Forex markets and equities have diverged today. European stocks are modestly lower after having a mixed start to the session, while the dollar continues to fall and EURUSD is testing 1.3660/70 after falling as low as 1.3370 on Monday. The risky assets have tended to move in a block in recent weeks, so today's price action is worth investigating a little more.

Reasons for the divergence include quarter-end flows interrupting market sentiment that may be weighing on the dollar. However, it might be that fundamentals may start to have different effects on different assets classes. News that the EU would propose a 0.1% financial transaction tax aimed at hedge funds, investment and insurance companies, pension funds and stockbrokers has weighed on stocks. The plan will be presented at the next G-20 meeting in November and, if agreed, would take effect in 2014. According to the EU's calculations the tax could raise EUR 57 billion a year but would have a negative effect on growth to the tune of 0.5% of GDP. Banks in Europe have enough problems at the moment that another tax is only going to stretch their finances even more, so it is no surprise that stocks in Europe have taken a beating this morning, with French and Italian banks in particular, under pressure.

However, the euro hasn't followed equities lower. The continuing positive tone may be down to quarter and month-end rebalancing, but it could also be due to positive sentiment from a report that Germany was planning a secret plan to save Greece. This plan focused on the sale of Greek state assets worth EUR125bn to the European Union, which would allow the Greek state to re-purchase its debt from the ECB and EFSF. It also proposes a stimulus programme for Athens worth 8 per cent of GDP and cutting the state's interest rate burden by 50 per cent due to debt reduction and an improvement in the Greek credit rating. However, this plan was apparently touted in the past and still hasn't solved the crisis, so it's unlikely that this is the panacea to Greece's problems.

Thus, we tend to this that the euro is still at risk from a sell off as risk events start to crop up. The first is a vote by Finland to approve the EFSF extension agreed back in July, the Germans hold the same vote tomorrow, and then there is the ECB and ecofin meetings next week. The ECB meeting is likely to set the tone for the euro for some time. There is an expectation that the ECB may cut rates as soon as next week, but we think the ECB will wait until November at the earliest to assess the growth situation and to see if the EU can sort out the sovereign crisis. Also, inflation pressures persist. Regional German inflation data for September showed that price pressures had grown during the month. This will add to the war chest of the hawkish faction at the ECB, who are reluctant to cut rates so soon after raising them. Providing long-term funding to the banking sector is more urgent right now as interest rates, even with two hikes since April, remain negative.

Things are definitely picking up pace in Europe. The Eurogroup has announced an extra meeting in October and the European Commission has denied that there are talks going on to increase private sector bondholders' share in Greece's next bailout. The Ecofin meeting next week should give investors a better idea of Europe's official line on new rescue measures like a large extension of the EFSF. Next week will be a crucial week for the Eurozone in our view.

Elsewhere, the US may take centre stage today as durable goods orders for August are released. They are expected to fall 0.2 per cent on the month. This data will be watched closely as sales of durable goods and autos are usually the first places to show signs of recession. The dollar is lower across the board today, however it may have made a short term base as EURUSD runs into resistance below 1.3700 and AUDUSD fails to break above 0.9950.

The pound has been fairly mixed today, after the Bank of England Financial Policy Committee raised concerns about the UK banking sector that it is finding it increasingly tough to raise funds in wholesale markets that could limit lending in the economy. It recommended that banks raise long-term funding as soon as possible and that any decline in banks' profits is reflected in lower dividends and pay levels. In GBPUSD 1.5580 is =good support, while 1.5670 is still good resistance.

Overall, it still seems like we are in a correction and that the longer-term trajectory for risk is still lower.

Data Watch:
12.00BST (0700 ET) EU Finland votes on EFSF enlargement
13.00BST (0800 ET) EU Mersch Speaking
13.30BST (0830 ET) US Hoenig speaking
13.30BST (0830 ET) US Durable Goods Last 4.0 Exp -0.2%
13.30BST (0830 ET) US Durable Goods Ex transportation Last 0.7 Exp -0.2%
17.15BST (1215 ET) CH Jordan speaks in Basle
19.40BST (1440 ET) US Rosengren speaking

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Kathleen Brooks| Research Director UK EMEA |

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