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The dollar's correction came to an early end after Treasury's Summers called for the Japanese government and Bank of Japan to do more to resuscitate Japan's ailing economy. The downside move in the dollar had appeared to begin in earnest yesterday. Nevertheless, the dollar's bull move has not resumed and the risk is for choppy trading with a slight downside bias ahead of the weekend.

Summers suggested, in a way that only a senior U.S. official can, that Japan ought to further ease monetary policy. The Treasury aide cautioned against pursuing a weak-yen policy, but surely he, an eminent economist, recognizes that a weaker yen would likely be the consequence of the BOJ easing monetary policy further. This is especially true in the context of heightened fears that the

Federal Reserve

may contemplate rescinding at least one of the 25-basis-point rate cuts delivered in the midst of the credit crisis last fall. Summer's comments helped reverse the early weakness in the Japanese bond market, and the benchmark bond yield slipped 4 basis points to 1.885%.

In one of the few bright spots in the slew of economic data published by Japan today, January industrial production posted a 0.8% increase. This was at the upper end of market expectations, but below the 1% gain forecast by


. MITI now forecasts a 0.7% increase in February and a 0.4% rise in March.

Japan continues to work off its inventory overhang problem.

Inventories fell 1.7% in January, marking the ninth consecutive monthly decline. The inventory-to-shipments ratio fell 2.9 points to 104.3. When this ratio falls closer to 100, many market observers expect a more sustained recovery in output. This said, the inventory problem in part reflects excess capacity, which MITI has acknowledged it is looking at ways to reduce. Other economic data were not as favorable. Construction spending and housing starts continued to fall and by more than many expected.

While it is commonplace to talk about the deflationary forces in Japan, many are still reluctant to see a similar force at work in the eurozone. Yet for the record, Tokyo's CPI for February, reported earlier today, showed a 0.2% year-over-year rise; that is essentially the same increase as reported by Germany and France earlier this week. There is a clear consensus among European central bankers that eurozone interest rates are sufficiently accommodative. On one hand they say that the weakness of the euro, some 6% against the dollar since inception, is being driven by fundamental considerations, such as growth differentials. On the other hand, many have been critical of politicians like


, who they say are talking down the euro.

I submit that comments by key central bankers, indicating that the weakness of the euro is not a cause for concern, are more significant than the politicians' talk. Note that in a newswire interview an official at a large Japanese life insurance company expressed disappointment over the weakness in the euro and with the


for tolerating it. He suggested that Treasuries may be more attractive than eurobonds. A Japanese paper quoted other life insurance executives expressing a reluctance to buy foreign bonds, true to the general

pattern seen ahead of fiscal year-end.

The backing up of U.S. interest rates following Greenspan's Humphrey-Hawkins testimony has been excessive.

After today's GDP report, for which most are expecting an upward revision with a 6% handle, look for U.S debt instruments to begin recovering.

Because the June FOMC meeting takes place on the last day of the month, the July contract is a better gauge of expectations for the first half. At 95.07, the July contract implies about a 70% chance that the Fed hikes by 25 basis points. This seems excessive. Most Fed officials have argued that the outlook for U.S. monetary policy is uncertain. Global risks remain and the rise in U.S. rates aggravates these risks, at least on the margin. Seasoned Fed watchers still have to exorcise ideas that strong growth alone will prompt the Fed to tighten. This was the mistake many had made last year and some have apparently not learned the lesson. In the current environment, the backing up of market rates does the Fed's work.

To some extent, there is a single pool for long-term capital. So that the rise in U.S. interest rates has helped fuel a rise in European interest rates. German bonds, or bunds as they are called, are the benchmark for Europe. Ten-year bund yields rose 14 basis points yesterday to poke above 4% for the first time in three months. They are largely steady today. The German two-year note, which is more sensitive of course to interest-rate expectations, rose 11 basis points to an eight-week high.

No one is seriously arguing that the back-up in German rates reflects expectations of a tightening by the European Central Bank.

Instead, market flows (long liquidation) appears to be the driving force. The U.S.-German 10-year interest rate spread stands near 140 basis points, the widest in nearly a decade. Given the growth differentials, the risk is that the interest-rate spread will continue to widen on a trend basis.

Marc Chandler is an independent global markets strategist who writes daily for At the time of publication, he held no positions in the currencies or instruments discussed in this column, though positions may change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at