Risk appetite appeared to be gaining ground in Asian hours but the FTSE 100 index has given back many of its opening gains since the start of the London session. Similarly the EUR is softer with selling pressures capping EUR/USD at 1.2720 early in the session. Mirroring the step back from risk, the JPY is also a touch stronger on the crosses, though AUD/JPY has found solid support at 77.20.

The better tone noted in stocks this week can be explained as a corrective reaction to the strong losses registered since April. At the start of this week, the S&P 500 was down 15% from its April 2010 high. Even though stocks have been climbing this week, overall evidence that risk appetite is returning has been patchy; with the bond markets looking mixed despite the better tone in stocks. In all it seems that investors are unconvinced about the potential for further gains in risk near-term. While fears over a double dip recession in the US are likely to prove overdone, there is still plenty scope for negative news in the coming months. Firstly the market needs to come to terms with the likelihood that growth in the industrial world is likely to be relatively slow during the next few years. Also expectations regarding the potential for Chinese growth this year are currently being moderated. Added to this, the impending publication of stress tests for European banks could yet create difficulties for the EUR.

Speculation that European stress tests would not be tough enough to trip many banks was linked to gains in banking stocks yesterday. This enthusiasm, however, may be short-lived. The market has been demanding stress tests as a means of increasing transparency. If tests are not tough enough the current suspicions that are hindering the ability of some banks to fund themselves in the open market could persist. In effect this could prolong negative risk for the EUR. In an effort to offset talk about soft stress tests, this morning EC President Barroso commented that the stress tests are credible. He also reassured the market that the EU will be available to help if the tests produce casualties. Until the results are published, the market is likely to be wary of aggressive long positions on the EUR. That said Euribor has edged higher again this morning. While this supportive of the EUR, ECB President Trichet yesterday made it clear that there was no intention by the ECB to signal higher rates. Money market conditions have been usually volatile due to last week's expiry of the June 2009 ECB EUR 442 bln loan, though conditions are likely to settle in the forthcoming week.

Sterling has clawed back some ground vs the EUR this morning despite disappointing trade data and softer than expected PPI. The total trade balance widened to its worse level since before the financial crisis, throwing cold water on hopes that the weaker position in sterling over this period would produce an export led recovery for the UK. While there are signs that the German economic recovery is gaining ground, the relatively soft position of the Eurozone demand is weighing against a strong recovery in UK exports. Meanwhile imports have strengthened suggesting UK domestic demand may be recovering. PPI data were softer than expected. This should help sooth fears that underlying inflation pressure in the UK are rising. While sterling turned lower vs the USD on the release of these data, EUR/GBP was dragging lower by the softer tone in EUR/USD .

Canadian employment data and housing starts are due this afternoon.

Jane Foley

Research Director FOREX.com jfoley@forex.com +44 207 398 5024   FOREX and other leveraged products involve significant risk of loss and may not be suitable for everyone. FOREX.com is a trading name of GAIN Capital - FOREX.com UK Limited and is authorised and regulated by the Financial Services Authority (FSA FRN 190864)

The information and opinions in this report are for general information only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions. This report has been issued by GAIN Capital - FOREX.com UK Limited (FOREX.com), authorised and regulated by the Financial Services Authority.