USD stronger on Bernanke inflation comments. USD pushing at big resistance levels ahead of BOE and ECB today.

Drumbeat of bad news from banks continues in background. NZD pummeled across the board on Bollard's rhetoric.

MAJOR HEADLINES – PREVIOUS SESSION

• New Zealand RBNZ left the official Cash Rate unchanged at 8.25% as expected
• Australia Apr. Trade Balance out at -957M vs. -1700M expected

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

• UK May HBOS House Prices (0700)
• Germany Apr. Factory Orders (1000)
• UK BOE Interest Rate Announcement (1100)
• EuroZone ECB Interest Rate Announcement (1145)
• US Weekly Initial Jobless Claims (1230)
• EuroZone ECB's Trichet holds press conference (1230)
• Canada Apr. Building Permits (1230)
• US Fed's Kohn to testify before Senate (1400)
• US Q1 Mortgage Delinquencies (1400)
• Canada May Ivey PMI (1400)
• US Fed's Plosser to speak (1600)
• US May ICSC Chain Store Sales (1730)
• EuroZone ECB's Bini Smaghi to speak (1800)
• Australia May AiG Performance of Construction Index (2330)

Market Comments

The USD eked out new recent highs against many of the major currencies yesterday after further rather hawkish rhetoric from Bernanke at a speech at Harvard University. While Bernanke did say that evidence of an increase in inflation expectations is a "significant concern", he did not fell that there was evidence of the economy moving into a 1970's style wage/price spiral. The USD traded at new highs for the week vs. EUR and the other major currencies overnight on yesterday's developments. A continued strong drop in oil prices helped the USD and the ADP survey was also stronger than expected, though the market gives this survey little credence. It has shown little ability to predict the outcome of the monthly US employment report (the May employment report is up tomorrow).

The key test for the USD today will come with Trichet's press conference after the ECB interest rate decision, where no change is expected. The forward expectations in the market are calling for the ECB to possibly tighten policy by late this year, while many analysts feel that the ECB is more likely to move into an easing regime by then. Our view for now is that the ECB has its hands tied and that Mr. Trichet will need to increasingly nod toward the risks to growth in the broader EuroZone. In any case, Mr. Trichet's performance will bear watching: hawkish rhetoric that prepares the market for a hike would certainly be the biggest surprise (we consider this scenario highly unlikely). The key as always will be the balance of growth vs. inflation concerns. EURUSD is close to the tipping point, so the next couple of days are likely to provide the pivot for the pair either way...

The BOE is also up today and no change is expected from King and company either. UK home builders are out formally complaining that the BOE must cut rates. Also, a report out yesterday from the OECD gave Gordon Brown's government very low marks for irresponsible over-spending and said that the UK is more vulnerable to the credit crunch than any other large nation except for the US. The report also said that the BOE would be handcuffed on cutting rates due to inflation, which has been aggravated by the pound's weakness vs. the EUR over the last 18 months. It's catch 22 indeed for the BOE. GBPUSD has taken out almost all meaningful support ahead of the huge 1.9350 level - a break of which in coming weeks would possibly open up huge additional downside for the pair.

While the market is distracted with inflation talk, the drumbeat of bad news from banks is growing louder in the background and actually keeping rates under pressure. Yesterday, it was Ambac and MBIA that were in the spotlight with downgrade news from Moody's. Again, this kind of news is significant for risk appetite and could push JPY and CHF stronger if it continues.

Overnight, New Zealand RBNZ's Bollard grabbed a large megaphone and shouted as clear a signal as humanly possible that we should be selling the kiwi: he said he was likely to cut interest rates on a deflating housing bubble and found that the kiwi's decline was "desirable". This rhetoric clearly moves forward the rate cutting regime that was already partially priced into forward expectations for NZD from later this year to as soon as the next meeting. NZDUSD took a massive hit, down some 2% from yesterday's levels, and AUDNZD shot to a new 6-year+ high briefly. The path is clear for NZD, but the tricky aspect of trading the currency will be that traders are likely to become periodically over-positioned as the story is so obvious. In a relatively illiquid currency compared to the majors, the path lower for the currency, therefore, could be a choppy one.