The US dollar traded higher against the euro overnight but was stable against the yen, with EURUSD trading down to a low of 1.5419 from a high of 1.5518, while USDJPY traded between 104.43 and 105.19. The S&P500 rose by 0.6%, while Treasury yields fell, with the 10-years down by 7bp. Oil dipped briefly, but is back up again and is currently trading around US$124.46/bbl. Data was generally disappointing - jobless claims rose slightly, the Empire State manufacturing survey deteriorated, while the NAHB housing market index dipped and was below expectations. Fed Chairman Bernanke stuck to his topic of liquidity and did not provide any near-term insights for monetary policy or provide any insights into his latest thinking on the dollar. Of greater interest was the TIC portfolio report, which may provide some clues as to the disintegrating relationship between oil and EURUSD. It showed net inflows to the US of US$60.3bln, up from US$47.3bn in February (our numbers differ from the raw data as we strip out pre-payments on asset-backed securities). The improvement was driven primarily by increased foreign purchases of US Treasuries, which rose to US$55bln up from US$20.6bln the month prior. These in turn were driven by increased outflows from the oil-producing countries, which nearly trebled their US Treasury purchases in the latest month. The increased Treasury purchases by the oil-producing countries follow a particularly sharp run-up in oil prices between February and March. As such it provides some evidence that oil reserve managers were more comfortable holding dollars. The current environment is characterised by an unsettling trend higher in oil prices juxtaposed against trend improvement in risk appetite. The high oil prices prevents policymakers in Europe from cutting rates and raises the possibility of central bank 'policy error', while in the US Fed officials are clearly more concerned on the potential for entrenched inflation. Near-term currency views should be formulated on the basis of a stronger dollar, trend improvement in risk appetite on a multi-week scenario but against a backdrop of slowing global growth. Over a longer time period, risk aversion should return again given the potential for policy error by central banks. We like downside in EURUSD but see increased risks that USDJPY could remain elevated despite this morning's better than expected GDP.

GDP for Q1 was released this morning and rose by 0.8% q/q, higher than market expectations of 0.6% q/q, and largely driven by net export contributions. While this morning's data was stronger than expected, we think the yen could become a bit more vulnerable to data disappointments as higher oil prices make other central banks less willing to cut rates, thereby re-emphasising Japan's negative yields differentials. Also, while we have been expecting risk aversion to rebound, it has actually been declining in trend terms. If sustained, USDJPY is likely to trade higher.

Following yesterday's soft retail sales our NZ economist notes that the odds of a start to the easing cycle occurring sooner rather than later have increased. A September start is the most likely outcome and it is possible that the RBNZ begins easing aggressively with a possible 50bp cut to the OCR. However, our base case is that the RBNZ will cut the OCR by 25bp at each opportunity from September through April next year, pausing when the OCR is at 6.75%. We remain short NZDCAD from 0.7822, targeting 0.7400.

In light of the recent events in the UK, our economics team have revisited their BoE rate call. They have delayed the next rate cut from June to November, and instead of looking for a total of 100bp of rate cuts, they now expect 75bp. The deterioration in the inflation outlook - the inflation rate accelerated by 3% y/y in April (vs expectations of 2.6%) - suggests rate cuts will be more gradual, i.e. one each quarter corresponding to publication of the Inflation Report in November, February and May. Our economists note that the outlook for overall activity is more pessimistic compared with the latest BoE forecast particularly for next year, which should allow the BoE to continue cutting rates. We believe an upcoming string of negative news justifying a growing slowdown in the UK economy will continue to weigh heavy on the pound. Recent BoE commentary also suggests that a weak pound will help to rebalance the economy, and as such is now viewed as a having a favourable effect. Our GBPUSD forecasts remain unchanged at 1.92 and 1.93 over one and three months respectively.

Generally bullish data from Eurozone surprises the market with stronger than expected Q1 GDP at 0.7% (cons. 0.5%) up from 0.4% in Q4 '07. Adding more to the positive note, CPI turned out to be a big downside surprise recording at 1.6% (cons. 2%) and core-CPI at 1.6% due to one off factors, according to our economists. Despite weakening consumer confidence in Swiss for Q2 '08 at +2.0% down from previous +14%, data from Germany and France seem surprisingly stronger than expected. Converging growth and interest rates in G3 countries will keep EURUSD under pressure and as such we remain short EURUSD from 1.5455, targeting 1.5010.