The US dollar strengthened against EUR and JPY on Monday but weakened against the high-yielding AUD and NZD as risk sentiment improved moderately. This morning, EURUSD is squeezing higher with no obvious catalyst. Risk sentiment may in part be improving ahead of the G7 meeting this weekend based on the view that central banks may announce a coordinated response to the credit crunch. For instance, on Friday, Japanese newswire Jiji reported that one scheme being considered would involve central banks lending local currency to the local branch offices of foreign banks, should they have difficulty procuring funds in that currency. Under such a scheme for example, the BoJ could lend yen to the branch office of a US commercial bank, and would accept US Treasuries held at the Fed as collateral. There has been no official endorsement by the BoJ on such a development, but nonetheless the talk does signal the sort of developments we could expect out of the meeting this weekend. More tangibly to risk appetite, it was reported overnight that a large struggling US mortgage lender was close to obtaining a substantial cash infusion from investors, in a signal that mortgage lenders may now be starting to see better access to funds. In addition to general risk appetite, the G7 meeting could be important for views on the potential for joint intervention to support the US dollar. In a poll on FXWeb, we asked our client about expectations on this front, and only 26% of participants expected no change in the language of the G7 statement with respect to FX markets. Rather, 61% thought there would be additional concern on recent FX volatility noted, 8% believed that the statement could signal intent to intervene, while 4% believed that the G7 would result in concerted intervention to support the US dollar. What's interesting is that no change in the statement - the status quo is always a powerful force - would likely result in broad US dollar weakness. However, there are a number of supportive factors for the US dollar at the moment, and in particular rate expectations could become supportive. Later today we have the FOMC minutes to the March 18 meeting. At that meeting the Fed signalled increased uncertainty over the inflation outlook, suggesting an unwillingness to cut rates further. EURUSD could remain high over the next 1-2 weeks, but we would recommend positioning for downside on 1-3 months.

Australia's trade deficit for February released yesterday widened sharply due to the impact of extreme weather on export volumes, but new contract prices for iron ore and coal should help to structurally lower the deficit significantly from April onwards. While, the improved trade balance may be positive for the AUD, activity data, including Friday's retail sales and yesterday's jobs ads, has started to confirm a moderating in domestic demand. Meanwhile, in NZ, data is deteriorating as well, with the NBNZ business outlook yesterday pointing to the most pessimistic business conditions since early 2006, and supporting our view that that the RBNZ will cut rates before year end. Deteriorating conditions were echoed in the March quarter NZIER business survey released this morning. We like the upside potential for GBPAUD as a low vol view that negative sentiment on the housing market is already expressed in current levels of the GBP, while for AUD there is room for additional disappointment. NZD is a more extreme example, and we in turn like upside in AUDNZD on a 1-3 month view. We forecast AUDUSD and NZDUSD at 0.91 and 0.79 in 1 and 3 months.

The government has finally proposed BoJ Deputy Governor Masaaki Shirakawa for the governor role, and will likely be endorsed by the opposition DPJ in the upper house this week. Indeed he will be addressing the Diet this morning, despite the BoJ beginning this week's two-day board meeting. However, it is still unclear who will take on the deputy governor role, as the DPJ may very well oppose the government's preferred candidate Hiroshi Watanabe, due to his MoF background. Otherwise this week it's relatively light on the data front with machinery orders for February and the current account surplus for March both due on Thursday and the corporate goods price index due on Friday. We maintain our bullish yen targets with USDJPY at 98 over 1 month and 100 over 3 months. However, with risk appetite on the ascendancy and economic weakness beginning to experience stronger fundamental headwinds, we see potential for short-term USDJPY strength, and on Friday we went long USDJPY as a trade recommendation, targeting 105.

The BoE will meet on Thursday to decide on rates and we are looking for a 25bp cut, in-line with market expectations. Inflationary pressures remain pressing but we believe that the BoE has shifted its policy focus on limiting the effects of the credit crisis and ensuring the UK does not suffer a sharp economic downturn due to a housing market slowdown and weakness in the financial sector. Although there are clear medium-term risks to the pound, we are still looking for a corrective rally in the short term and target EURGBP at 0.78.