USDJPY broke below 104 in US trading on another bout of risk aversion, this time triggered by talk that London-based hedge funds were forced into liquidating positions, but helped along by disappointing earnings reports from a major US insurer. Economic data on Friday also kindled concerns that the US is either on the brink of a recession or already in recession, adding to downward pressure on the S&P500, which declined by a hefty 2.7%. In the Treasury market, 2-year yields fell by 20bp, outpacing the fall in yields in most other markets, with 2-year Eurozone yields down by 11bp. Chicago PMI for February was 44.5, well below market expectations of 49.5 and down from 51.5 in January. It echoed the weakness in the earlier NY and Philadelphia Fed manufacturing surveys. Meanwhile, the Uni of Michigan consumer sentiment index for February (final reading) came in at 70.8, down from 78.4 in January but in line with expectations. The long-term inflation expectations components pushed higher, with the one year ahead and five year coming in at 3.6% and 3.0% respectively. Finally, the core PCE for January rose by 0.3% m/m as expected, but higher than the December reading of +0.2%, leaving y/y growth at 2.2%. Non-farm payrolls for January are due on Friday and the market expects a shallow rise of +25k, while out economists expect a more bearish -50k decline in employment. Other data due this week includes the manufacturing ISM index, due later today, and non-manufacturing ISM due on Wednesday. With last week's break out in the US dollar, we shifted our forecasts last week from 1.47 and 1.43 for EURUSD to 1.55 and 1.47 over one and three months, respectively. Ahead today, and in addition to the manufacturing ISM data at 1500 GMT, Fed's Kroszner speaks at 1900 GMT.

RBA is meeting this week on Tuesday and the market is pricing in a 84% chance that the central bank will lift rates by 25bp to 7.25%. Meanwhile, Prime Minister Kevin Rudd is warning that the inflation fight will hurt families, while Treasurer Swan has acknowledged that growth could slow "a lot". Australian 2-year yields are actually down by 27bp since Thursday, outpacing the 20bp decline in the US and may point finally to a cracking in growth expectations. Given the tone of the yen at the moment, investors may want to consider short AUDJPY positions, as a play on both risk aversion and downside risks to Australian economic growth. Elsewhere in the commodity bloc the Bank of Canada meet this week and our economists forecast a below consensus 25bp cut to 3.75%. We expect the RBNZ to keep rates on hold on Thursday and the tone of the accompanying commentary should be less hawkish given the recent sharp decline business confidence. We are long AUDNZD from 1.15 although the trade is looking mature now on the eve of the RBA meeting.

USDJPY fell sharply on Friday in the aftermath of in line to slightly positive economic data, but the yen buying owed more to positioning and risk sentiment than economic developments. Nationwide core CPI for January rose by 0.8% y/y, slightly less than market expectations of 0.9% y/y. The jobless rate for January held steady at 3.8% y/y, slightly better than consensus for 3.9%. Of greater interest was the surprise surge in all-household spending for January, which rose by 3.6% y/y versus consensus of 0.3% y/y. The strong household spending data follows on from similarly strong retail sales data for the same month released earlier in the week. Together the data suggests that consumers are proving somewhat resilient despite disappointing household income conditions. Last week the focus had been on around Y600 bn in investment trust launches, which reportedly have been undersubscribed. This development may be adding to positive yen sentiment on the understanding that retail outflows will not undermine the yen. However, positioning data from the TFX capturing margin trading activity has been volatile of late. We estimate that as of Thursday, aggregate short yen positions at the TFX were Y273 bn up from Y190 bn as of Monday. The run up in short yen positions seems to be primarily against the US dollar. Those traders would have been burnt by this week's developments, and their subsequent unwinding is at the margin contributing to downside in USDJPY.

European HICP inflation for January was confirmed at 3.2% y/y, but core inflation fell to 1.7%y/y from 1.9%y/y, well below expectations of a 2.0% gain. The numbers should finally provide some relief to the ECB but an elevated headline number will keep the ECB on its current hawkish track. As such, our economists have revised their ECB rate call. We still look for 100bp in easing this year but expect the first move to come in Q2, at the June ECB meeting. The 100bp in expected easing is consistent with our view that Eurozone growth will fall sharply this year, but the central bank, unlike the Fed, will cut every two or three months, in increments of 25bp. In other data released overnight, services and industrial confidence indices tell to 10 and 0 from 13 and 1 respectively, both disappointing market expectations. Consumer confidence was steady at -12. Our economists note that the although the declines were greater than expected, the data is not a surprise as all of the national indices bar the Ifo were down on average on the month. Meanwhile, the unemployment rate registered a decline to 7.1%, confirming a resilient labour market. Second-round inflationary effects, especially from wages, is another factor behind the ECB's temporary hawkish stance, but we don't expect any further downside in unemployment, which should help contain demand-side price pressures. We expect EUR strength to top out once the ECB signals a willingness to ease in the coming months.

UK mortgage approvals beat market consensus earlier this morning, coming in at 74k in January versus the expected 70k and up from the December number. The previous month was marginally revised down to 72k from 73k. Secured lending dropped to ?7.4 bn in January, below consensus expectations of ?8.2 bn, while consumer credit rose to ?0.9 bn after ?0.6 bn in December. Our economists note that despite the comforting recovery in approvals from 72k to 74k, it is too early to suggest that the market has bottomed out. A number of lenders remain stretched for resources and unless these funding constraints are lifted over time, credit conditions are likely to continue to tighten. In other news, Nationwide house prices extended its fall, dropping by 0.5% m/m in February after a revised down -0.3% m/m from -0.1% m/m in January. We continue to see sterling weak in the near term. However, we believe that the overshot in the euro, combined with excessive negative news already priced into the pound will eventually result in a downside move in EURGBP. We continue to target the pair at 0.75 over one month.

Sweden's Q4 GDP released earlier this morning showed growth expanded by 0.8% q/q and 2.8% y/y against the consensus of stable 0.6% q/q and 2.5% y/y growth, unchanged from Q3. Sweden's labour market-one of the tightest in Europe-helped consumer spending increase. In addition, the boost to growth came from higher investment suggesting the growth momentum in 1H 2008 continued despite the global financial crisis. However, export growth slowed as global slowdown hurt demand for exports. The outcome surprised markets to the upside, given most indicators were pointing to weaker growth in Q4 compared to Q3. Nevertheless this is backward looking data and most Q1 indicators like industrial production, consumer confidence and retail sales have all been down. In other news, Sweden's Finance Ministry cut its forecast for economic growth in 2008 to 2.3% down from previously expected 3.2%. We continue to see the Riksbank embarking on an easing path in the second half of the year and deliver cumulative 50bp in easing by the end of the year. We maintain our view the euro shine will have to fade as the Eurozone growth starts to disappoint and the ECB endorses a more dovish stance. However, in the near term we believe EURSEK will stay elevated. Our 1 and 3 month EURSEK forecasts are 9.35 and 9.25, respectively.