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It's been a day of two halves so far. After a lacklustre Asian open we then had a wave of dollar selling at the European open that caused EURUSD to bounce back to  1.3375 highs and then the US came in and the dollar has regained strength and EURUSD is hovering below 1.33.

There's definitely some head-scratching going on regarding the likelihood or not of more QE from the Federal Reserve. One of the reasons for the burst in dollar strength may have been that durable goods orders bounced back from the lows recorded in January, February durable goods sales ex -transportation rose 1.6% on the month, slightly below expectations, but above the 3% decline at the start of the year. This is a good lead indicator of economic strength, as durable goods tend to tally well with levels of business investment. So durable goods are saying to us that the economy is fine - it's growing, but not exactly in a lustrous fashion.

To contract or not to contract...


This justifies the Federal Reserve's Ben Bernanke saying that the recent jobs' gains may not be sustainable if the economy doesn't pick up the pace of growth. Right now Bernanke argues that a lot of job growth is through businesses cutting workers at a slower pace, and isn't a sign of a strong organic recovery. This requires continued accommodative monetary policy from the Federal Reserve. But this isn't necessarily dollar negative (usually QE goes hand in hand with a weaker greenback). The use of the word continued by Bernanke is crucial. The Fed is in the middle of Operation Twist, yet its balance sheet has been shrinking in recent weeks. So a continuation of policy could mean further contraction of the Fed's balance sheet, which should be dollar positive.

The market doesn't know one way or the other. Right now it looks like there will only be more QE if the US economy deteriorates sharply and today we didn't see any sign of that. Hence the move higher in the dollar and the slight risk-off tone to markets.

Europe back in focus:


We pointed out yesterday that this is the eve of Spanish Prime Minister Rajoy's first national strike as leader. He is also two days away from delivering his first Budget. What we know so far is that the Budget isn't finished yet. Insiders have leaked that there won't be any rises in consumption tax and public sector wages won't fall. However, we got some more worrying news about Spain; after reports surfaced that the EU is pushing Madrid to help its ailing domestic banks to re-capitalise. The reports say that the EU is happy to allow Spain to tap the Eurozone bailout fund to help with the effort.

Now that is a stigma and a half - first borrowing from the ECB was considered bad form, now it's borrowing from a bailout fund. Spain looks increasingly vulnerable; it has to deal with a weak financial sector at the same time as the regions are likely to need federal support (we should hear more about this in the Budget). Add in the fact that Spanish banks boosted their purchases of Spanish sovereign debt this month and it's easy to see how dysfunctional Spain's economy has become.

Hence its 10-year bond spread with German debt has widened slightly, although the LTRO funds and bank purchases of government debt is keeping a lid on bond yields for now.

 It's a pivotal week for Spain. It is garnering all of the negative attention and the spread between Spanish and German bond yields relative to Portuguese and German bond yields has actually been deteriorating.

Market moves:


Right now 1.33 has been breached in EURUSD, which is negative in the short-term. With Spanish woes at the forefront this pair is looking more and more precarious, however 1.3250 should act as good short-term support. 1.3350-80 is an incredibly sticky zone, likewise, the Bernanke comments, even if they don't signal QE, could cap gains in the dollar.

If you prefer a trending pair then the Aussie should be on your radar. AUDUSD is below 1.380 - an enormous level in the market that is the 200-day moving average, which has held as good support in recent days. If we get a close down here tonight and further weakness during the Asia session then the Aussie is at risk from weakening further in our view and possibly to parity.

Sterling has also started to look weak and is below 1.59. Some dovish BOE comments and a downward revision to Q4 GDP to a 0.3% contraction are to blame along with dollar strength. 1.6050 is a major resistance zone - the 200-week moving average. The fact we have backed away from this level suggests that is the top for now, with good support in the near term at 1.5850, ahead of 1.5800 recent lows.

Oil has been another interesting mover, falling sharply after reports that France, the UK and US were considering releasing reserve supplies to put downward pressure on the oil price (no surprise that two of those nations have Presidential elections coming up...) Brent crude is down $2, but as we have mentioned in the past the release of strategic reserves tends to only have a temporary downward impact on the price of crude.

And to mix things up even more, month and quarter end flows could disrupt things for the next few days.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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