Positive risk sentiment dominated this morning's Asian session as Chinese economic data confirmed what the financial world had been waiting for - China is now the second largest economy in the world (in nominal USD-based terms). In addition, the residual effect of Egypt's Mubarak stepping down of Friday during a closed Asian markets seems to have given a boost to Asian risk appetite. Regional equity indexes reacted to the news by trading significantly higher with Shanghai leading the way up 2.54%.

China's January trade data came in much better than expected supporting further risk to domestic economic activity and by default escalating inflation concerns. Export growth surprised to the upside at 37.7% y/y vs. a 22.5% expected. However imports jumped higher as well, climbing 51% vs. 27% exp. The Chinese New Year effect added to the upside surprise too, but overall the solid data points to strong external and domestic demand in the future. Chinese authorities now need to engage in a delicate balancing act - tighten too little and creating a market panic that inflation is out of control (which in turn will fuel more inflation) or tighten too much and risk slowing down Chinese growth and the global recovery.

Despite clear indications that officials are determined to attack inflation, such as the Lunar New Year's surprise hike, we suspect that another 3 rounds of tightening should be expected in 2011 but will not significantly damage growth which should finish up around 9.7% y/y. Under this assumption, the world's engine for economic growth should keep demand high and risk correlated trades a buy (especially commodities which saw a massive acceleration in the import side of the trade data).

Japanese data showed that Q4 GDP declined by -0.3% verse a -0.5% expected. While there are some signs of a pickup in the Japanese economy, the overall situation is still fragile and it's doubtful that Japan will lead anyone to economic recovery.

The USD has been holding its own in recent days yet there is growing ancillary pressure that could remove its support. First of all, Fed Chairman Bernanke's testimony to Congress sounded very dovish and unconvinced on the US economic outlook; cementing the market's assumption that movement away from the artificial stimulus of QE2 and ultra-loose monetary policy in not in the cards for the near future.

President Obama's planned 2012 budget announcement today - which supporters hope will reduce the deficit down to $300bn within the next 10 years - is already under criticism as not being realistic nor large enough to stave off a sovereign credit crisis.

We are seeing a contentious US political environment rear its head with unease in both parties. Expect the Republican /Democrat divide to be become the primary hindrance to economic reform. While limited expectations for widening interest-rate differentials and growing concerns over the European comprehensive solution/heavy Asian bank intervention has provided USD bulls some optimism - we suspect that these concerns will eventually fade, leaving the US dollar with serious economic skeletons to deal with

In Europe, we are inching closer to the point that EU policymakers had promised - a comprehensive measure to solve the European peripheral debt problems (circa late March). However, news headlines have hinted that an agreement might be further away than originally anticipated. With the EuroGroup meeting today and ECOFIN on Tuesday, plus Irish elections on Feb 25th AND public debate over Portugal's austerity plans - the market will be anxiously awaiting any fresh rhetoric and watching how the political environment develops.

As far as the Forex market is concerned, we can look to the bond market to gauge some sentiment. Last week saw peripheral Euro nations vs. German yield spreads widen out prompting the ECB to actively step into the secondary markets. The ECB intervention caused the market to ask the question - how far is the ECB willing to extend itself?

If Euro traders needed more uncertainly, there are rumours circulating that ECB Governing Council member Weber will step down on April 30th as the President of the Bundesbank - leaving a huge hole in the German succession within the ECB governing Council and potentially for the ECB Presidency itself.

Today's light economic will keep trading subdued and investors will keep their eyes on news tickers including recent developments with WestLB - a troubled Irish lender which failed to reach an agreement on its restructuring on Sunday.

Forex-Chart