The downgrading of Greek and Portuguese debt ratings hit the Euro hard, and helped push the Dollar higher, as investors fled ‘riskier’ currencies and sought the relatively safety of the greenback.  The increased likelihood that Greece will not be able to service their debt is now a growing problem, which will impact all markets if in fact it happens.  The Euro is now trading at a one year low against the Dollar.

Today, Euro recovers mildly after having the largest fall against dollar in a year yesterday. ECB President Jean-Claude Trichet and IMF Managing Director Dominique Strauss-Kahn will brief German parliament in Berlin today and markets are hoping for some positive news from there. Also, there are speculations that IMF will increase its share of financial aid by EUR 10b from the current EUR 15b to EUR 25b. However, the overall market sentiments are still favoring dollar and yen for the moment. S&P’s downgrade of Greek government bonds to junk and rating cut of Portugal triggered wave of risk aversion flow and sent DOW down as much as -1.9% and closed below 11000 level while S&P dropped -2.34%. Nikkei followed by falling -2.57% today and remained weak throughout the trading session. Dollar index managed to risk on wave of flight-to-safety fund flow and broke recent high of 82.24 while Gold also jumped to above 1170 level.

S&P cut its credit rating for Greek government bonds by 3 notches, from BBB+ to BB+, to junk after assessing the political, economic and budgetary challenges the country is facing. Outlook remains ‘negative’ and further downgrade is likely if the Greece government’s ability to implement its fiscal and structural reform program turns out to be ‘materially’ weaker that what is currently estimated.S&P also downgraded Portugal’s rating by 2 notches from A+ to A-. The agency viewed the country’s fiscal and economic structural weaknesses are in ‘a comparably weak position to address the significant deterioration in its public finances and expected lackluster economic growth prospects over the medium term’.

While risk aversion dominates the markets, Aussie managed to stage a strong rebound today on stronger than expected inflation reading. CPI rose 0.9% qoq, 2.9% yoy in Q1 versus expectation of 0.8% qoq, 2.8% yoy. The strong inflation reading raised the bets that RBA will have another rate hike next week to cool inflation.

Looking ahead, FOMC rate decision will be the main focus today. Fed is expected to keep its Fed funds rate unchanged at 0-0.25% today and we do not see the Fed will remove the language for the time being. Rather, policymakers will revise up economic assessment despite warning employment situation.