Risk-correlated trades took a thrashing yesterday as concerns over the weak US recovery gave way to macro-concerns about the fragile global recovery. Soft retail sales out of China and the large US trade deficit multiplied by the FOMC's bearish review caused risk appetite to shrivel. The pessimism reignited fears of a potential relapse in EU sovereign problems as news broke that Ireland still has lingering budgetary problems - 10 yr Irish bonds widened 297 bps over their German counterparts as a result.

The magnitude of the spread widening is not necessarily a fire alarm, but the sudden reversal does have market participants watching. Short USD positions that had been built up over the past few weeks were quickly squared yesterday causing heavy losses in both the Euro and the Pound.

However as of this morning, the EURUSD was able to rally off its low in Asia giving some hope to Dollar bears. Today's very light economic calendar - mostly tier-2 data during the European session - will leave the Forex market with only equity markets and the US yield curve as core drivers.

The trending movement of the Yen continues to give Japanese policy makers a massive, deflationary headache. Aside from a few rouge comments, leaders on the island are still fervently critical of a strong Yen. As the comments hit the wires, the USDJPY did move, albeit slightly. Japanese Prime Minister Kan escalated his Forex stance calling Yen movements one-sided and rough - causing the USDJPY to jump 30 pips. The Local press reported that Trade Minister Naoshima will conduct an emergency survey of some 200 major exporters to gauge the effect of the strong Yen on Japanese business and Vice Finance Minister Tamaki alleged that he had been in conversations with the Bank of Japan about possible intervention.

The rhetoric from officials should continue but any direct intervention by the Japanese government would be difficult to justify to the nation's trading partners. According to Reuters, unnamed EU officials stated that unilateral Japanese intervention would be unwelcomed and the propensity for coordinated action to weaken the Yen just isn't on the table right now. The core driver of USDJPY will continue to be the US/Japan interest rate differential which economically speaking, is trending in the wrong direction. US yields continue to fall as 30 yr Treasury yields dipped below 2.7%, however the potential for BoJ action should keep the 84.70 floor intact. We maintain that the upside potential on the USDJPY outweighs the downside risk and long USDJPY positions may soon be ripe for some short-term gains.

In the UK, yesterday's dismal Quarterly Inflation Report further underscored market anxiety of a double dip recession. Although GDP is expected to increase gradually to above 3% y/y by 2013, the estimate is down from previous forecasts. BoE Governor King stated that growth expectations were revised lower due to weaker consumer confidence and coalition's fiscal austerity plan. The inflation report will shift focus back the possibility of additional QE by the BoE.

The overall effect on Sterling was limited due to the broader macro-concerns coming out of the US and a strong Euro selloff. We are doubtful that the BoE expectation that inflation would be naturally tempered off by slowing growth will come to pass. Look for stubborn price pressure to shift the market's focus back toward Sentances' minority report.

Today's Key Issues (time in GMT):
07:30 SEK Jul CPI,
07:30 SEK Jul CPIF, -0.4% m/m, +1.7% y/y eyed; last unch, +1.9%.
08:00 EUR ITA Jul CPI - final, +
08:00 EUR ITA Jul HICP - final, -
08:00 NOK Jun retail sales, +0.3% m/m; last +0.2%, -3.2% y/y.
08:00 EUR ECB monthly bulletin published
08:30 GBP Q2 CML mortgage repossessions, Justice Ministry possession orders.
09:00 EUR Jun ind production, +0.7% m/m, +9.3% y/y eyed; last +0.9%, +9.4%.
09:00 EUR TA Jun trade balance - global;
12:30 USD Initial jobless claims, thous (4wma)