Australia's first drop in the jobless rate in eight months announced Thursday turned out to be more than just a blip on the radar. Friday's lower than forecast U.S. payroll decline was preceded by an out-of-the-blue rise in Canadian employment. Equity markets are rallying after the government's stress-testing revealed a capital need of $74.6 billion between the 19 banks under scrutiny. All in all, investors are beginning to see a better landscape in economic terms than the severe conditions under which the stress testing was conducted. The dollar suffered as investors stepped up their appetite for riskier currencies and assets, while the bigger loser was the Japanese yen.

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The Australian and Canadian dollars this week rose to their highest points against the U.S. dollar since November as fundamental data supported the view that the commodity rebound was indeed signaling better growth prospects despite the fact that much of the current data points to a slowing of the contraction. The Canadian economy, which was expected to show a decline of 50,000 jobs in April saw employers add 35,900 bringing the rate of unemployment to 8%. June Canadian dollar futures rose more than a cent to 86.33.

The June Aussie dollar future rallied to 75.79 as traders assumed out performance of the Australian economy thanks to its proximity to China. The other major gainer on the week was the Mexican peso, which is tending back towards 13 pesos per dollar. The predicted rejuvenation of the American economy and the dissipation of fears over swine flu led investors to come back to the peso after a sharp drop lately. The U.S. buys 80% of what Mexico exports and so a healthier climate north of the Rio Grande has also boosted the desire for risk appetite associated with a kick-start to the Mexican economy. The peso has added around 5.2% this week against the dollar making it the best performer against the U.S. unit across the majors.

The yen remained depressed across the board but is currently relatively unchanged versus the dollar at ¥99.10 after today's key employment report. The rate of unemployment in the U.S. rose to 8.9% despite the smaller 539,000 reported job losses. There were also downward revisions to previous data. Earlier this week Fed chairman, Ben Bernanke said that ongoing and sizable job losses would continue throughout 2009 before the economy bottomed and finally turned around.

Today's report does confirm this with the number of jobs lost since the start of the recession now totaling 5.7 million. In the April report there were further large declines announced with factories shedding 149,000 jobs compared to a March loss of 167,000. Within this data 29,100 auto manufacturing jobs were shed. Builders shed 110,000 jobs in April after a March decline of 135,000 jobs. Financial services shed 40,000 positions compared to 43,000 the previous month while retail jobs declined by 46,700 compared to 63,900 in March.

As you can see the picture confirms that the contraction is lessening across just about all key areas. And the picture is supported by associated evidence from around the globe. What will be key to watch going forward is to what point the dollar loses ground. Some of the dollar's decline will likely be due to portfolio flows shifting between asset classes. In terms of the yen, we expect investors to relinquish the safe haven bid for it and so should expect a far weaker yen than we currently see. But we don't expect a devaluation of the dollar in the same way. At the margins this week we have seen dollar weakness. But this is through preference for currencies that will benefit from the predicted revival of the U.S. economy.

The danger looking ahead is that investors are overly optimistic today about the prospects for growth. Ask any central bank and they will lay it on pretty thick: The contraction is slowing and the recovery is a long, long way off. Sure that eliminates the need for safe havens, but investors are piling into the Aussie and Canadian in the expectation that the growth rebound will come fast and furious. Simply put it probably won't.

We admit that the stress testing under the assumptions that were adopted are now looking too stringent. However, this is no green light to take on a massive rebound in economic fortunes. Under those circumstances the banking system is likely staring down the barrel at combined losses amongst banks of $599.2 billion if loans continue to sour. With the largest portion of this being mortgage-related loans, which stand to lose out by $185.5 billion in the event of further contraction, the housing market has a crucial role to play in economic recovery. It's also highly unlikely that post-testing the banking system will either want to nor actually resume the size of loans that mortgagees wanted two and three years ago. Housing prices will continue to decline and so crimp consumer spending going forward. Today's positive data out turn hardly reassures us that unemployment won't reach double-digits by year end.