As oil prices continue to ease and economic data improves, risk aversion has slowly melted from FX markets. GBPUSD had enough momentum to break the 1.6300 barrier taking near term stops with it, while EURUSD found its sea legs right before the European open, climbing rapidly to 1.3830. Asian regional indices were able to sustain their three day rally, with the Nikkei rising 1.22%. Even a warning from the CBRC head that Chinese lending growth has been rising too quickly and real-estate prices were increasingly irrational wasn't able to dampen investors' appetite as the CNY fixed 50 pips lower against the USD at 6.5706 and the Shanghai Composite was mildly higher 0.48%.

As was widely expected, the RBA held rates at 4.75% and in their statement acknowledged that investment and wage growth had increased but they feel comfortable letting the currently rate stand. The RBA did comment that moderate (inflation) outcomes are being assisted by the high level of the exchange rate and that the earlier decline in wages growth and strong competition in some key markets...have worked to offset large rises in utilities prices. Overall the statement provided little forward guidance stating the current mildly restrictive stance of monetary policy remained appropriate in view of the general macroeconomic outlook. We are worried that the AUD might be heading for a sell off as the global tightening cycle begins to accelerate elsewhere. Asian EM economies are already looking to fight commodity driven inflation and the ECB & BoE are widely expected to start normalizing policy sometime in 2011. However, the RBA maintaining a tightening bias and strong commodity demand should keep the AUD carry trades supported.

The highlight of the day could be the Canadian interest rate announcement. While no change is expected from 1.00%, there could very well be a mention of FX rates. The USDCAD is now trading at low levels not seen since 2007 and while most G10 FX pairs are trading on the inflation/interest rate theme the CAD appreciation is fully entrenched in equity and crude prices. Part of the lack of interest rate focus has been the fact that the BoC has been particular in aligning their monetary policy with the Fed's, steering expectations to the dovish side. While a total shift towards a hawkish stance is unlikely due to the lagging recovery in the US balanced with domestic prospects, a subtle acknowledgement of improvements should be expected. More interesting for FX traders could be a mention of CAD in the accompanying statement. Recently we have heard that policy members see a stronger CAD as a tool to mitigate inflation pressures and slow down the economic recovery. We suspect that any mention of the CAD will keep the upside capped in the short term.

Today's Swiss GDP rose faster than expected; quarter on quarter GDP in Q4 rose 0.9% vs. 0.5%. expected, up from 0.8% at the last reading. Year on year the economy expanded 3.1% vs. 2.7% expected after printing 2.6% last time around. The EURCHF reacted strongly to the solid news, dropping to 1.2840. The reaction to the economic data was a clear indication that the CHF is not only a safe haven trade but has joined the ranks of currencies like AUD, NZD, GBP and EUR, driven by projected interest rate differentials. While we suspect that the CHF advantage against the EUR should erode as risk appetite returns we don't expect as sharp a sell off as many predict.

In recent days the Fed has been on the propaganda offensive to reiterate its core themes; namely that the Fed will normalize the balance sheet over a roughly five-year period, commodity price pressures are short term, and adjusting policy would be hasty so most FOMC members do not want to shift from the current program of bond purchases. Today, Fed Chairman Bernanke begins his semi-annual testimony to Congress, but in regards to monetary policy he should merely reinforce the corporate line. Since Fed member Dudley's statement that the FOMC is still nowhere near its dual mandate of full sustainable employment & price stability, traders suspect Mr Bernanke will express satisfaction in and hint of a continuation of current round of asset purchase. Watch for USD weakness on this type of comment.
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