• Interesting development of the FX market was noted in the past two weeks. When market focused on how central bankers defend the economic slowdown in the aftermath of the credit crisis, the US Fed and ECB surprised traders by turning their focus to fighting inflation.
  
  
• Fed Chairman Ben Bernanke in a speech to the International Monetary Conference held last week voiced concern about the impact of a declining dollar on inflation. He reiterated that Fed was working with the Treasury to "carefully monitor developments in foreign exchange markets" and interest rates were "well positioned" to promote growth and stable prices, cementing market's expectation that the central bank is done with the rate cut cycle. The inflation hawkish comment by Bernanke caught market by surprise, pushing the dollar to strengthen against most majors with USD/JPY knocking down key barrier at 106 and EUR/USD breaching the lower bound at 1.54. Bernanke's comment was echoed by Treasury Secretary Paulson and other top Fed's officials this Monday, including Geithner and Fisher, who even implied that intervention would not be ruled out to underpin the dollar.
  
  
• Meanwhile, ECB President Jean-Claude Trichet also delivered surprise in policy shift, remarking "heightened alertness" over growing inflation risks in the territory. As he hinted that a rate hike could come as early as in ECB's next meeting in July, the euro once rallied over 200 pips against the greenback in a single day, off the three-week low marked in early last week. Yet, Fed's comment this week erased the euro's gain, leaving the single currency with more obstacles for its run to 1.60.
  
  
• Looking ahead, FX market will remain volatile as policy comment, risk appetite and yield differential will wrestle to drive the currency movement.
  
  
• Re-surface of crude oil prices to level above USD 135 per barrel and renewed credit concerns have been pulling interest rates in different directions, leading in increasing volatility in the market.
  
  
• With the price of crude remaining at historically high levels, inflation risk is rising, which in turn shifts Fed's focus from reviving economic growth to fighting inflation. In fact, an increasing number of investors are expecting the US central bank to hike rates as early as in September this year.
  
  
• We are, however, more skeptical about the market's projection. While we no longer call for a cut, we only see interest rates remain on hold at 2% for the remainder of the year. Despite rising headline inflation, core prices, that is, excluding food and energy prices, in the US remain tame. The economy is still weak. In particular, with the sharp jump of unemployment rate in May, the US economy is at best described as fragile. Meanwhile, the credit crisis is by no means over. The latest downgrade of the ratings of three major US investment banks, including Lehman Brothers, Merrill Lynch and Morgan Stanley due to their deteriorating earnings outlook by Standard & Poor's is a case in point.
  
  
• Across the Atlantic, both the European Central bank and the Bank of England kept rates unchanged, at 4% and 5% respectively, at their regular meetings last week. ECB officials have been threatening to raise interest rates to cap rising inflation pressures. Given the hawkish comment by Trichet last week, it is likely that the central bank will put words into action and a rate hike may come as early as in the next ECB meeting in July.
  
  
• The situation in the UK, however, is worsening. The UK housing market is deteriorating fast as banks tighten credit standards and prices are falling. The BOE will be under more pressure to cut rates rather than following its eurozone counterpart for a tightening move.

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