There has been a lot of conflict in the market over the course of the last week or so. There is plenty of fodder in the bear's camp, with prevailing concerns that production in China is slowing and worries that the US may see a double dip recession being compounded by this week's warnings from the IMF over the pace of the global recovery. In contrast to these fears, the bulls have been predicting that stock markets valuations are looking cheap.

A few days ago the S&P was down 15% relative to its April high. The correction higher this week took has taken it through a key technical level, which could prompt further gains. Oil and other commodities have also corrected higher. This recovery in risk is reflected in the fx market most obviously in a softer tone of the yen which has performed poorly across the board but most clearly vs the AUD. While a correction from oversold conditions may have been inevitable in stocks, doubts over the pace of the global recovery and fears over the results of the EU's stress tests should be sufficient to limit aggressive long positions on risk in the coming weeks.

EUR/USD is currently little changed from its London opening levels, with the recovery in other risk assets failing to have much impact. While the tone of the EUR has improved over the last few weeks, the outlook remains marred by concerns over the health of the banking sector. Yesterday the Committee of European Banking Supervisors stated that stress tests on banks would be applied on the basis that growth may be 3% less that the EC's forecasts. This has produced a flurry of forecasts this morning over the number of banks that may fail. It has also intensified fears over the ability of banks to recapitalise themselves now that market sentiment is weighed down by concerns over sovereign default.

US banks in 2009 managed to recapitalise themselves faster than consensus expectations but investor interest was underpinned by what were perceived to be rock solid government guarantees. The results of these stress tests are likely to set the tone for the EUR for the next few months though today focus will be diverted by the ECB press conference.

The ECB's provision of liquidity is likely to garner much attention today. Money market activity surrounding last week's expiry of last June's EUR 442 bln 12 mth loan did hint that some banks are still heavily reliant on the ECB for funding. Clearly if some banks perform poorly in the stress tests funding conditions could worsen for these institutions. While the ECB has made clear that it is pulling back its emergency liquidity provisions, there is speculation that the ECB may resume purchases of covered bonds this summer. EUR bulls are likely to remain sidelined for now.

The BoE is not expected to make any policy changes today. That said the publication of the minutes of today's meeting will be greeted with much interest given that Sentance last month voted for a rate hike. The debate about whether or not underlying inflationary pressures in the UK are growing continues to rage suggesting that sterling will be very sensitive to inflation data in the coming weeks. This morning the pound suffered a setback on the release of weaker than expected Halifax house price data (-0.6% m/m); all other recent house prices surveys have also been weak.

While May UK production data were better than expected, the impact on sterling was muted by the fact that April brought downward revisions. Net, however, production continues to trend higher suggesting that into the spring the recovery in this sector did continue. More pertinent for sterling, however, is the degree to which growth potential will be hindered by austerity measures. Given sterling's post budget gains, the pound is vulnerable to bad news on the economic front. EUR/GBP has traded higher to 0.8360 this morning. Cable is down at USD1.3535.

The bounce in commodity prices and another better than expected set of labour data boosted the AUD overnight. Australian employment rise by 45.9K in June pushing the unemployment rate down to 5.1%. AUD/USD rose to 0.87500 before stalling, AUD/JPY rose to 77.00.

This afternoon US initial claims, consumer credit and Canadian new housing price data are due.

Jane Foley

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