The yen was once again the weakest major overnight with USD/JPY rising to a high of 119.40 by early London trade. The news from the land of the rising sun continued to disappoint as Machine Orders – one of the critical components of capital spending - fell by a much larger than expected -10.1% vs. forecast of only a -1.1% decline. Business investment and capital spending have been the primary drivers of Japanese GDP growth while consumer demand has remained lackluster providing little fuel to the economy.

Therefore, tonight’s downward surprise suggests that Japanese growth which has been so export-dependent may slow going forward, especially in light of the fact that tonight’s Eco Watchers survey – the best measure of the country’s consumer sentiment - slipped deeper into contractionary territory below the 50 boom/bust line, printing at 44.7 versus 45.5 the month prior. In short, tonight’s data brought back the carry trade as the dour economic news out of Japan indicated that BOJ is unlikely to raise rates in August, while yesterday’s FOMC announcement assured the markets that US rates will not be lowered from their present 5.25% rate at least for the time being.

As part of the carry comeback, the high yielders caught a mild bid, with the Australian dollar rising steadily throughout the night after RBA raised rates as expected to 6.5%. The Australian central bank offered no forward guidance, but noted that so far the fallout from US sub-prime fiasco have had little impact on Australian growth and inflationary pressures persisted throughout the system. Overall, the message from G-10 monetary authorities appears to be that those economies leveraged to Asian demand are far less vulnerable to US slowdown as China becomes a potent agent of global growth, irrespective of US economic conditions.

Those sentiments were echoed by the BOE today as well in the bank's quarterly inflation report. The UK central bank confirmed market expectations that another rate hike to 6% is likely by Q1 2008 and noted that a material upside surprise to UK growth was possible. The BOE, much like the RBA, stated that global growth will be driven by Asia, and predicted that UK inflation will not subside to the 2% target before 2009, rather than the initial forecast of 2008. After an initially fluttering lower, the pound steadied on the news and built some upward momentum going into New York trade as traders were reassured that the BOE will continue its tightening policy.

With little US data on the calendar today, currencies are likely to trade on interest rate and risk aversion dynamics for the rest of the day. The broad picture that is taking shape in the FX market is that the rest of the G-10 world continues to follow tightening monetary policies as their growth remains buoyant, while US at best will maintain a neutral stance. Thus interest rate differentials between US and the majors will continue to move against the greenback, and the unit’s only near term support comes from the safe haven bid if equity markets once again take a plunge.

Boris Schlossberg is a Senior Currency Strategist at FXCM.