevertheless, expectations of a strong take up at today’s ECB second 3-year Long term refinancing operation (LTRO) should keep markets on the straight and narrow for the rest of this week.

As for the US Dollar and given the upbeat equity market mood overnight it is no shock that the Greenback was on the slide as the euro appears determined before today’s 3-year LTRO by the ECB.

Bernanke’s Semi-Annual Monetary Policy Report later today will provide the Dollar some bearing but no major surprises are expected.

The euro will continue to rally against the US Dollar if we are correct about a strong euro 600-700 billion take up at the LTRO but it will interesting to see if the 1.35 level can be breached.