By Kathleen Brooks, Research Director UK EMEA, FOREX.com

The dollar was generally bid for most of the London session; however it has managed to claw back some gains mid-afternoon, as the euro stumbled as it made attempts to crack 1.28. This has also been reflected in stock markets, which have also given back some gains as risk sentiment has started to wane. However, European credit markets continue to do well, and spreads between French, Italian and Spanish bond yields with German Bunds continue to narrow.

So as we think about positions for tomorrow the question we need to ask ourselves is: is this just a normal pullback in risk or are markets getting spooked about 1, Greek PSI discussions and 2, the long-term debt auctions coming up on Thursday morning for Spain and France? Both of these things are major stumbling blocks for risk sentiment and have the power to disrupt the recent recovery in risk assets that we have seen. So we could be back to choppy ranges as we head into the middle of the week.

But while Eurozone event risk remains high, there has been some undoubtedly good economic data coming from both sides of the Atlantic in the last couple of days. The upward trend in the Empire State manufacturing survey was re-affirmed today. The index rose to 13.5 in January from 8.2 in December, which is the highest reading since April 2011. The detail of the report was also positive with gains for the forward-looking new orders index and employment. This comes on the heels of other strong regional indices and highlights how manufacturing is driving the recovery in the US after retail sales slipped in December.

Elsewhere, German investor confidence survey the ZEW jumped in January, which adds to evidence that the markets consider the worst of the Eurozone debt crisis behind us. The increase in the forward looking index, which aims to forecast what will happen 6-months ahead, jumped from -53.8 to -21.6, the largest monthly gain in the history of the ZEW. So it seems like the ECB's super-tender of long term debt last month is having a soothing effect on German investors.

In the UK inflation fell sharply to 4.2% annual rate from 4.8%, which is the lowest level since March 2011. This could ease pressure on household finances and boost consumer and business confidence. Falling prices may also help to mitigate some of the expected damage to consumption from a deteriorating labour market. However, we think it will weigh on the pound as it gives the BOE more reason to do QE at its February meeting.

So things are moving in the right direction and the ECB's liquidity support for banks has had a profound impact on investor sentiment, yet there are still some major concerns, mostly centred on Greece. The Greek PM will meet the IIF ? the negotiators on behalf of Greek bond holders ? tomorrow to re-start discussions about agreeing to private sector haircuts. These discussions broke down on Friday after the detail of the debt swap was considered unsatisfactory by the IIF.

These discussions need to pick-up in a better state than where they left off on Friday, otherwise fears will grow that without an agreement Greece will have to default on a bond maturing on 20th March. If these discussions don't reach some sort of conclusion soon then we could see markets start to price in the chance of a Eurozone break-up. But we continue to believe that the stakes are too high for European authorities to allow that to happen, so we think that some 11th hour agreement will be struck avoiding the worst case scenario from panning out in a couple of months' time.

Europe's bond yields moved lower once again today, however the EFSF ? the currency bloc's rescue fund ? has actually seen the yield on its debt move higher although it easily sold bonds at an auction this morning. This could be because the fund was downgraded last night by the EFSF, it could also be investors pricing in the chance that EU authorities will need to concede to private holders of Greek debt to avoid a painful default, which means that Athens' debt load won't fall by as much as expected, forcing it to accept another bailout loan further down the line...

EURUSD 21-hr sma support is holding for now at 1.2725, suggesting that could be a temporary low for the cross. Likewise, AUDUSD has also stabilised at 1.0390 after failing to sustain gains above 1.04, when it ran into 200-day sma resistance at 1.0415. EURCHF has hovered around the 1.21 mark after market speculation that it was a big option level. However, the Swiss economy minister came out today and said that EURCHF remained under -valued and that he hopes that upward pressure on the franc will start to ease sooner rather than later. This has eased some fears that the Swiss authorities would go soft on the EURCHF 1.20 peg post the departure of former SNB head Hildebrand, so watch out as there could be some sharp short covering the closer we get to 1.2050.

Gold has managed to hold onto its gains today and remains above the crucial 200-day sma support at $1,640 per ounce. The precious metal could trade in a tight range today between $1,640 and $1,660, the 100-day sma. The Brent crude oil price has managed to sustain gains above $110.52 per barrel after Saudi Arabia came out yesterday and said that it wanted a $100 per barrel oil price.

Watch out for UK unemployment tomorrow (expected to remain the same), US PPI and industrial production and German and Portuguese debt auctions.

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