USD strength continues on hawkish Fed focus. USDJPY trades to strong new highs, soon threatening 200-day moving average.

Bank of Canada surprises by keeping rates steady at 3.00%. More Fed appearances on tap for today.

MAJOR HEADLINES – PREVIOUS SESSION

• US Weekly ABC Consumer Confidence was steady at -45 vs. a fall to -47 expected
• UK May NIESR GDP Estimate out at 0.2% vs. 0.4% in Apr.
• Japan Q1 GDP (final revision) adjusted up to 1.0% vs. 0.9% expected and 0.8% originally
• Japan May CGPI rose at a 4.7% clip vs. 4.0% expected and 3.9% in Apr.
• Japan Apr. Adjusted Current Account out at ¥1,511B vs. ¥1,826B expected
• New Zealand May REINZ House Sales fell -52.9% YoY vs. -45.5% in Apr.
• Australia June Westpac Consumer Confidence fell -5.6% vs. +2.7% in May
• China May PPI rose 8.2% vs. 8.3% expected and 8.1% in Apr.

THEMES TO WATCH – UPCOMING SESSION
Key Risk Events (All times in GMT)

• France May CPI (0645)
• UK May Jobless Claims Change (0830)
• UK Apr. Avg. Earnings (0830)
• UK Visible Trade Balance (0830)
• Canada Apr. New Housing Price Index (1230)
• US Weekly Crude Oil and Product Inventories (1435)
• US Fed's Kohn, Fisher to speak (1530)
• EuroZone ECB's Stark to speak (1530)
• US Fed's Kroszner, Pianalto to speak (1615)
• US Fed's Bullard to speak (1700)
• US Fed's Beige Book (1800)
• New Zealand May Business PMI (0000)
• Australia Unemployment Rate and Employment Change (0130)
• China May CPI (0200)

Market Comments

New highs in interest rates yesterday meant new lows for the JPY overnight as the market obsession with inflation continues to punish the yen. USDJPY traded to new highs and is now within striking distance of its 200-day moving average around 108.35 The affects of higher prices around the world continue to show up dramatically in Japan's current account surplus, which has fell nearly 30% from the previous month, mostly on rising costs of imports, especially oil. It seems the JPY may remain under pressure as long as rates are steaming ever higher with the damage to yield differentials that this entails. Still, we're wary of the potential for risk aversion to manifest itself soon again with a potential return of the credit crisis part 2, which will only be worsened by the pressure that higher rates will put on credit markets.

At a press conference yesterday, Treasury Undersecretary of the Treasury McCormick downplayed the potential for this weekend's G-8 meeting to generate any dramatic new statement on the dollar, pointing out that no central bankers would be at the meeting and saying that currency issues were not a formal part of the agenda, even if they would inevitably discussed to some degree. The Fed's Fisher, widely considered the most hawkish member of the FOMC (he dissented 3 times while the Fed was cutting rates since last year), was out with rather balanced rhetoric yesterday, saying that any rate rise would likely be gradual, and that he worried about rising inflation expectations, even if wage pressures are not yet evident. More Fed on tap today, though their scripts are not likely to add dramatic new information to the mix of what we have seen over the last several days. Also up is the Fed's Beige Book, the Fed's latest read on the state of play in economic activity, which is likely to offer a dour view on the situation. EURUSD is still in a range, and we use the 1.5400/1.5800 levels as our breakout indicators - though the downside is given higher odds at this point. Considering our view that risk aversion will eventually return, the key will be to see whether the USD is able to flourish in that environment as well.

The Bank of Canada shocked the market by not lowering interest rates 25 bps as expected, but keeping the rate steady at 3.00%. The Bank's assessment of the situation, it should be no surprise to us by now, has shifted dramatically to the direction of inflation. This development arrived just as USDCAD was pushing at the upper bound of the large range that has contained it all year. The shift in focus is likely to mean that interest rate differentials will have a harder time moving strongly in favor of the USD, and other factors like the price of oil will gain in importance. While the short term affects of the shift in posture from the BoC could result in a move stronger in CAD (particularly in non-USD crosses), an eventual break higher in USDCAD is the default expectation.

The GBP seems to be riding the USD's coattails a bit and remains strong versus EUR and CHF, even as it was pulled dramatically lower vs. the USD yesterday. EURGBP is trading just below the 55-day moving average and could be headed for a follow up move lower, especially if the rising line of consolidation (now coming in around 0.7855) gives way in the days ahead. Any downside breakout will likely depend on EURUSD breaking lower as well.

Australia got a dose of bad news overnight with a sharp fall in Consumer Confidence after the previous month's positive move. AUD has seen little damage across the board in the last 24 hours as it seems to remain protected by its high interest rate. Still, one shudders at the thought of what will happen to this currency if we see a move toward risk aversion - the AUD strength appears woefully misplaced and may prove to be so down the road.

Another potential source of weakness for the Euro arrives tomorrow with the Irish vote on the Lisbon treaty, which contains modifications of the Maastricht Treaty on how the EU operates and must be ratified by all of the member nations before going into force. Ireland is the only country that is using a popular referendum for approval of the treaty. Polls suggest the referendum vote is too close to call. A non-ratification of the treaty would supposedly bring the EU to a halt. The situation is perhaps being portrayed as more dramatic than it actually is by the press. (We recall the situation in 2005 with the failure of member countries to ratify the new EU constitution). Still, a strong no vote from Ireland could be a sign of problems to come for the union, considering the diverse policy needs already evident as some member countries' economies are in dire straits while others are not.

Chart: AUDUSD
AUDUSD is at the tipping point once again as it finally broke lower out of the recent range and through the rising trendline from earlier this year (note that we saw a false break of the previous trendline in May). It is still trading above the 55-moving average, however. It would appear that it is either time for the pair to make a dramatic stand here and pop back up into the range, or to face a strong move lower as the longer term bulls are forced to give up their charge. Watch tonight's Australian employment report for a possible trigger.