USD

The US dollar gained ground against both the euro and yen overnight; trading as strong as EURUSD 1.5655 and USDJPY 107.42. WTI dropped 4% during NY trading hours - our commodity strategists think commodity prices are vulnerable to snap backs, given thin summer liquidity. The Dow advanced by 1.34%, and the S&P500 is up by 1.64% at the time of writing. The NOK and CHF lost 1.22% and 0.83% respectively, amid falling oil prices and rising risk sentiment.

In economic news, the pending home sales index (PHSI) fell more than expected in May: -4.7%m/m (cons and UBSe: -3.0%). April was revised up to 7.1%m/m from 6.3%. Our economists say data leave unclear whether the downtrend continues. Fed Pres Lacker said that downside growth risks have "diminished significantly" and "the inflation outlook has deteriorated". The hawkish comments have not been surprising, given his recent comments and focus on inflation fears. Mr. Bernanke avoided addressing the near-term economy and policy in his prepared remarks to a Federal Deposit Insurance Corporation forum on mortgage lending. Ministers at the G8 meeting expressed "strong concerns about the sharp rise in oil prices" and high commodity prices, but "remain positive about the long-term resilience" of the G8 economies. However, the summit also noted downside risks to the world economy, especially serious financial market strains. There was also a call for emerging economies to shift effective exchange rates-a key demand of central bankers within the G8 bloc, who viewed inflexible exchange rate regimes as a major source for global inflationary pressures.

We are looking for EURUSD to trade towards 1.60, which is also our 1-month forecast. Weak US data, rising European rates, sticky oil prices and risks of continued risk aversion are not good news for the dollar. We also advise to sell into USDCHF and USDJPY rallies. Ahead today, MBA Mortgage Applications from July 4 are due.

JPY

The JPY should strengthen amid low risk appetite in financial markets. However, JPY crosses have managed to gain further ground despite waning sentiment elsewhere. Note, this seems to hold true for carry trades in general. Currency markets seem to benefit from a positive liquidity premium. We don't think this will last, should financial indicators continue to weaken and hence we caution being long carry. In data released on July 7, a survey of Japanese service sector works for June pointed to a slowdown in consumer spending and retail trends. The "economy watchers" index fell to 29.5 in June, down from 32.1 in May. The release was the third consecutive monthly decline, and the outlook index pointed to worsening future conditions, coming in at 32.1 in June compared with 35.1 in May. In other news, the number of corporate bankruptcies in H1 2008 showed a 6.91% increase. The numbers point to ongoing weakness in the Japanese economy, and weaker real demand may offset any inflationary pressures from elevated commodity prices. Activity numbers remain the focus for the week, with core machinery orders (UBSe: -2.5%, cons. -3.7%, prior 0.5%) due later today and industrial production numbers out on Friday.

EUR

Recent German data suggests a deteriorating outlook on the German economy-such as yesterday's weak industrial output release-and our economists note that that Q2 GDP will likely be very weak, probably in negative territory. The German Chamber of Industry and Commerce said on Monday that on the back of higher energy prices and a strong euro, growth of around 1% in 2009 would be an optimistic outlook. In the last few months a firm German economy acted as a counterweight to weakening growth in the Eurozone, and while the outlook is increasingly deteriorating this will complicate further tightening in rates, even if inflation expectations keep on rising. However, we also do not expect the ECB to apply a more dovish stance on monetary policy before commodity prices start to lose upside momentum, which remains critical for inflation expectations to moderate. Elsewhere, ECB?s Tumpel-Gugerell said on Tuesday that the Governing Council shares Trichet's stance of not leaning to a rate hike or not, and that the latest rates hike is intended to prevent second round effects. At 7 am, GMT ECB President Trichet will present the banks annual report to the European Parliament.

GBP

The DCLG House Price Index registered a 3.7%y/y gain in May, higher than market expectations of 3.5% but down from last month's figure of 4.9%. Nevertheless we note that this number lags significantly behind earlier releases and the pattern is consistent deterioration in the UK's housing markets. In other news, a European Commission diplomat announced that European Union finance ministers have started disciplinary budget steps against the UK, warning that the deficit was set to exceed the country's fiscal commitment of keeping the deficit below 3% of GDP. The news comes on the back of a UK news paper report which points to a NIESR study warning of a GBP 7.5bn budget deficit for the government next year, as a result of lower receipts attributable to the global downturn. The UK's fiscal position will remain in a precarious position as the economy continues to slow, and a US-style fiscal stimulus may also be unfeasible it the UK is bound by EU regulations from further spending. We remain wary of sterling and target EURGBP at 0.80 in 1m.

AUD, NZD

Westpac Consumer Confidence is due today (prior -5.6%). Business surveys released on July 7 in both Australia and New Zealand were disappointing. The RBNZ QBSO showed a net balance of 18.3% of firms recorded that they expect trading activity to decrease in the next three months, vs. a net balance of 7.9% looking for a decline previously. This is the highest since 1991, and our economists note that the domestic trading activity outlook is consistent with real GDP falling by around 2%y/y by the end of the year, much worse than previous expectations. On the policy front, we note that the QSBO increases the risk of a July 24th start to the RBNZ's easing cycle, or even a more aggressive start (50bp vs. 25bp) in September. In Australia, the NAB confidence dropped to its lowest level in 7 years to -9. The business conditions index fell to 0 from +7 previously. The NAB survey pointed to clear signs of weakening domestic demand, as the measure of sales of profits fell sharply, in addition to a drop in consumer confidence. The RBA remains concerned about terms-of-trade effects offsetting declines in demand but today's survey makes a near-term hike very unlikely. However, the survey also pointed to remaining wage pressures, and the A$21.66/w pay rise for more than a million of Australia's lowest paid workers awarded by the Australian Fair Pay Commission will do little to alleviate these concerns.