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The markets have been trading in a fairly tight range today, as one would expect in the lead up to the Jackson Hole conference this weekend. The markets are looking for signals that more stimuli is coming from central banks and hence it's all about positioning ahead of two major events: 1, Ben Bernanke's speech at Jackson Hole tomorrow at 1000ET/ 1500BST and 2, the ECB meeting on the 6th September.

Price action in recent weeks suggests that there has been some "pricing in" by the markets of more QE from the Fed, the ECB or both. Bond yields in Spain and Italy have backed off from their highs, the dollar has fallen on a broad-based basis and commodities and oil have risen along with stocks. However, the markets do like to buy the rumour and sell the fact. As we lead up to the first of the two main events - Bernanke's Jackson Hole speech - we have seen investors act a bit more cautiously as the prospect that there will be no more stimulus forthcoming from either central bank starts to hit home.

Bernanke's speech is a hard one to call, and to get our take read our research note here: Last year Bernanke sounded fairly upbeat and enacted Operation Twist at the following Fed meeting after Jackson Hole, but has the situation deteriorated enough to justify more aggressive monetary action this time round? We think Bernanke could take a mildly dovish middle course, and hint that the Bank could take pre-emptive policy action to help bolster the US economy from any adverse shocks relating to either the Eurozone sovereign debt crisis or the US fiscal cliff. For traders the Jackson Hole speech should at least bring some volatility to the market and help set the stage for a more exciting autumn after a fairly dull August.

The Italian bond auction this morning went off without a hitch. Rome managed to sell 5-year and 10-year debt and demand was strong. More importantly yields were much lower compared to auctions last month, the 5-year yield was 4.73% down from 5.29% at the end of July, and the 10-year yield fell to 5.82% from 5.96%. But is this all good news for Italy? A good bond auction could actually put the ECB off doing more dramatic action like targeting a specific bond yield through the re-activation of its SMP sovereign bond-buying programme in the coming weeks. If that happened then we could see bond yields reverse course and start to move higher once again. The FT reported today that a potential bond-buying programme is on the cards, but that the details won't be agreed in time for next week's ECB meeting. This could hurt sentiment towards European bond markets and also other euro-based assets, so watch out for some volatility.

Elsewhere, German unemployment came in roughly in line, and UK money supply data picked up a bit in July rising 0.5% on the month after a dismal June reading. However, the annual rate of decline in the money supply is still 4.6%. Euro-area economic and business confidence fell in August to its lowest level for three years. These sentiment indicators have been good lead indicators for overall growth in the currency bloc, and a further decline in sentiment suggests that the currency bloc could slip into a formal recession in Q3. This didn't have much impact on the euro as it remains stuck in a 40 pip range leading up to Jackson Hole. Not even good news can push EURUSD above 1.2570 - its recent high. Euro-area banks borrowed EU370mn yesterday from the ECB, the lowest level in a month. This is a tentative sign that funding conditions could be getting better for Europe's beleaguered lenders, which could mark the beginning of the end for this crisis.

Watch out today for initial jobless claims and US PCE data, but overall, we seem to be floating into Jackson Hole tomorrow.

One to Watch: USDJPY

It has to be dollar vs. yen as we lead up to Jackson Hole as this cross is particularly sensitive to changes in US monetary policy. As mentioned above Bernanke's speech is difficult to second guess - if he suggests more expansive monetary policy is on the way this is USDJPY negative and we could turn around to touch 78.00 and maybe even the 76.00 lows from February this year. If he isn't as dovish as some expect and remains non-committal regarding future policy direction then this is USDJPY positive and we could re-test 80.00. Either way at 1000ET/ 1500 BST on Friday should be volatile for this pair.


Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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