The lack of fear-generating news equates to USD bulls having too little to latch on to. Clearly the FX markets have shifted their focus from EU sovereign credit concerns and Egypt contagion worries to the global inflation story. Barring a safe-haven trigger event, we suspect that the USD, CHF and JPY will continue to be the funding currencies of choice and their central banks are expected to significantly lag those of more hawkish G10 banks.

In the Asian session, Asian banks returned from the Lunar New Year and the USD was on the back foot amid chatter/ speculation that reserve managers were rebalancing their books by selling USD.

After drifting lower, AUDUSD was able to reverse its losses, trading up to 1.0185 on comments from the RBA's Corbett and S&P's Curry. RBA member Corbett stated that the effect of Queensland's floods would be short lived while S&P's Curry stated that there would be little impact if Australia's surplus slips. Traders have been speculating on the RBA's rate path as a series of natural disasters has caused considerable uncertainty regarding growth and inflation. Despite bumps in the economic data, such as the modest rise in retail sales, we are siding with the recent MPS which contained minor positive adjustments in growth and no change in inflation expectations. In our mind the market is still positioned on the dovish side and will be caught short if the RBA hikes three times in 2011 to 5.50%.

In Asia, it's been interesting how well the JPY has withstood higher US yields. Generally the correlation between yield differentials and the USDJPY has been very tight but recently US yields have ticked higher (10yrs above 3.66%) while USDJPY keeps getting stuck in daily cloud cover (currently around 82.40/50). There are a few potential reasons why this is the case including portfolio inflows and risk premium advantage provided by small external finance needs and consistent trade surplus, but we suspect the sudden jump in US yields have caught investors off-guard as the participation / expectation surrounding the Fed should keep rates constricted. We suspect that as participants become more comfortable with rising yields and adjust their rate path, USDJPY will hastily play catch up.

In Europe, ECB's Mersch provided some supportive words for the EUR stating that the ECB would intervene if the secondary effects from commodity prices failed to ease. He also went on to say that the EFSF should be allowed to buy bonds directly. With four consecutive days of lower lows, the EUR definitely has a bearish feel, however from a fundamental standpoint we suspect that a hawkish ECB will propel the single currency higher as a single drop in US employment rate doesn't signal a sustained recovery in labor markets. Part of the EUR fall could be attributed to the soft German factory orders which makes today's German Industrial production even more important. Considering the weak growth prospects of peripheral EU countries, anchor countries such as Germany and France must be the economic engine. Without performance from these countries, not even a comprehensive agreement can hold the union together.