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• Euro Finds Little Comfort in Regional Banks Passing the EU's Financial Stress Test
• Japanese Yen Finds Little Strength From Improved Tankan Business Forecast

US Rallies Ahead of NFPs on a Drop in Risk Appetite, Questionable Data
It may seem natural that the US dollar posted its largest daily advance in a month on the day that offers the most economic data for the week. However, there were significant headwinds working against a spark in volatility - much less a rally from the greenback. Tomorrow, we are expecting one of the most consistently influential economic indicators in terms of market reaction: US non-farm payrolls. What's more, the dollar's appreciation fights the general trend that the market has developed for the better part of seven months now; and countertrends are usually quieted when there is a fundamental blackhole just ahead. So, what was driving the dollar? Economic data? Forecasts from policy officials? Speculation? In the end, the currency's advance was a mix of all three.

For those that claim the dollar's strength was solely based on easily recognizable economic indicators; we need to point out that the steady appreciation actually began well before the US data crossed the wires. When we consider what has been the most influential fundamental current for the greenback in the past 12 to 18 months, we can spot today's primary driver. It wasn't hard to miss the pull back in risk appetite that began in the Asian session and maintained its bearing through the US close. In fact, matching the performance of the dollar, the benchmark Dow Jones Industrial Average closed its worst down day (in percentage terms) since July 2nd and has subsequently extended its deepest retracement in its long-term advance since the same period. This highlights one fundamental truth: that the dollar is still considered a safe currency. This will likely remain the case for the time being; but when the United States' pace of growth starts to overtake its counterparts and benchmark market yields pick up from record lows, this correlation will start to break down. Enjoy it while lasts. In the meantime, what was driving this turn in sentiment? This morning, the IMF released its World Economic Outlook and the statistics were unabashedly positive. The projection for the global economic contraction this year was revised up to a 1.1 percent drop from the 1.4 percent forecast offered in July. At the same time, the outlook for 2010 was bumped up from 2.5 percent to 3.1 percent expansion. As the largest world's largest economy, the US enjoyed a similar revision with next year growth expected to hit 1.3 percent rather than the 0.8 percent originally projected. However, with these growth expectations, we have to also take into account the results of yesterday's Global Financial Stability Report from the same group. The bank suggests we have only accounted for half of the total losses the financial and economic crisis has ultimately wrought. If that is the case, the argument for revenues and growth fueling a long-term bull rally are quickly diminished.

Data and policy officials would also do their part to weigh in on domestic growth. Fed Chairman Bernanke headlined a long list of names offering commentary today. Testifying to the House Financial Services Committee, Bernanke tried to deflate soaring expectations of recovery by saying he does not expect growth through 2010 to significantly reduce unemployment (itself a key component to establishing a true trend of expansion). He suggested the jobless rate will remain above 9 percent through the end of next year. Rolling back our forecast time frame, Fed's Lockhart was on the same cautionary thread; but he did remark that growth in the third quarter could run 2.5 to 3.0 percent and that the risk of a second economic dip had diminished. Today's economic indicators offered surprise; but the market would use the same moderating tone in its interpretation. The biggest release on the day was personal spending for the month of August which surged 1.3 percent or the most since 2001. However, it should be noted that this was not far off of expectations, was likely a one off and income only rose 0.2 percent. We should anchor the ISM report the other way. The 52.6 read was well below expectations and the first month over month decline the whole year; but we are more concerned with the trend in factory activity which is certainly promising.

Looking ahead to tomorrow; there is but one concern on traders' minds: NFPs. Forecasts are calling for another moderation in monthly job losses of a net 175,000 contraction with an uptick in the unemployment rate to 9.8 percent. It should be said that in the middle of trends economic series (growth, employment, factory orders, etc), the market prices in the trend rather than the month-to-month trend. Therefore, we will look at the general pace of the data rather than the monthly change (unless the jobless rate unexpectedly ticks down); and more importantly, we will monitor the general reaction from risk appetite to the data.

Euro Finds Little Comfort in Regional Banks Passing the EU's Financial Stress Test
The euro was generally mixed on the session; but the fundamental scene was rather disappointing. Top event risk was the EU's announcement that the regional financial market had passed its stress test. The details of this test are not fully known; but the officials say their assessment was extensive with a sample of 22 banks under a worst case scenario that assumed a 5.7 percent economic slump this year and 2.7 percent drop in 2010. Deeming the major financial institutions sufficiently capitalized, the group of finance ministers and central bankers suggested the member economies should still follow up on the test and work to further stabilize their markets. Measuring the market's reaction to this announcement, the generally bullish outlook from speculators has already priced in as much and skepticism is just as assured as it was in response to the United States' evaluation. For data, the bias was more straightforward. Holding greater impact, the Euro Zone unemployment rate rose as expected to a decade high 9.6 percent. Despite German and France's quick return to growth, it is clear that there are fundamental hurdles to a true recovery and eventual ECB rate hikes. Garnering less attention, German retail sales for the same month plunged 1.5 percent. This was the biggest contraction in 17 months (and the sixth in eight months); but this indicator is very volatile and often overlooked.

Japanese Yen Finds Little Strength from Improved Tankan Business Forecast
It is interesting to note that while risk appetite was tumbling through Thursday's session, the Japanese yen ended the session little moved against the dollar and pound. This is a sign that the traditional risk correlations are shifting. However, looking beyond risk; the economic outlook for the world's second largest economy incorporated important data. The business sector - considered a more immediate fix to the country's woes than a long-term return of domestic demand - offered a measured improvement in its outlook. The third quarter Tankan survey showed improvement across the board; but all the readings are still showing net expectations for contraction plans to cut spending were worse than expected at 10.8 percent. The IMF's decision to leave its forecast for growth through 2010 at 1.7 percent, coincidently seems warranted.

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Written by: John Kicklighter, Currency Strategist for