In the US session on Friday EURUSD traded in a 1.5668 to 1.5774 range while USDJPY traded up to a high of 107.95 from a European session low of 106.58 as risk appetite improved. Equity markets managed to reverse some of Thursday's declines, with the S&P500 up by 0.4%. This was despite an Australian bank last week heavily marking down it's valuation of ABS securities, which raised fears about the valuation of such securities on Wall St bank balance sheets. Treasury yields also rose reversing Thursday declines, with the 2-years up by 10bp, while the 10-years rose by 11bp. Finally, oil prices continue to decline despite stronger US data, with the benchmark Nymex crude oil futures down US$2.06/bbl from US$125.49/bbl. The fact that the dollar is not stronger in lieu of lower oil prices is an anomaly worth watching.

Economic data was supportive of equity markets and the dollar. Durable goods orders rose unexpectedly by 0.8% m/m against consensus for a decline of -0.3% m/m. The Uni of Michigan consumer confidence index for July also improved unexpectedly to 61.2 in July, above consensus from 56.4 and June's final reading of 56.4. Finally, Senate lawmakers on Saturday passed a package aimed at supporting the GSEs and the broader housing market. Data in the week ahead is unlikely to be supportive of the dollar in our view. Non-farm payrolls are due no Friday. Our economists are looking for a 75k decline in jobs on the back of last months' -62k release. This is below market consensus of -70k. Also, we expected advance GDP for Q2 to disappoint at 1% annualised versus consensus for 2.3%.

Last week's German Ifo business climate survey, which was released considerably below market expectations at a multiyear low, will likely keep upside momentum in EURUSD limited. Our economists believe there is a 35% chance of a recession in the Eurozone, as hinted by leading indicators and declines in both industrial and construction sectors, and most recent commentary from ECB members already hints to the direction of necessary downward revisions to growth. However, a material change in the ECB's outlook is needed to trigger a move towards and below the range-bottom at 1.5300, and a further decline in inflation expectations will be supportive to such a move. As such, it remains important to closely follow energy prices, which remain the main driver of inflation expectations in the Eurozone up ahead.

Ahead today, there is little in the way of economic events scheduled. Fed Governor Mishkin speaks at 1600 GMT. However, the topic is "Federal Reserve Communication Strategy", and sounds unlikely to include market moving comments.

UBS tracks positioning at the Tokyo Financial Exchange daily based on publicly released data. Our Friday update shows that Japanese margin traders have been buying NZD in significant amounts following the RBNZ rate cut decision. As of Thursday, total long NZD positions at the TFX were Y143bn, a record and almost double levels a week prior. There are more long NZD positions then in all the other G10 currencies combined. Given the low liquidity in NZD, if it wasn't for the Japanese, NZD would be even weaker following the RBNZ rate cut on Thursday. The activities of the margin traders are consistent with prior behaviour of buying the dips regardless of fundamentals. From our perspective, macro forces in New Zealand will force those positions to unwind and it's a matter of judging the pain threshhold in NZDJPY. We would probably not trade the yen in trade-weighted terms based on the data, but liquidity in NZD is low enough for the retail margin trading data to be meaningful. For clients that wish to track the TFX margin positioning please follow our daily Strategy Comment "Japan FX Margin Positioning" on FXWeb. Note that we treat the TFX data as a representative sample, as the TFX's market share of total FX margin trading in Japan is likely less than 10%.

Eurozone M3 for June rose by 9.5% y/y well below expectations of 10.3% y/y and down from May's 10.5% y/y, but still well above the ECB's preference for around 4.5% y/y growth. However, M3 growth has now declined steadily since its peak at 12.5% in November 2007, and the market slowdown is easing the pressure for additional tightening. At 9.8% (cons. 10.1%, previous: 10.4%) loans to the private sector also decreased. Our economists note that at 4.4% loans to households for house purchases declined to the weakest reading ever. Elsewhere, ECB Governing Council member Liebscher was on the wires, saying that the ECB has not exhausted its room for manoeuvre on rates. However, he also highlighted that interest rates are at a good level for the moment, and that a downward revision to growth cannot be ruled out. Looking ahead, we expect we expect EURUSD to remain vulnerable to the downside, and expect the pair to be a sell on rallies up ahead.

UK GDP for Q2 was in line with expectations at 0.2% q/q and 1.6% y/y and relatively unchanged from 0.3% q/q in Q1. Our economists note that they expect activity to slow further, with a distinct possibility of negative growth in H2 2008. The data is unlikely to have a major impact on policy rates up ahead, as the outcome will have come as no surprise to the MPC, and hence rates are expected to remain steady at 5.0% for now. However, and in a scenario of European growth conditions deteriorating considerably as confirmed by the most recent data releases, we expect sterling to outperform the EUR. We remain short EURGBP as a trade recommendation from 0.7819, initially targeting 0.7400.