Kathleen Brooks, research director at Forex.com, gives her outlook on the news and events affecting the currency markets.

Risk-on gets green light from payrolls
 
The risk-on rally spurred by the higher than expected reading of March’s payrolls data in the US has continued into the European session. Payrolls data have the power to determine the tone of markets for the rest of the month, and if the same happens this month it would be good for risky assets.
 
We saw AUD/USD make a new intra-day high over the Asian session of 1.0400. It hit 1.0417 but has since retreated to 1.0385/90. The Aussie is benefiting from two main forces: a pick-up in growth in the US and China after the Asian powerhouse’s PMI rose in March to 53.4 from 52.2 in Feb. Added to this, the  growth story is bolstered by lose monetary policy in the US.
 
Although there has been some talk of the Fed potentially stopping QE2 before its June expiry New York Federal Reserve president William Dudley suggested this was unlikely. He is arguably the second most important member of the Federal Reserve (Fed) after Ben Bernanke, so his views will be closely watched. Although the unemployment rate contracted in March to 8.8 per cent from 8.9 per cent in February, Dudley said that the Fed is still 'pretty far away' from its employment mandate. He also added that he wouldn’t be surprised to see core inflation tighten some more but the Fed 'can’t tie its hands' on an exit from its stimulatory monetary policy.

Inflation pressures are no doubt increasing as commodity prices feed into price pressure further down the inflation pipeline. The risk is that rising prices are not keeping up with wage growth. Although employment picked up in March, average earnings data was flat on the month and the annual growth rate was an anaemic 1.7 per cent. This contrasts with gas prices which are at their highest level since 2008. This suggests that households may remain constrained for some time yet.

Short-term Treasury yields came off slightly on the back of his comments, which fuelled some dollar weakness especially versus the euro and risky currencies like the Aussie. The focus will be on the European Central Bank  (ECB) this week as the markets get ready for the ECB to bite the bullet and become the first major central bank to hike rates. There is some concern that a single rate rise won’t stem inflationary pressures in the core economies of France and Germany, so ECB president Jean-Claude Trichet may have to signal further tightening during his press conference on Thursday afternoon.

Yet this would be another burden on the peripheral economies who are trying to reign in unsustainable deficits. So we would also look to Thursday’s press conference to find out how Trichet plans to navigate monetary policy while also warding off the deflationary impact from budget consolidation measures in Ireland, Spain, Portugal and Greece.

We think that the ECB will come down more strongly on inflation and will go to lengths to try and stub out inflationary pressures. This is the ECB’s main mandate and since Euro-area inflation hit 2.6 per cent last month we think the ECB may well signal further rate hikes based on the trajectory of future prices.

Ahead this week, central bank meetings (ECB, Bank of England and Reserve Bank of Australia) will take centre stage along with Fed minutes and economic data including the Services sector ISM due out tomorrow. Risk assets should remain supported in the absence of any adverse shocks and we think that USD/JPY will continue to trade with its upward bias. So far this morning European stock markets have traded with a slight upward bias. Market action may be rather more muted compared with Friday when the S&P 500 rose nearly 1 per cent. Also, watch out for Bernanke who is talking tomorrow. Although he isn’t scheduled to talk about monetary policy it will be interesting to see if he shares a similar sentiment to uber-dove Dudley.

Irish government bond yields remain fairly static after an investment bank published a bullish report with a buy recommendation on Irish sovereign debt, arguing that the stress tests were credible, and medium-term public debt levels will stabilise at the high, but manageable, 120 per cent level. It argues that if the banking sector stresses can be overcome then the focus will be on Ireland’s positive economic fundamentals. It will be interesting if this sentiment starts to spread. For now though Europe’s peripheral credit markets are likely to remain volatile.