In the Asian session, risk aversion has been gradually seeping into the general psyche of FX traders. The bombardment of graphic images from Bahrain and other Middle East nations combined with official confirmation that Iran is looking to send two naval vessels through the Suez canal has clearly weighed on risk correlated trades.

CHF has been the main beneficiary of early safe-haven flow with the USDCHF dropping sharply to 0.9450 and EURCHF falling to 1.2907. However, equity markets saw a modest rally and commodity prices failed to react, suggesting that the impact of Middle East events are still merely a marginal driver. While the official process for crossing the Suez Canal is slightly muddled, it's most likely that international treaties state that the primary reason for denial by the Egyptian Defense Ministry would be in case of war, which suggests the Iranian request will be granted. Interestingly, Suez Canal administrators do not take Iran Rial, so we should hope they have some greenbacks in petty cash.

Traders will be watching events unfold cautiously, especially if Israel steps up the hawkish rhetoric. As expected, crude prices have also reacted to regional activity with Brent's front end steadily increasing to $104.52 before retracing slightly. Given the unease heading into the weekend we suspect that FX trading will remain subdued and rallies in EURUSD will remained capped. US data yesterday followed the FOMC minutes with a slightly optimistic read as the Philadelphia Fed manufacturing survey jumped to 35.9 from 19.3. However, while the pundits celebrated the so-called sign of recovery (although we have very little faith in surveys right now), the Fed's dovish Charles Evans stated that the speed of recovery remains disappointing. He pointed to the elevated unemployment data and benign inflation data (even though yesterday's fresh CPI print was slightly higher than expected), suggesting that the Fed had missed both their policy objectives; adding that there was a long road ahead before we return to full utilization. Treasury yields dropped partially due to risk flow and partly to potential for further QE.

Today's data calendar is light; G20 finance ministers and central bank Governors will meet in Paris, Canadian CPI and Geithner & Bernanke will be speaking .

As we expected, the sterling has had a volatile week which has been rounded off by much stronger than expected retail sales figures for January (1.9% MoM, 5.3% YoY vs. expectations of 0.5% and 4.0% respectively). We had suspected that the data would rebound strongly following the disappointing end of year data that was distorted by inclement weather, and believe that the UK growth data will continue to improve. After the punch sterling bulls received from BoE Governor King on Wednesday (King will be speaking today), the GBP has rallied back nicely. Ultra hawk Andrew Sentence sped up the process yesterday saying he sees danger that high inflation becomes ingrained and the BoE needs faster, bigger rate rise than markets expect. We agree wholeheartedly and continue to see short term corrections as an opportunity to build long GBP positions.

As for the G20 communiqué expected to be released Saturday, we suspect that policy officials will look to flex their muscles with a strongly worded statement against FX speculation.