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The oil market dominated headlines and financial market activity yesterday after WTI crude oil touched $100 per barrel for the first time since September 2008. A similar bullish sentiment gripped the Brent market, which touched more than $119 per barrel earlier in the European session. The fundamental driver is uncertainty in North Africa. Investors are worried that the political uprisings in Egypt, Tunisia, and the violence that has broken out in Libya will spread to the Middle East. Right now Bahrain looks the most at risk from an uprising, but if events there escalate then we could see it spill over to oil-rich Saudi Arabia. The surge in oil prices in the last 24-hours is the first indicator of what havoc trouble in Saudi could wreak on t he wider global economy.

Up until recent days commodities and stocks were rising together while bond yields were falling. But now we've seen a major reversal. Stocks are lower, oil is higher and bond yields are also rising as investors fall into the safety of top -graded government debt. The decline in bond yields (10-year US Treasury yields are coming back to their prior range between 3.30% and 3.50%) is a reflection of the threat oil above $120 poses to the fragile global economic recovery.

This is best exemplified in the UK. Short-term Gilt yields that are most sensitive to interest rate expectations, actually moderated yesterday even though yesterday's Bank of England minutes suggested that the BOE took a step closer to a rate hike at their meeting earlier this month. This oil price wild card has totally shifted growth concerns for the UK economy. Can the UK manage an oil price shock, austerity cuts and an interest rate hike all at the same time? Probably not in our opinion. This has weighed on sterling, which is the worst performer out of the other G10 currencies. The dollar is also weak, while the euro is mixed-to-weak, as the bulk of long positions flow into the safe havens of the Swissie and the yen.

Right now the dollar has lost its status as safe haven. This is due to two reasons: firstly, the US economy is the world's largest consumer of oil, so a price shock would adversely affect US growth and, if this Middle East supply shock is sustained, could push the US back into recession. Secondly, the US's fiscal concerns are also coming to the fore as workers strike across Wisconsin at the prospect of harsh budget cuts. This shows us that reigning in the US's vast deficit will be a long, hard slog for the politicians brave enough to take it on.

Stocks are lower for a fifth day today, although the decline could be less severe than in prior sessions. There are some signals that investors are scaling back their risk off trades and talking a breather after getting a bit ahead of themselves. Although the trend is still lower, we may see some profit taking and risky assets claw back some losses. USDCHF seems to have found some support at 0.9250 for now after cracking to a new all-time low. Also, Brent has recouped some losses and is currently around the $113 per barrel level.

EURUSD is trading strongly after a 4-year high in Eurozone economic confidence for February. The pound is lower on the back of weaker yields, fuelled by fears about the oil price and CBI data on retail sales; it reported that sales fell sharply in February, which weighs on the growth outlook for the first quarter of 2011. EURGBP has popped above 0.8500, which heralds further gains towards 0.8600.

Risk aversion is the theme of the day and all else is taking a back seat.

Data watch:


United States 13:30 GMT (0830 ET) Fed's Bullard Speaks

United States 13:30 GMT (0830 ET) Initial Jobless Claims (Feb-19) 410K LAST, 405K EXP.


United States 13:30 GMT (0830 ET) Durable Goods Orders (Jan) m-o-m -2.5% LAST 2.8%


United States 13:30 GMT (0830 ET) Durables Ex Transportation (Jan) m-o-m 0.5% last, 0.5% exp

UK 15:30 GMT (1030 ET) BoE's Weale Speaks

UK 18:30 GMT (1330 ET) BoE's Andrew Sentance Speaks

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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