Unsurprisingly the better tone in the S&P index over the past couple of sessions has allowed for some relaxation in the levels of the VIX index. Also suggestive of less tension in the market is the tapering off of the gains in libor and the increase in US rates across the curve relative to levels seen at the start of the week. That said, the levels of both the VIX and Libor remain elevated and US rates are very low by historical standards. In absolute terms the level of tension in the market is still high and the uncertainty with respect to the levels of debt and in particular the exposure of European financial institutions suggests that choppy conditions could persist for some time yet.

The EUR has responded well to the better tone in other risk indicators this morning; a short squeeze has pushed EUR/USD to an intraday high of 1.2448. News from the Spanish regulator that it has tightened its rules for banks’ provisions against bad loans will help shore up confidence in Spain’s banking sector over the longer-term. However, in the near term is may bring forward the shake out of the banks most heavily exposed to the Spain’s crumbling property market; suggesting more bad news is possible over the next couple of months. Coming on the back of continued concerns that Greek debt will have to be restructured sooner or later and given simmering worries over the tangible increase in sovereign default risk in Portugal, Italy and Ireland over the past year or so, respite for the EUR could prove to be short-lived. A move to the longer-term average of USD1.18 in a 1 to 3 mth view is likely.

The sour fundamentals of the Eurozone have massively damaged the EUR’s positive correlation with risk that was clearly evident last year. This means that even if stocks manage to extend this week’s better tone the prospects for EUR gains are set to remain muted. On fiscal matters the US government has also failed to keep its nose clean; its budget deficit could reach a stunning 11% of GDP this year, yet it is performing better on growth relative to the Eurozone. In addition, the federal structure of the US economy means there are no issues with respect to inter-sovereign fiscal flows that could hinder a program of fiscal repair. The USD is likely to retain a firm tone on the crosses potentially for the duration for this year.

USD/JPY is trading off its morning highs. That said it remains in a short-term uptrend. Overnight Japanese data were disappointing. Unemployment was higher than expected, deflation more deeply entrenched and household spending was weaker than expected. These data are likely to increase the pressure on the BoJ to further stimulate the economy. Aggressive JPY shorts are unlikely to be built in view of the uncertainties surrounding debt in Europe. However, the present more settled conditions in addition to the weak Japanese data may push USD/JPY higher within the recent trading range and will further encourage AUD/JPY and CAD/JPY higher.

Cable has suffered a choppy morning, the pound possibly being influenced by the ‘on/off’ nature of the Prudential deal. EUR/GBP has pulled back from yesterday’s lows but technically the outlook is weak. That said the GBP0.8400 is tough support.

Today’s US personal income and spending data in addition to Chicago PMI and Uni. Of Michigan confidence will be of interest is assessing whether the US recovery is becoming self-sustaining. Canadian current account data are also due.