Political tensions and street protests in Egypt weighed on risky assets at the end of last week boosting safe haven currencies including the US dollar, the yen and the Swiss franc. However, as we start a new week safe havens have come off their highs but European equities are following Asian markets lower at the start of the London session. Protests on the streets of Cairo may have lost some of their intensity on Monday, but the pressure is still on President Mubarak to step down. The political uncertainty this creates is unnerving investors and we would expect the safe havens of the dollar, the franc and the yen to remain in demand for as long as this crisis remains unresolved.

This is not the only factor weighing on stocks, however. The S&P 500 and the Dow Jones failed to break above key resistance levels of 12,000 and 1,300 respectively last week. So even prior to the Middle East problems there were signs that the bull rally in equities was starting to lose some of its momentum. Large cap stock indices are following small caps lower. The Russell 2000 is at a pivotal level and is fast approaching support at 770. If it breaks below this level then we could see further losses to the 750 level. The Russell is down nearly 4 per cent in the last two weeks, while the S&P is down 1.5 per cent. Since small caps led large caps higher during the bull-run, the reverse might also be true.

Elsewhere, economic data will also come into focus this week. Non-farm payrolls, an ECB meeting, Federal Reserve president Ben Bernanke's speech to the National Press Association and a monetary policy forecast from the Reserve Bank of Australia at the end of the week all have the potential to be game changers for the FX markets. Right now markets expect sluggish US jobs growth, a fairly hawkish ECB, the Fed to remain committed to quantitative easing and the RBA to revise lower their rate expectations on the back of the economic uncertainty caused by the Queensland flooding.

Instability in the Middle East also remains in the background, which will add to market jitters in the coming days. Indeed, the Vix index (which measures the amount of risk aversion on Wall Street and is regarded as a market-wide fear gauge) is rising and is above 20 for the first time since the start of December. The current situation across the Middle East is a timely reminder that we can't take for granted that political risks are benign in emerging markets.

There was further evidence that the ECB's job will be getting more and more difficult in the coming weeks. The first estimate of CPI for January was higher than expectations at 2.4 per cent, up from 2.2 per cent in December. ECB President Trichet said at his last press conference that price stability is the Bank's mandate, which suggests that if price pressures look to be mounting the ECB will hike rates even if the peripheral economies are still struggling. This has boosted Euribor - the European inter-bank lending rate - which is higher this morning on the back of this data as is the Euro 3-month swap rate. This should lend support to the single currency. Interestingly, the euro has been more sensitive to yield differentials than to risk in recent months, suggesting that if the ECB maintains its hawkish stance EURUSD could still rally even as geo-political tensions weigh on other risk assets.

Gold is higher, as is oil due to the importance of Egypt as a major oil refiner and as a transportation route for supplies to Europe through the Suez Canal. Gold is back above the $1,335 per ounce level.

Data watch:
13.30 GMT (0830 ET) US Personal Income Last 0.3 Exp 0.4
13.30 GMT (0830 ET) US Personal Expenditure Last 0.4 Exp 0.5
13.30 GMT (0830 ET) US PCE Price Index Last 0.1 M/M 1.0 Y/Y Exp 0.1 M/M 1.3 Y/Y
13.30 GMT (0830 ET) US Core PCE Last 0.1 M/M 0.8 Y/Y Exp 0.1 M/M 0.8 Y/Y
14.45 GMT (0945 ET) US Chicago PMI Last 66.8 Exp 64.5
15.00 GMT (1000 ET) US Housing vacancy rate Last 2.5 Exp 2.5
17.00 GMT (1300 ET) US Lockhart speaking
19.00 GMT (1400 ET) US Senior Loan Officer Survey results published
Best Regards,
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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