The brief respite in risk aversion seen yesterday, quickly evaporated in Asian trading. The catalyst seemed to be the FT report that EU finance ministers were working on a coordinated strategy to recapitalized European Banks. US stock quickly reversed earlier losses and EURUSD made a boomerang maneuver as it touched 1.3146. The Austrian Finance Minister Fekter commented that Eurozone countries were evaluated their domestic banks capitalizations. However, the lack of details has already begun to weigh on the initial optimism. In addition, Moody's chopped Italy's sovereign rating three notches to A2 and outlook negative. The market's reaction was muted since the agency had already warned in July that a cut might be coming and the downgrade merely puts Moody's in line with other rating agencies. We suspect that psychological effect was stronger than price action suggests, especially considering tomorrow critical ECB meeting. Continued speculation in the media of larger haircut on Greece debt for private investors put pressure on EUR and AUD this morning. In the US, Fed Chairman Bernanke testimony to the congressional Joint Economic Committee did his best not to disrupt or panic the markets. He stayed within a well defined script and reiterated past statements. In particular, while he repeated that the FOMC now expects a somewhat slower pace of economic growth over the coming quarters he steered clear of using the verbiage there are significant downside risks to the economic outlook a phrase that originally frightened the financial markets. The Chairman also added a plea to fiscal policy makers to assist with the recovery and not to expect to solve all the US problems with monetary policy.

With a noticeable lack of real, lasting news hitting the wires, it became painfully clear how complex the Greek crisis had become. While FX provided haphazard price action, equities in particular, provided a clear signal that it was highly concerned with the current situation. The lack of activity from the Eurgroup and the unexpected cancellation of the next Oct 13th Eurogroup meeting (which was set to be the date the 6th tranche of cash was expected to be approved for Greece) was highly disappointing. In addition, the official announcement that Greece's 2011 budget deficit was wider than originally feared brings to the forefront two disturbing questions: first, has the economic erosion due to the sever austerity programs actually pushed growth past the point of no return thus triggering the death spiral (suggested by Soros) to begin? And further along within this line of reasoning, when the spending cuts begin in earnest, will this drive the downturn even deeper, while marginally helping the top line spending? Secondly, with the official announcement implying that the original €109 rescue program will need a topping up--who is going to step up and provide the additional funds? The overriding rhetoric from European policymakers suggests that they don't want Greece to default, or more extreme, to leave the union. However, they so far have provided little in term of solid measures. Risk reduction will remain the driving theme in asset pricing, although it seems to be less impactful on FX than interest rate differentials. However, the probability that deterioration in growth due to regional uncertainties might force the ECB to cut policy rates on Thursday. Any rate cuts will weigh significantly on EUR pricing.

As for tomorrow critical ECB meeting consensus that the central bank will hold policy rates at 1.50%. The economic data produced from the Eurozone clearly highlights a worrying downward trend towards recession, which has provoked call for aggressive cuts. However, Fridays Eurozone flash estimate of CPI inflation, which came in at significantly stronger 3.0% yoy vs. 2.5% yoy consensus forecast, should give Trichet reason to delay pulling the trigger. As well as generates event risk that Trichet issues a more hawkish statement then the market was anticipating. We do believe the ECB will lower policy rate in December, but this meeting be focused on loosening non-standard measures. In addition, this will be Trichet's last meeting as the ECB chairman, and we suspect Trichet will be mindful of setting a course before Mario Draghi has a time to take the reins.

On the data front, Australian August retail sales printed significantly stronger than expected at +0.6% mom vs. 0.2% exp however, it did little to inspire AUD bulls. The market is now pricing in roughly 41bps of rate cuts for Novembers RBA meeting. A number with think is high considering the rash of strong economic data. In the US, traders will briefly turn their attention to the ADP private payrolls as a precursor to Fridays important payroll read.
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