The US dollar was stable against the euro but traded lower against a firm yen in the context of higher risk aversion. EURUSD traded in a 1.5638-1.5714 range while USDJPY traded from a high of 107.98 down to a low of 107.42. Equity markets fell sharply, with the S&P 500 down 2.3%, led by financial stocks and homebuilders. Treasury yields also declined, with the 2-year yield down 13bp to 2.61% and the 10-year yield down 11bp to 4.01%. WTI crude oil prices rose $1.10/bbl to $124.74 after falling $7.40 in the previous two days. Economic data overnight in the US was largely disappointing. Initial jobless claims for the week ended July 19 rose by +34k to 406k, above expectations for 380k, and above the revised 372k reading seen in the week prior. However, the 4-week average at 382.5k is still lower than levels witnessed in prior recessions. Existing home sales for June also declined by 2.6% m/m to a SAAR of 4.86 mln, below expectations for a decline to SAAR 4.94 mln. The deterioration in the Eurozone indicators coupled with lower oil prices is calling into question whether the ECB can lift rates in coming months. These developments are entirely consistent with our 3-month view, as reflected in our 3-month EUR put that we purchased back in mid-June, which is now coming back to life. The key question is whether oil prices are falling due to speculative forces or are falling due to fundamental developments. As we noted yesterday timely indicators of Asian demand, such as exports for Korea, Japan and Singapore all point to slowing growth and concern has been growing over the China growth outlook as the country combats rising inflation amid sharply lower stock prices. For now we maintain our 1 and 3-month forecast for EURUSD at 1.60 and 1.53 respectively.

The German Ifo business climate index for July fell to the lowest level since 2005 at 97.5 (con. 100.0, previous 101.3), suggesting an end to the economic upswing in Germany. The expectations index fell to 90 from 93.2, and the current conditions index fell to 105.7 from 108.3. According to the IFO institute there is no need for any ECB action in order to reduce inflation pressures up ahead. The less constructive ifo release came in, after French business confidence fell to 98 (cons. 100, previous: 102), and the German manufacturing PMI fell to 50.9 (cons. 52.0, previous: 502.6), the lowest level since August 2005. The German Services PMI was released at 53.3, above an expected reading of 51.5. However, the expectation component fell to the lowest reading since February 2003, also pointing to a less constructive outlook in the services sector. The deterioration in German growth conditions considerably decreases the probability for further tightening by the ECB; an outlook supported by lower crude oil prices. According to French breakevens, medium-term inflation expectations have reached a multi-week low, and if crude oil depreciates further we expect this development to continue. Looking ahead we expect EURUSD to remain vulnerable to the downside, and also remain short EURGBP from 0.7918, initially targeting 0.7400.

UK June retail sales have been released considerably below expectations at -3.90% m/m and 2.20% y/y (cons. -2.50% m/m, 4.40% y/y ; previous: 3.50% m/m; 8.10% y/y). Our economists note that the monthly drop is the largest since the inception of the series in 1986. The outturn is regarded to be consistent with recent surveys and corporate trading statements. As the MPC has placed weight on the surveys, the weak number will come as no major surprise to the committee. Nevertheless it removes relevance from the MPC minutes released yesterday, which showed a less dovish outcome than expected. We remain of the view that the downside in sterling is limited for now, and stay short EURGBP from 0.7918, initially targeting 0.7400. Investors' focus will now shift to tomorrow's preliminary Q2 GDP release. The market is looking for a 0.3% q/q rise; our economists forecast 0.2% q/q.

Swedish June unemployment was released at 8.1% (cons. 7.3%, previous: 5.9%), considerably above market expectations, confirming a trend of deteriorating growth conditions. However, price pressures are also on the rise, and producer prices have been announced at 3.0% y/y (cons. 2.9%, previous 2.9%). Although worries over upside risks to price stability remain intact, we expect the current tightening cycle to end soon. One further rate hike by 25 bp is our maximum forecast, and under such conditions the upside in NOK will be fairly limited up ahead.

The yen firmed overnight on higher risk aversion. Japan CPI released this morning was broadly in line with expectations. Nationwide CPI rose by 2%, slightly higher than market expectations of 1.9%. Nationwide CPI excluding both food and energy rose by just 0.1% y/y, against slightly higher than market expectations of 0% y/y. Japanese trade data for June released yesterday showed the first y/y decline in exports in five years. Overall exports fell 1.7% in June and in volume terms exports dropped 1.4%. The data showed drops in demand across the board. Exports to the US fell for the 10th consecutive month, led by a fall in the auto-sector. Exports bound for the EU fell 11.2%, and although exports to emerging Asia gained, the pace of increase to China slowed sharply to 5.1% from 12.2% in May. Our economists note that the trade data points to a very weak Q2 GDP reading (we look for a -0.6% q/q figure) and Q2 industrial production likely contracted for two consecutive quarters, which would be the first since 2001. The numbers are also indicative of a wider global slowdown, which will have significant consequences for Japan's export-driven economy. BoJ's Mizuno yesterday warned that the government may say Japan is in a recession and the central bank is more concerned about downside economic risks than inflation.

We revise our NZD forecasts in light of the RBNZ decision yesterday to begin its easing cycle. We are aware that it's a consensus view for the NZD to weaken but that has been the case for several months now and consensus has been consistently proven right. The underlying forces operating in the NZ economy with the household sector tightening its belts and financial conditions deteriorating are overwhelming any speculative positioning risk. We set our NZD forecasts against the AUD and choose to target AUDNZD at 1.31 over 1 month and 1.33 over 3 months, up from our previous 3-month forecast of 1.27. The forecast reflects not only our weak NZD view but also our expectation that AUD should hold up relative to its terms of trade and yield differentials owing to large China investment flows into Australia's resource sector.