The US dollar extended its broad gains Thursday in New York. The 24-hour loss in EURUSD summed to 1.2% at the 1.5437 low; the range high was 1.5666. USDJPY moved from 103.50 to 104.59. With US equities poised to trade higher, we see the dollar gaining more strength, also against the safe-haven CHF and JPY. The S&P 500 overcame 1400, a key resistance level. Rising stocks and, hence, waning downside risk to global growth bode well for risk-sensitive currencies such as the dollar. Commodity prices continued to correct lower. The selloff in gold reached $849 and oil $110. Our commodity strategists believe that these selloffs could continue amid positioning risks; there's also possible weakness in demand for heating oil during May.

US data brought the April manufacturing ISM index at 48.6 (cons: 48.0, UBSe 47.5). The level, our economists argue, continues to signal contraction in manufacturing, but at a modest pace compared with typical economy-wide recession periods. Weekly jobless claims rose more than expected, to 380k (cons and UBSe: 365k). Ahead today, non-farm payrolls take centre stage. We expect the employment report to add to the evidence that a consumer-led recession is underway. In the current stage of the cycle, payroll gains risk being overstated initially. Hence we are not only forecasting -100k (market -75k, prev -80k) but we also forecast a 0.2% rise in the unemployment rate to 5.3% (from 5.1%, market 5.2%).

Despite US data risk, we still think the dollar should do well as long as a shallow recession remains the core scenario. With markets losing confidence in economic resilience in Europe and the rest of the G10, policy-rate expectations will likely move in favour of the dollar. Improved risk sentiment should also benefit the dollar, and weaker commodity prices should also help to alleviate pressure on the greenback. We remain short EURUSD from 1.5660, targeting 1.5200.

The Eurozone's CPI estimate for April came in at 3.3% on Wednesday, below market expectations of 3.4% and was the first decline since August last year. A weaker print was expected after the sharp drop in German and Spanish inflation, though our economists note that the firm number points to CPI holding up in other European countries. The ECB will need to see inflation actually trending lower before signalling an ease and markets remain doubtful that any cuts are feasible this year, but falling sentiment may prompt the central bank to follow the Fed and BoE to cut to contain economic deterioration. Sentiment indicators across the Eurozone came in weak overnight. The business climate index dropped to 0.44 from 0.80 in March (cons. 0.70), economic sentiment fell to 97 from 99.6 (cons. 99). Industrial and services sentiment fell, while only consumer sentiment was flat. Weaker national sentiment readings over the past month had already pointed to such an outcome and calls for monetary accommodation from the ECB will only grow up ahead. ECB rhetoric will likely remain biased to the hawkish side in the short term, as inflation expectations have failed to come down and input costs remain high. The European Commission stated overnight that inflation data should be treated with caution, subscribing to the ECB's current stance. However, more disappointments in zone-wide and national PMI readings due next week may cause the ECB to further shift its language at its policy meeting, and stress downside growth risks, rather than price stability, will be the key focus for the central bank up ahead. Europe was closed on May 1.

The Bank of England published its semi-annual Financial Stability Report overnight. Its assessment of the financial situation cast an upbeat tone stating that the costs of the crisis will likely overstate ultimate losses. John Gieve, BoE Deputy Governor of Financial Stability noted that "while downside risks remain, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months". Over the past week the spread between sterling 3m Libor and OIS rates has narrowed to slightly above 91bp from 96bp in mid-April, and the market still remains very sensitive to negative news from the financial sector. Overall deterioration in confidence as well as the fallout in asset prices suggest downside risks to already weakening economy. But higher inflation and rising inflation concerns prevent the BoE to cut rates at a faster pace. On Thursday, April manufacturing PMI survey showed a marginal decrease in the index coming in at 51.0 down from 51.3 in March, and was above market's expectations of 50.8. The detail of the survey showed the output prices balance rose to the highest level since the survey publication started, while input prices rose to the second highest level. We are looking for the market to shift focus to a less upbeat outlook in the Eurozone, which will help EURGBP to continue to retreat. Our 1m and 3m EURGBP forecasts are 0.78 and 0.76.

At 1.20 (cons. 1.48), the KOF leading indicator for April came in considerably below market expectations on Wednesday, and last month's reading was revised down to 1.40 from 1.54 previously. Our economists note that the poor reading was mainly driven by the sub-index of the credit industry. Overall the latest reading confirms the outlook of faltering growth momentum in Switzerland, and our economists expect the SNB to start easing rates by Q3'08. Going forward, we expect inflation to ease, enabling the central bank to employ such a departure from its on-hold policy stance. We expect recent improvement in risk appetite to continue, keeping the franc under pressure. However, EURCHF gains will likely be capped as further weakening in the Eurozone will undermine the euro. Our short term EURCHF forecasts are 1.61 over 1m and 1.58 over 3m.