The US dollar was mixed in New York trading Monday, strengthening slightly versus the GBP and CHF but weakening versus the high-yielding AUD and NZD as confidence in carry came back. The euro traded in a wide 1.5158-1.5274 range against the dollar, with a notable downward move following comments from Eurozone policymakers making it clear that the strengthening euro has not escaped their attention. Meanwhile, USDJPY traded in a 102.80-103.71 range. Commodity prices rallied again, boosting mining and energy company shares. After being down for much of the session, US equity markets managed to close essentially flat. On the data front, the manufacturing ISM index fell from 50.7 in January to 48.3 in February, slightly better than expected. The index level in February implies weakening for manufacturing, albeit not necessarily to the degree that is normally associated with economy-wide recessions. The survey included sharp declines in the production indices and smaller declines in new orders. The prices index stayed fairly high, falling from 76.0 to just 75.5, reflecting firm commodity prices. Construction spending fell 1.7% m/m in January, after declining 1.3% in December. Diminished residential investment continued to drive down overall construction spending in January.

Declining home construction is sure to be a drag on growth in 2008. Our economists look for more recession-like data, including a 50k decline in payrolls and an uptick in the unemployment rate to 5.1% in Friday's employment report. The OIS market is currently pricing in 70bp of easing at the March 18 FOMC meeting, while our economists forecast a 50bp cut to 2.50%. We believe it is unlikely that the ECB will follow the Fed's easing suit with Eurozone inflation still elevated. In addition, contrary to Eurozone officials now signaling displeasure with the strong euro, US officials have thus far welcomed a weaker dollar in the current environment. We are long EURUSD as a trade recommendation with a target of 1.56 and a stop loss at 1.5020.

Ahead Tuesday, there are no tier one data releases. Fed Chairman Bernanke will speak on mortgage foreclosures at 1400 GMT. Fed Governor Kohn will testify before the Senate on banking conditions at 1500 GMT. Dallas Fed President Fisher will speak on inflation and growth and Fed Governor Mishkin on the economy at 1800 GMT.

The Nikkei plunged by 4.5% in Asia trading Monday on the back of the twin combination of higher risk aversion, coupled with the impact of a sharply stronger yen, which is rising on higher risk aversion. The markets will be fretting about the prospects for intervention, and indeed Cabinet Office Councilor Hamano said Monday that sharp moves in currencies are undesirable. He also said that the government will watch for any deflationary impact stemming from the rise in the yen. It should be noted with the general deterioration in data in Japan, the market has become more confident that the Bank of Japan will adopt an easing bias this year, and the OIS markets pricing in 14.5bp of rate cuts over the next twelve months. This in turn means that intervention to cap yen strength could become consistent with monetary policy. As such, investors wishing to trade the risk aversion trade may be better off considering short EURCHF positions. Ahead Tuesday, Japan's monetary base, due at 2350 Monday, likely expanded in February (UBSe 0.5%, consensus 0.1%, previous -0.1%) after contracting slightly in January.

The flash estimate for Eurozone HICP came in flat on Monday at 3.2%, in line with consensus expectations. The number confirms short-term inflationary pressures - still 1+% above target - will remain the ECB's key focus in the short term. Our economists believe that inflation could still edge higher in the coming months to 3.3%, but will not likely spur the ECB into hiking. Governing Council member Liebscher warned Monday that the impact of high commodity prices, particularly oil, on Eurozone inflation is crucial for policymakers. However, the strength of the euro has dampened the impact of soaring commodities costs. EURUSD traded sharply lower after Luxembourg Prime Minister Juncker said he was becoming "increasingly concerned" about the euro's rally and ECB President Trichet said the US government's strong dollar policy is "very important." The comments suggest that the strengthening euro has not escaped the attention of ECB officials, and place more focus on Thursday's ECB meeting. While we expect no change to rates on Thursday, the rhetoric at the subsequent press conference will be key.

Ahead Tuesday, Eurozone PPI for January (UBSe 4.6%, consensus 4.9%, previous 4.3%) and Q4 GDP (UBSe 0.4%, consensus 0.4%, previous 0.4%) are due at 1000 GMT.

Swiss PMI fell from 61.6 in January to 60.5 in February, essentially in line with expectations. Our economists note that the employment sub-index provided some support. However, from a forward-looking perspective, the order backlog sub-component fell further behind the production sub-component, pointing to weakening demand. We expect the SNB to cut rates by 25bp at its March 13 monetary policy meeting but inflationary pressures may yet complicate the decision. Inflation for February, due Tuesday, is expected to remain flat at 2.4% y/y, but remains well above recent SNB projections and the 2.0% price-stability target. Renewed strength in the CHF should help contain inflation in the medium term but this will be dependent on safe-haven demand. Carry unwinding pushed USDCHF to a record low of 1.0308 on Monday, before profit taking on short-dollar positions erased the franc's gains for the day. EURCHF performance points to ongoing risk liquidation and we expect the cross to remain steady at 1.58 over the medium term. Ahead Tuesday, the February inflation report (UBSe 2.4%, consensus 2.4%, previous 2.4%) will be released at 645 GMT.

The data week in the UK began with a positive February manufacturing PMI survey coming in at 51.3, slightly above expectations and up from an upwardly revised 50.7 in January. The prices balance jumped higher with input prices at 72.2, the highest level since November 2004, while output prices at 59.9 were at the highest level since records started in 1999. The price components will certainly add to the inflation concerns of the Bank of England, widely expected to leave rates on hold at 5.25% on Thursday. While the strength in the manufacturing PMI points to some resilience in manufacturing sector growth, the services PMI, due Wednesday, will be more important to the MPC. We expect a small deterioration. We continue to target EURGBP at 0.75 over 1 month and 0.74 over three months. Ahead Tuesday, the construction PMI survey for February (consensus 53.0, previous 53.9) is due at 930 GMT.

Swedish manufacturing PMI, released Monday, was stronger than expected today, rising from 54.6 in January to 55.7 in February, above the expected 54.0. While the increases in the majority of components suggest that strong domestic and export demand persists, the employment component fell to the lowest level since January 2006. This is in line with recent unemployment statistics releases indicating some easing in the Swedish labor market. The planned production component also declined further, reflecting a downward trend in growth. Recent updates on the economic front suggest that the impact of global financial turmoil on Sweden has so far been only marginal. However, as the economic slowdown in the Eurozone and the UK unfolds, risks to growth in Sweden are clearly to the downside. In the absence of major data releases in Sweden this week, EURSEK will likely to stay elevated. Our short-term EURSEK and EURNOK targets remain unchanged at 9.35 and 7.95 over 1 month. Ahead Tuesday, Norway's PMI survey will be released at 800 GMT, and is expected to be slightly weaker.

We and the consensus expect the RBA to hike rates by 25bp to 7.25% on Tuesday. The market is pricing in an 88% chance of such a move. Asian data releases on Monday pointed toward a solid Q4 GDP reading for Australia, due Wednesday. In addition, Australian company profits for Q4 rose by 3.9% q/q, after contracting by 1.4% in Q3 and are up 11.7% y/y. Inventories for Q4 were also released and rose by 0.7% q/q, slightly better than market expectations. The data are consistent with the Australian economy finishing 2007 strongly, although our economists note that wages growth actually slowed. On the whole, the data are consistent with Q4 GDP rising by 0.8% q/q, down slightly from 1% q/q in Q3. Australian 2-year yields are actually down since Thursday, outpacing the US decline, possibly pointing to a crack in growth expectations. Ahead Tuesday, January retail sales (UBSe 0.5%, consensus 0.5%, previous 0.5%) and the Q4 current account (UBSe -A$17.8bn, consensus -A$18.0bn, previous -A$15.6bn) will be released at 030 GMT. The RBA rate announcement (UBSe 7.25%, consensus 7.25%, previous 7.00%) is expected at 330 GMT.

Canadian GDP, released Monday, contracted 0.7% m/m in December, well below the expected 0.2% decline. Q4 GDP grew at an annualized rate of 0.8%, also below expectations and down from the 3.0% y/y rate reported in Q3. With GDP growth trending downward and a softening in the labour market expected to be indicated in Friday's employment report, the Bank of Canada is widely expected to cut rates on Tuesday. Our economists forecast a 25bp rate cut to 3.75% while thirteen of the 26 surveyed economists on Bloomberg are looking for a 50bp cut. The OIS market is currently pricing in 48bp of easing this week and 121bp of easing over the next twelve months. Our economists forecasts rates reaching 3.00% by year end. We forecast USDCAD at 0.97 in one month and 1.02 in three months. Ahead Tuesday, the BoC rate announcement (UBSe 3.75%, consensus 3.50%, previous 4.00%) is due at 1400 GMT.