Although we remain in a risk seeking environment, gains in risky assets might take a bit of a breather today. While the dollar is continuing to trade softly against the Aussie and Kiwi dollars, stocks are flat after some mixed earnings releases early in the European session. Swiss investment bank UBS reported mixed results - although profits rose 7 per cent in the fourth quarter in 2010 versus the same period in 2009 - investment bank profits slumped and it reported continued net withdrawals from its wealth management unit. This highlights the ongoing problems faced by the financial sector, which may keep a lid on stocks after yesterday's relatively strong performance.

Added to this dampening effect on stocks was news that the UK Chancellor George Osborne will increase the government's levy on banks by GBP800m this year. However, he justified the rise by saying that the UK's banks were strong enough to pay the full levy of GBP2.5b (it was cut by GBP800bn last year over fears the banks were not strong enough to pay) and thus should contribute to closing the UK's yawning budget deficit. This initially hurt the FTSE 100 as financials make up more than 21 per cent of the entire index.

In FX markets, commodity currencies remain well supported against the dollar, but the greenback has been able to claw back some losses against the major currencies. EURUSD is hovering just above the 1.3600 level after failing to break above 1.3650 earlier this morning. Also, GBPUSD looks like it is on shaky ground above 1.6150. The pound received a boost overnight after the RICS house price balance was better than expected at -31 per cent versus expectations of -38 per cent. However, even though this is the highest level since August 2010, it is still in negative territory suggesting that house prices remain weak.

As we mentioned yesterday, movements in the bond markets have reverberated across other financial assets. The break higher in Treasury yields on Friday boosted the dollar; likewise, UK yields have also risen sharply on the back of increased expectations of interest hikes in the coming months. However, yields are showing a bit of consolidation, which could fuel some short-term weakness in the greenback and the pound.

However, in the medium-term the fact that stocks, yields and commodities are rising together along with the dollar suggests that we are in a sweet spot for global growth. Usually a stronger dollar and rising yields don't equate to stocks performing as well as they have been. However, since yields and the dollar are coming off such a low base even the recent rise in 10-year bond yields are unlikely to adversely impact growth. Also, it's still questionable whether central banks will actually raise interest rates due to the uncertainties facing growth in the developed markets: debt burdens, increasing food and energy prices and fragile economic recoveries. Due to this, we could see this sweet spot prevail for longer than it would in more normal economic conditions. For now the spread between 2-year and 10-year Treasury yields continues to steepen, which is bullish for equities in the near-term as it shows expectations for rates at the short end of the curve to remain low with yields further out the curve rising at a faster rate.

Ahead today, regional Fed speakers will dominate the action as investors try to determine the direction of the Federal Reserve after a marked improvement in economic data. The Fed's Fisher, Lacker and Lockhart are all speaking. Fisher is considered hawkish and investors will be listening to his speech carefully as Lacker and Lockhart are non- voting members this year. Fisher is expected to reiterate that he would not support further QE after the second round of asset purchases expires in June.

Data watch:
UK 10:30 BOE's Andrew Bailey Speaks
Germany 11:00 Industrial Production sa (Dec) m-o-m 0.50% -0.70% 0.20%
United States 13:45 Fed's Lacker Speaks
United States 18:00 Fed's Lockhart Speaks
United States 18:30 Fed's Fisher Speaks

Best Regards,
Kathleen Brooks| Research Director UK EMEA |
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