EURUSD traded higher overnight to a high of 1.5767 from a low of 1.5718, while USDJPY traded down to a low of 107.35 from a high of 107.78. Equity markets traded lower on Monday following the FDIC closing two banks on Friday, with the S&P500 down by 1.9%. Meanwhile, 2-year yields slumped by 14bp to 2.58%, presumably in part due to risk aversion flows.

Economic developments overnight were limited to a sprinkling of Fed commentary. Fed President Stern (a voter) said that the credit squeeze in the US economy will persist for many months and said that its impact on growth could be yet to come. Meanwhile, Fed Governor Mishkin spoke on the subject of Fed communication and said that a numerical inflation target would help to anchor expectations. He said that having a credible inflation goal would aid international financial stability but he said that he wasn't sure if central banks should coordinate policy internationally.

The dollar is looking to consolidate on last week's gains as risk appetite stabilises but this week's data events may prove to be challenging. Consumer confidence will be released today and the market is looking for another decline to 50.0, down from 50.4 previously. Advance Q2 GDP may surprise (UBSe, prev. 1.0%, cons. 2.0%), but all eyes will be on Friday's non-farm payrolls report. The market is looking for a decline of 70k jobs (UBSe -75k) and for the unemployment rate to rise to 5.6%. Apart from US data, further signs of economic weakness in the Eurozone may support the dollar. Inflation numbers and PMI surveys due this week in the Eurozone may fuel speculation of stagflation developing, but how such developments will weigh on ECB expectations remains to be seen. We believe, and ECB officials have also pointed to, that inflation expectations are beginning to come down and confirmation of these trends will, especially through official rhetoric, will likely weigh on EURUSD. We continue to target the pair at 1.53 in 3m.

Ahead today, consumer confidence for July is due at 1400 GMT and the market expects a reading of 50 compared with 50.4 in June.

Employment data for June, released this morning, showed the jobless rate rising to 4.1%, against expectations that it would stay steady at 4%. Following this morning's labour market data the government has warned that job conditions in Japan are deteriorating. However, household spending data came in slightly better than expectations at -1.8% y/y versus consensus of a decline of -2.8% y/y. BoJ Deputy Governor Nishimura spoke with Market News International and said that the BoJ's policy options were 'wide open' amid growing upside and downside risks. While conditions at the margin are deteriorating, economic developments are still moving at a glacial pace, leaving the yen a function of external factors such as oil prices, risk aversion and global growth. We continue to target USDJPY at 105 over 1 and 3 months. There is a lot of talk of month-end investment trust launches in the market. At the margin, this could keep the yen weak heading into next week.

The German GfK consumer confidence sentiment for August came in lower than expected at 2.1 (cons. 3.5, prev. 3.6). The large undershooting of consensus forecasts comes on the back of last week's Ifo result, and is now at a 5-year low. All the components within the GfK registered large declines compared to the previous month, especially business cycle expectations which once again turned negative. The number marks a bad start to a crucial data week for the Eurozone. German CPI will be released todayand we expect an above-consensus reading of 3.3% (cons. 3.1%). Eurozone CPI will be released on Thursday (cons. 4.2%, UBSe. 4.1%, prev. 4.0%) and the readings are likely to be uncomfortable for the ECB. Our economists are now forecasting a 35% chance of a recession in the Eurozone, given crucial sectors such as construction and industrial output are already contracting. PMI numbers out of the Eurozone on Friday will likely confirm these trends.

The NAB business confidence index released yesterday fell to the lowest level since 1991, hitting -8 for Q2 from -4 during the previous quarter. The report warned that falling consumer confidence, rising borrowing costs and share market volatility is shaking business confidence. The result is the latest setback for the AUD, as concerns over the financial sector are mounting as domestic exposure US subprime securities continue to result in losses for banks., Australia Treasurer Wayne Swan said the Australian banking system is strong enough to withstand a hostile global financial environment and expressed confidence in the country's regulators. In other data, the Housing Industry Association home sales survey posted a 4% increase in June after May's 5% decline, but the report warned that activity in H1 2008 was still weak as borrowers faced high credit costs. The AUD has lost some of its shine over the past two weeks but strong commodity and asset inflows remain supportive, and any bounce in risk appetite would likely contain any downside.