The tone of today's news has been overwhelming good. Chinese exports surged a greater than expected 48.5% y/y in May while property prices were up 12.4% y/y. Also, Japanese Q1 growth was revised higher to a much better than expected 5.0% annualised, the Fed's Beige Book reported growth in all 12 regions (although it is still slow in some areas) and the Spanish 3 yr bond auction managed a respectable 2.1 bid/cover. The decisions by the RBNZ, and the Brazilian central bank to raise rates overnight also reflect a strengthening of economic conditions.

The risk trade has had a mild renaissance on the back of this better news; stocks indices and oil are higher, EUR/USD has remained comfortably above the 1.20 level through the European morning and AUD/USD has climbed back above 0.8400. The obvious question to ask now is whether the correction in risk assets which has dominated markets since late April has run its course of whether there is further to come. There has been a clear logic behind the recent correction in the risk trade. Investors have been spooked by higher levels of sovereign deficits and debt and the process of fiscal repair will weigh on growth potential in the coming years. The prospects of fairly slow growth was not consistent with the exuberant rallies in assets such as oil and stock indices which had dominated since the middle of last year until April, hence the correction. That said, while growth rates may be slow over the next few years, there is no firm evidence that any of the world's major economies are in imminent danger of double dip recession. While investors are likely to remains sceptical on the prospects for an acceleration in growth prospects in the industrialised world until the US jobs numbers post a decent recovery, current data are suggesting that growth is sustaining in the US, Germany and Japan and this is suggestive of a floor, at least for now, for the risk trade.

The decent demand seen in this morning's Spanish 3 yr bond auction follows a smooth result for the Portuguese bond sale yesterday and will bring a sigh of relief from EU officials. It was not without cost, however. The 2.1 bid/cover ratio was won with a rise in the average yield to 3.317% up from 2.007% in April. Even so the fact that there is still appetite for Spanish and Portuguese debt on the open market reduces the likelihood of sovereign default as well as providing an endorsement from investors on the budgetary commitments of the Spanish and Portuguese governments and on the exceptional measures taken by the ECB and EU policy makers. That said, the war has not yet been won. Budget deficits still have to be crushed and whether or not the electorates have the stomach for budgetary reform has yet to be thoroughly tested.

The NZD performed well on the back of the well anticipated 25 bp rate hikes by the RBNZ; the improvement in the risk environment lending support. The statement from the RBNZ's Bollard that underlying inflationary pressures are expected to increase has strengthened the risks of further RBNZ rate hikes. The AUD has also strengthened on the back of strong Chinese data and on better than expected domestic news that employment rose by 26.9K in May. Technically, the recovery above the 21 day sma AUD/USD0.8417 is a bullish indicator for the AUD.

Neither the BoE or the ECB are expected to announce any policy chances this afternoon. Even so, the ECB's press conference will likely be keenly watched insofar as this is the first since the ECB started buying bonds to limit fears of sovereign default and contagion. Questions about sterilisation are likely to be asked, though the release of German May CPI this morning at 1.2% y/y confirms the lack of inflationary pressures at present.

US trade data and initial claims and Canadian trade and housing data are due this afternoon.

Jane Foley

Research Director +44 207 398 5024


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