This is article is released weekdays under the heading Daily Fundamentals at 5pm EST on www.dailyfx.com

The US Dollar remained supported despite a sharp rally across Asian stock exchanges, diverging from risk trends on news the Treasury will sell a record $115 billion in bonds next week, boosting interest rate expectations and driving yield-seeking interest in the greenback. Germany's IFO Survey and UK Gross Domestic Product data headline the calendar in European hours.

Key Overnight Developments

• US Dollar Supported as Stocks Surge with Treasury Sales to Boost Yields
• Euro, British Pound Consolidate at Familiar Levels in Overnight Trading

Critical Levels

The Euro traded sideways in Asian hours, oscillating in a narrow 30-pip range below 1.4170. The British Pound tried higher to test above 1.65 but prices retreated late into the session, yielding an effectively flat result ahead of the opening bell in Europe.

Asia Session Highlights

With no major market-moving data on the economic calendar, forex market consolidated near familiar levels in overnight trading hours. Interestingly, prices seemed to look past a sharp rally on Asian stock exchanges, a dynamic that over recent months has meant losses for the safety-linked US Dollar. A similar divergence was on display in New York hours, with the currencies shying away from breaking key levels even as risk appetite continued swell. The greenback may be seeing support as traders react to the US Treasury's announcement that they will sell a record $115 billion in bonds next week. Treasuries declined as the news crossed the wires, with 10-year notes posting the largest daily loss in nearly seven weeks, sending yields to the highest level in a month. We have argued for some time that the US Dollar will benefit as the government issues debt to finance the rapidly growing public deficit: Treasury prices will head sharply lower as the market is flooded with new supply, putting tremendous upward pressure on the long-term interest rates. This will make USD-denominated assets attractive to yield-seeking investors, driving demand for the greenback.


Euro Session: What to Expect

Germany's IFO Survey of business sentiment is expected to rise for the seventh consecutive month in July, pointing to continued improvement in firms' 6-month economic outlook. Still, the reading is expected at 90.1, a print below the 100 boom-bust threshold, suggesting conditions are still deteriorating but at a slower pace. The Euro Zone Purchasing Manager Index is set follow a similar a similar trajectory, printing at 43.5 in July to show that the manufacturing sector shrank for the 14th consecutive month, albeit at the slowest rate since the metric hit a record low in February. Some recovery is to be expected as an array of fiscal packages from governments across the currency bloc filter into the broad economy, but the big question in the Euro area as well as most anywhere at this stage is whether growth is sustainable after stimulus cash dries up. As it stands, the latest economic forecast from the International Monetary Fund (IMF) reveals that the Euro Zone will stand apart from other industrialized economies in seeing economic growth continue to contract in 2010, pointing to a comparatively slower return to higher interest rates that will keep the Euro on the defensive against most major currencies.

In the UK, Gross Domestic Product is set to shrink -0.3% in the second quarter, a far smaller decline than the -2.4% lost in the three months through March and the smallest drop in a year. London-based think tank NIESR has forecast the moderation, saying the U.K. economy is now stagnating rather than continuing to contract at a sharp pace. Minutes from the last meeting of the Bank of England echoed the optimistic outlook, with policymakers saying risks to GDP have probably diminished and speculating that the economy may shrink less than was previously expected. Not everyone is as sanguine, however: the British Chamber of Commerce urged the BOE to add 25 billion pounds to their asset-buying scheme, saying a recovery is not guaranteed, a sentiment that has been echoed by the Shadow Monetary Policy Committee (a group of independent economists that meet at the London-based Institute of Economic Affairs). This makes today's report critical to shaping the market's expectations of future of monetary policy: traders will likely be less sensitive to a print in line with or better than what is expected, as this would only reinforce themes that have already been priced into the exchange rage; conversely, a disappointing outcome could weigh heavily on sterling as traders readjust their exposure to reflect a likely expansion of quantitative easing.


To reach Ilya regarding this article or subscribe to his email distribution list, please contact him at ispivak@dailyfx.com