Right now the markets are in flux. We have started a new month yet it is not clear if we are in a risk-on/ off environment. This has made for a very choppy couple of days. Stocks are suffering today and the pan-European Eurostoxx index is down more than 1%, reversing yesterday's gains. However he FX market isn't playing ball. The risky end of the FX spectrum is suffering and the euro and the Aussie are both lower along with the pound, however the yen and gold, the traditional safe havens, are both lower. The main winner in FX today seems to be the dollar; the dollar index is 0.5 per cent higher so far.

So what is driving these moves? It's difficult to pin-point, and that is probably why there are some confusing signals. Although there are heightened expectations of more QE from the Fed it still isn't a done deal, so investors may not be willing to jump on the back of a risk-on trend completely only to have their hopes dashed. Added to this Eurozone fears have also come back on the radar. The sell-off in EURUSD began last night when a story surfaced that claimed the Greek government had hired a US law firm to try and help it leave the Eurozone. This story was swiftly denied, however, it re-focused minds on event risks coming up later this month. Greece is scheduled to receive its next tranche of bailout funds; however the IMF has said it won't make a decision on whether to release its portion of funds until the end of September. The IMF has already delayed its report on how well Greece is progressing with its austerity programme, so it looks like the Greece issue will be pushed right to the wire again, sparking fears of a disorderly default in the currency bloc.

The Greeks aren't doing themselves any favours. A Parliamentary report released yesterday, which said that Greece's debt dynamic was out of control, was criticised by the Finance Minister today who said the report was based on inaccurate data. This seems to be a bit of a theme in the currency bloc right now - EU officials are also claiming that an IMF report that says that European banks need to be urgently re-capitalised is based on inaccurate data. No wonder the euro is under pressure in this confusing political environment.

Reports are suggesting that the ECB is actively buying Spanish debt today in the secondary markets. This comes after a 5-year debt auction by Madrid, which attracted fewer buyers than expected. The auction sold only EUR3.6bn out of EUR4bn on offer and although yields were lower at 4.48% versus 4.87% in July, they are still higher than the market rate of 4.35%. The Spanish and Italian bond markets are still not functioning properly and are reliant on the ECB. This is worrying since Spain has nearly EUR50bn of debt to auction by the end of the year, while Italy has a massive EUR119bn left to finance, including EUR61bn this month.

EURUSD fell below 1.4300 earlier, and dropped below the 1.4275 support zone, the lowest level since mid-August. This was also fuelled by a weaker than expected reading of August PMI. Manufacturing contracted in the Eurozone to its lowest reading since August 2009. Although the peripheral states dragged the pan-European index lower, Germany and France also saw their index decline more than expected. The French reading came in at 49.1 down from 49.3 in July, the German index declined much more than expected to 50.9 from 52.0. Although the manufacturing sector in Germany is still expanding, it remains fragile. Ireland had a positive surprise; its index bucked the overall European trend and rose in August to 49.7 from 48.2 in July. This is still in contraction territory and since the Irish economy makes up such a tiny proportion of the Eurozone's total it had little influence on the parent index.

The UK's manufacturing PMI reading was as dismal as predicted at 49.0 - the second month in contraction territory. However, sterling only had a muted reaction to the data, probably because investors breathed a sigh of relief it was no worse than expectations.

The PMI's were expected to be weak and they didn't disappoint. The global economic outlook is still cloudy, although we know we are going through a slowdown we are not in recession territory quite yet. So we still need to see more economic data before we can tell how slow the slowdown will be. This means we are still in a waiting game. The ISM manufacturing survey in the US along with Non-Farm payrolls tomorrow will be useful indicators and after today's ISM report we may be in for a long countdown to payrolls. Added to that we are heading towards Labour Day weekend in the US, so volumes are reportedly extremely thin.

The dollar seems to be shrugging off comments from Atlanta Fed President Lockhart who said that the pledge to keep interest rates low until mid-2013 could be extended into the future. It's difficult to tell whether what this means for the markets: does it suggest that the Fed are looking at other easing measures outside of QE, or would pledges to keep rates low indefinitely be used alongside more QE? One thing is for sure, in the current uncertain economic environment the only thing that can fuel a sustained rally in risk is more policy stimulus by major central banks. If the Fed takes the plunge then the UK may follow. However, the markedly more hawkish ECB may not follow suit, however recent economic data along with a stabilisation in the inflation rate makes further rate rises this year unlikely.

Swiss Q2 GDP was in line with expectations at 0.4%. The franc continues to strengthen today, as investors test the SNB's resolve after they failed to announce new measures to weaken the Swissie this week. We wouldn't rule out more action as corporations are starting to speak out about the franc once again, including the head of food giant Nestle.

Data Watch:
Euro Area 13:15BST/ 0815 ET ECB's Nowotny Speaks
United States 13:30BST. 0830 ET Initial Jobless Claims (Aug-27) 410K EXP, 417K LAST
United States 15:00BST/ 1000 ET ISM Manufacturing (Aug) index 48.5 EXP, 50.9 LAST
United States 17:00BST/ 1200 ET Fed's Duke Speaks
United States 22:00BST/ 1700 ET Domestic Vehicle Sales (Aug) units mn n/a 9.62 9.50

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Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

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