The dollar traded with a softer tone, in a 1.5691-1.5802 range against the euro and 106.76-107.42 against the yen. WTI added 4% ($141.93), the S&P500 closed with a gain of 0.7%, following a volatile session. Fed Chairman Bernanke said Government Sponsored Entities (GSEs) Freddie Mac and Fannie Mae need to raise more capital. Bernanke and Treasury Secretary Henry Paulson added that the two firms are critical to the US mortgage market, while stopping short of saying what the government would do to help them. The press reported that the US Treasury department feels it is necessary to have some form of government-based contingency plan should their problems worsen and access to market capital diminish. We agree that the GS's are too big to fail. However, instead of looking for a government bail-out soon, our mortgage strategists actually think that current levels are very attractive to buy GSE debt. Backed by strong demand, 5-year Agency debt over US Treasurys reversed its widening trend initially, closing flat on the day with the spread staying close to 100bp.

In his testimony on "Regulatory Restructuring" before the House Committee on Financial Services, Fed Chairman Bernanke's avoided commenting on the current state of the economy. Bernanke focused on the consolidation of supervision of investment banks; noting the Fed should get authority over payments system. Later in the session, Janet Yellen expressed concerns on downside risks to growth. On inflation, she noted that the Fed will not let a wage-price spiral occur but added that there was no evidence of that now.

Ahead today, we expect the trade deficit to widen amid rising oil prices in May. In real terms, however, our economists expect the trend lower in the deficit to continue, reflecting weak growth in domestic demand and still strong foreign demand. The University of Michigan survey will be the key release for the dollar today. The Michigan index reached a 28-year low in June. Our economists expect it to remain low in early July. The backdrop has remained fairly negative during recent weeks with the stock market weakening, gasoline prices rising and house prices not yet recovering. We anticipate the dollar to stay weak and continue to target 1.60 in EURUSD over one-month. However, our technicians note that the dollar could bounce, near-term as a lot of negative news seems priced. We advice to sell into USDCHF and USDJPY rallies.

At -4.1% y/y (cons: -0.9%, previous: 2.0%), industrial production in Italy was released considerably below market expectations. The weak reading is in line with most recent releases in Germany and France, and increases the likelihood for a second quarter contraction in Eurozone GDP considerably. ECB?s Ordonez highlighted yesterday that he would not be surprised of negative growth in Q2. Our economists agree that the risk remains on the downside, but still expect Q2 GDP at a positive 0.1% q/q. Although faltering data in the Eurozone is undeniable, we don't expect the ECB to shift its policy stance in the short term. Although crude has struggled in recent days, it remains at elevated levels and our economists don't expect energy-driven inflation to peak until Q3, allowing the central bank to switch tracks. The EUR will be exposed to such a move in the medium term and we target EURUSD at 1.53 in 3m.

Swedish headline inflation was released at 4.3% (cons: 4.1%, previous: 4.0%), remaining considerably above the Riksbank?s tolerance zone. Core inflation increased to 3.2% (cons: 3.1%, previous: 2.9%). Sweden's unemployment rate rose to 2.8% vs. 2.6% in May. Amid weakening growth conditions, the latest trend in inflation will unlikely enable the Riksbank to shift its focus away from price stability, increasing the change of further tightening considerably. In Norway, core inflation increased to 2.4% (previous: 2.3%, cons: 2.4%), but failed to confirm market expectations. Headline CPI rose to 3.4% (previous: 3,1%), matching market consensus. With inflation differentials widening, the Riskbank will likley remain the more active central bank, upside in NOKSEK is likely to remain limited.

The unemployment rate is expected to stay steady at 6.1% - changes in employment are expected to come in at 8.0K (prior 8.4K). Strong employment figures would give additional support to the CAD. Earlier in the week, the Business Outlook Survey from the Bank of Canada (BoC) showed continued strength in the business sector, investment rose sharply and hiring intentions also rose. Importantly, companies become increasingly concerned on pressures on inflation, the BoC said. Inflation expectations exceeded the banks 3% range, signalling that the bank may take this as a sign that rates should not be lowered from here (3%). The outlooks' positive results offered little news to the market which expects rates to be unchanged for now. We are keeping our 1/3month outlook at 0.97 and 1.03, respectively.

Figures released on Thursday showed a 29.8k gain in jobs in Australia in June, far stronger than the expected 10k rise. However, the May number was revised even lower to a fall of 25.6k (from 19.7k), implying a much weaker net rebound. The unemployment rate fell to 4.2% from 4.3% but remains up from its trough of 3.9% earlier this year. Our economists note that the data shows a trend easing in the labour market and is consistent with our core view of a soft landing for Australia's economy. Given employment is a lagging indicator, further softening in the economy is unavoidable. Nevertheless the AUD failed to register any decline, suggesting the currency's sensitivity to downside data may be diminishing. The data will see the AUD staying neutral for now as the economy continues to adjust, but we expect the RBA to stay on hold for the rest of the year and a cut only likely in early 2009. We continue to see high yields being supportive for now and target AUDUSD at 0.97 in m and 0.95 in 3m.