EUR/USD

The Euro retreated to lows below 1.4380 against the dollar in European trade on Tuesday as the currency was unsettled by a deterioration in risk appetite and an unwinding of carry trades. The dollar was unable to sustain the advance and the Euro then staged a powerful rebound and pushed to a fresh 15-month high above 1.4520 during the US session.

The US economic data recorded a small decline in the trade deficit to US$45.8bn for February from a revised US$47.0bn, but there was a decline in trade volumes which will dampen expectations of first-quarter GDP growth and there was also a decline in the latest consumer confidence data.

Comments from Federal Reserve officials remained under close scrutiny and Governor Dudley stated that the employment situation was still not satisfactory and that first-quarter GDP growth could disappoint. The remarks reinforced expectations that core members of the FOMC would resist pressure for any monetary tightening in the short term.

There was a narrowing of German/Spanish yield spreads during the day which had some impact in easing fears surrounding potential Euro-zone contagion threat, at least in the near term. These fears are still liable to return in the medium term, but markets are still looking to focus on yields for now.

The Euro drifted slightly weaker to the 1.4470 area in Asia on Tuesday as commodity prices remained under pressure.

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Yen

The Japanese currency maintained a strong tone in European trading on Tuesday as a further earthquake and an escalation in fears surrounding the Fukushima nuclear facility undermined risk appetite. The dollar was also unsettled by a decline in US yields.

The dollar did find support close to the 83.50 area and attempted to rally to the 84.20 area, but the yen proved more resilient as underlying risk appetite remained fragile. There was also a decline in energy and commodity prices which maintained pressure for a reversal in carry trades. In this context, there was also some reversal in short yen positions as volatility increased.

The Japanese Cabinet office downgraded the economic outlook for the first time in six months, maintaining the increase in fears surrounding the economy. The budget outlook will remain an important focus with further market expectations that funding pressures will intensify.

Sterling

The latest UK inflation data was significantly weaker than expected with a decline in the headline consumer inflation rate to 4.0% for March from 4.4% previously, in contrast to expectations for an unchanged rate. There was also a decline in the RPI inflation rate to 5.3% from 5.5%.

The decline in inflation triggered a further re-assessment of Bank of England policy with reduced expectations that the central bank would increase interest rates at the May MPC meeting, especially given the bank’s continued unease over the growth outlook.

With a strong market focus on yield expectations, the shift in market expectations had a strong impact on Sterling with the currency declining to lows near 1.6220 against the dollar while there was also a decline to one-year lows beyond 0.89 against the Euro.

Comments from Bank of England members will be watched very closely in the short term to assess any shift in sentiment. The UK currency was also unsettled by a deterioration in risk appetite as volatility levels remained higher, but found support above 1.62 against the dollar.

Swiss franc

The franc maintained a strong tone in European trading on Tuesday as the deterioration in risk appetite supported demand for the Swiss currency. The Euro retreated to test support below 1.30 against the franc and the dollar also retreated to test support below 0.8950 which pushed it closer to fresh record lows.

Degrees of risk appetite will remain very important in the short term and there will be further defensive franc support if there is a further decline in commodity prices. High volatility is likely to remain an important short-term feature.

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Australian dollar

The Australian dollar dipped to test support below 1.04 against the US dollar during Tuesday as risk appetite deteriorated and there was a decline in commodity prices. The currency rallied firmly to a high above 1.05 in the US session, but the currency was unable to sustain the gains and weakened again in US trading.

Domestically, there was a small recovery in consumer confidence according to the latest data. Finance Minister Swann stated that the strong currency was a burden on the economy and there will be some speculation that the Reserve Bank will act more aggressively in increasing its buying of overseas currencies.