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By FXCompass — Sunday, 21 March 2010

Europe is plunged back into uncertainty after Germany shifted its position in favour of an IMF aid rather than a EU bailout. Traders' attention will focus on this week’s EU summit at Brussels where a definitive solution to the Greek deficit problem is expected to emerge.

Meanwhile, risk-aversion is back in the markets which triggered heavy selling in risk-sensitive currencies. Both the euro and the pound suffered a topside failure and are heading back to last month’s lows.

Despite no change in the U.S. Federal Reserve speech in last week’s FOMC statement, favourable U.S. economical data suggest a rate hike might happen sooner than expected.

Europe still struggles to show tangible signs of recovery as inflation and employment are still under pressure. Moreover, rating agencies are still threatening to downgrade many of the European institutions.

On the other hand, commodity currencies are holding well. The Canadian dollar is approaching parity amid positive data and the expectation of a Bank of Canada rate hike by mid-year.

The Australian dollar remains strong and profits from growth in Asia, but it suffers from occasional risk-aversion selling.

We expect the dollar to remain well supported in the short to medium terms.

European currencies could find some relief on occasional short covering or positive data, but we expect their appreciation to be limited as long as sovereign risk fears persist.

We also expect central banks to remain cautious and keep their interest rates at exceptionally low levels until at least mid-year.