The dollar strengthened during US hours with EURUSD trading a 1.5684-1.5563 range. USDJPY continued to rally from 101.37 to 102.16. June gold futures fell $33.70 to $887.80 an ounce on the Comex division of the New York Mercantile Exchange, while stocks firmed, with the Dow up more than 380 points or 3%. In looking at daily price changes, gold and EURUSD have kept moving in tandem.

In recent comments we said that our short-term models signal that the dollar was oversold. However, we kept a bullish bias for EURUSD as the catalyst for buying the dollar seemed still missing. We change our view. Not only does the pair's upside shows signs of tiring, but we also see reasons to now go tactically short. Softness in growth/upward price pressure evident in European PMIs reported on Tuesday. They show that forward looking indicators remain weak, but input prices at their highest level since sep-2006. Contained inflation expectations (see Chart 1), this is key to the ECB cutting rates and further weakness in commodity prices would help to ease inflationary pressures. We see risks of further deleveraging in commodities, in gold and oil in particular. As those have shown a strong correlation with EURUSD this is particularly bearish for the single currency. Our proprietary FX flow and Equity Flow data also caution being long the EUR. The FX Flow monitor has registered strong repatriation trends in favour of the dollar from risk markets, and our Equity Flow Monitor also indicates decreasing selling momentum in US equities. We recommended selling EURUSD at 1.5615, with an initial target of 1.5200. Our stop is 1.5860. We also stay long CHFHUF from 163.80 with a target of 170.00. This morning we got stopped out at 1.5780 on our short EURCHF trade from 1.5640 reinstated on March 19.

Ahead on Wednesday, the ADP employment report is due, and at 9:30 pm local time, Ben Bernanke testifies before the Joint Economic Committee

At 52.0 (previous: 52.30) Eurozone PMI was released in-line with market expectations. The release showed that forward looking indicators remain weak. Our economists suggest that the latest number highlights the ECB's dilemma, as growth is on a downward trend, while inflation remains a concern. In addition, tentative evidence is emerging of manufacturing firms not being able to pass on rising input costs into final prices. This suggests that muted consumer demand could lead to a moderation in inflation pressures. Yesterday, at 3.5% y/y (vs. 3.3% in February) the Eurozone CPI estimate for March came in considerably above market expectations (3.2%), strongly driven by food and energy prices. However, both factors have lost upside momentum recently, and will unlikely contribute further to increasing inflation expectations for now. On the policy front, ECB's Noyer highlighted that a solid anchoring of inflation expectations remains a prerequisite for rate cuts in times of heightened financial uncertainty and downside risks to growth, consistent with the ECB's hawkish rhetoric. Elsewhere, negative news from the banking sector weighed heavily on the single currency, and suggests that decoupling from the US economy has become less apparent. In Switzerland, at 55.3 (cons. 60.0, previous: 60.5), the PMI disappointed strongly to the downside, with order backlog dropping to 53.3 while inventories were solidly on the rise. The latest data supports the view that concerns over growth are increasing.

Japanese business sentiment fell to a four-year low in Q1, as indicated by Bank of Japan Tankan quarterly corporate survey. Big manufacturers' sentiment was +11, compared with +19 in Q4 2007 and a market median forecast of +13, reaching the weakest level since Q4 2003. It has been down for two straight quarters. The expectations index for June is +7, suggesting firms expect conditions to worsen over in the next three months. Moreover, big firms expect their capital spending to fall 1.6% in the financial year which starts today, while market's median forecast was flat. Our reading of the numbers shows that non-manufacturing indices were slightly better than manufacturing ones, reflecting the uneven impacts of the global economic slowdown, and the high commodity prices on different sectors. In light of the survey results, Japanese government spokesman Michimura said after the release that there would be no change in assessment that Japan recovery is stalling. Although the market will price in further expectations of BoJ easing on the back for the release, we don't believe the cyclical environment is conducive for a rebound in the carry trade and investor bias in favour of low-yielders should keep the JPY well-supported. We have revised our forecasts for USDJPY and expect the pair to remain weak at 98 in 1m and 100 in 3m.

March PMI manufacturing index came in at 51.3 above market's expectations of 51 and unchanged from the month before. The output balance fell to 52.3-its lowest level since December 2006-and new orders were down as well. However, output and input prices continued to rise in February. In light of ongoing BoE concerns that risks to higher inflation and inflation expectations are to the upside, today's outcome presents significant difficulties in monetary policy for the BoE. Despite the steady outcome of the headline number, there is compelling evidence to support the belief that that manufacturing sector has been slowing. Our economists expect this trend to intensify as a response to past rate hikes, the slowdown in global growth and uncertainty related to the banking crisis. The GBP strengthened against the major currencies bar the USD and CAD this morning, as the better than expected data release cast some doubt on the possibility of a rate cut as early as next week. Our economists, however, maintain their view the BoE will opt for a 25bp cut on April 10. We have reviewed our short-term GBP forecasts and are now looking for EURGBP 1-month forecast of 0.78 and 3-month forecast of 0.76, while GBPUSD targets are now 1.99 and 1.96, respectively.

The RBA left its benchmark cash rate at 7.25% as expected, after hiking rates in both March and February. The statement said the 'tightening in financial conditions has been substantial' and 'inflation will remain high in short term, but decline over time'. The tone of the statement was judged as neutral compared to the last two statements. Besides emphasizing the softened business and consumer sentiment, slowed credit demand, fragile sentiment in global financial markets, possible below-trend global growth in 2008, increasing domestic funding costs, the statement also mentioned 'a further large rise in Australia's terms of trade is in prospect this year'. Without overemphasizing, the statement ascribed the strong growth in 2007 to rapid growth in domestic spending, and noted continuing strong employment growth. The statement evaluated the current monetary policy setting as appropriate for the time being but left the flexibility to adjust prospects for economic activity and inflation in the light of any new information. Elsewhere, as released earlier this morning, AiG performance of Mfg index for March fell a modest 0.2 points to 51.2 after bouncing 2.1 points in February, reflecting higher borrowing costs and uncertainty around the global economic outlook. Ahead this week, RBA governor testimony and retail sales will be released on Friday. In light of recent deterioration amongst high-yielders due to de-leveraging flows, we now target AUDUSD and NZDUSD forecasts at 0.91 and 0.79 for 1m, in line with our 3 months forecasts.