The markets remain jittery as a mix of Middle East fears, concerns about inflation pressures and ratings warnings for Portugal and Greece start to weigh on market sentiment. This is reflected in the gold price, which reached a record high of $1,435 yesterday, and after a small correction this morning is climbing higher once again above $1,430. The dollar, which tends to move inversely to the commodity price, has also moderated and is close to the bottom of its 2-month range on a broad-based basis. We expect this dollar/ commodity inverse relationship to persist for the foreseeable future especially if the Federal Reserve remains likely to keep monetary policy accommodative.

The oil price is also hovering close to the $100 per barrel level for WTI, a key psychological level for the market. Oil prices are rising at precisely the wrong time for the developed world, where fragile economic recoveries risk getting pushed off track by a rising cost of living. This is weighing on equity markets and stocks are also lower for the second straight day during the European session, highlighting the knock to investors' confidence in the last 24 hours.

The FX market is acting as it did last week. The traditional safe havens of the yen and CHF are higher, while the euro has also climbed back above the 1.3800 level versus the dollar and GBPUSD is also close to 4-month highs. The dollar is continuing to shed its safe haven status as markets focus on yield differentials as the driver for the major G3 currencies. The US also has problems of its own. Congress agreed to a two week extension to fund the federal government last night, which means the government will not run out of money until March 18. The Democrats and Republicans now have to fight it out to agree to long-term spending plans, which has been a tough ask so far. However, we imagine they will hammer something out before the deadline. The markets are sensitive to funding difficulties, thus the US - the world's largest debtor - needs to avoid drawing too much attention to its deficit and the political impasse at Capitol Hill if it wants to avoid funding difficulties.

This is adding to the dollar's woes. Also weighing on the greenback is the continued dovish stance of the Fed. Chairman Bernanke, during a scheduled speech to the Senate on Tuesday, said that higher oil prices should only have a temporary effect on prices, and he seemed more concerned by the economic impact of higher prices at the petrol pump. The Governor didn't give anything away about the future trajectory of monetary policy during his speech. At this stage it appears that the Fed remains committed to ending QE2, but we remain in the dark about the Fed's policy moves after June. Thus, speeches and minutes from Fed members and Fed meetings will be scrutinised in the coming weeks for any hint about the future direction of policy. This is vital for the direction of the dollar. While we remain in the dark, the bias is more likely than not for a lower buck.

The euro has brushed off news that a major ratings agency still has Greece and Portugal on negative ratings watch and the latter is still at risk of a bailout from the EFSF. Instead the market is focusing on the stronger producer price data for December, which saw annualised prices in the monetary bloc rise to 6.1 per cent. Pipeline inflation pressure continues to grow and this may cause ECB President Trichet to be hawkish at his monthly post-rate decision press conference tomorrow. Rates are expected to remain on hold at 1 per cent. But EURUSD bulls should watch out, however, as the 2011 high of 1.3865 is capping the rally for now.

The Kiwi dollar is under intense pressure after the Prime Minister called for a cut in interest rates as New Zealand tries to recover from last week's devastating earthquake. This is the first time the PM has explicitly called on the RBNZ to adjust policy as a result of the quake, and this added pressure for loose monetary policy has eroded the potential for any yield benefit to help prop up the Kiwi. The Aussie has recovered some of its losses and is trading back towards 1.0150 highs of the Asian session, after the fourth quarter GDP rose less than expected at a 2.7 per cent annualised rate, the market had expected 2.8 per cent.

Ahead today the market will look at the ADP jobs data. The market expects an increase of 180k jobs in the private sector last month. But the ADP's track record of predicting the more important non-farm payrolls number released on Friday is appalling, so the market is unlikely to move too much on the data.

Data Watch:
13.00 GMT (0800 ET) PO Polish Interest rate decision Last 3.75 Exp 3.75
13.00 GMT (0800 ET) US Hoenig (FOMC Non-Voter) Speaks on Foreign Relations
13.15 GMT (0815 ET) US ADP Private Payrolls Last 187K Exp 180K
15.00 GMT (1000 ET) US Bernanke speaking before the House Financial services Committee
19.00 GMT (1400 ET) US Beige Book released
19.15 GMT (1415 ET) US Lockhart (FOMC Non-Voter) Speaking on the US Economic outlook and US Monetary policy ( incl Q&A)
23.50 GMT (1850 ET) JP Japanese Corporate Survey (CAPEX Excl Software) Last 4.8 Y/Y Exp 5.1 Y/Y

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Kathleen Brooks| Research Director UK EMEA |

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