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

• Searching for the next crisis
• What's driving the dollar?
• Europe: what happened to the LTRO?

A couple of weeks ago the market was able to shrug off the prospect of a Greek default and a sharply rising oil price. Even weak Chinese economic data didn't de-rail risky assets. However, that optimism didn't last long and last week investors removed the rose-tinted spectacles and started to worry once more about the outlook for the global economy.

Last month China's growth rate was downgraded to 7.5% per year from 8%. Since China has a history of out-performing expectations this downgrade had little market impact. However, a fifth straight decline for the HSBC/ Markit manufacturing PMI survey reading and the markets are concerned that China could have a harder landing than first expected.

This is fuelling worries especially for commodity demand. China imports half the world's cement and bulk commodities, and a third of the world's base metals and soft commodities including agricultural products, so the market is taking notice. The steep decline in US and European equities this week suggests that a slowdown in Chinese growth was not priced in by the market and until we see some signs that China's growth has reached a bottom then it's hard to see how commodities and stocks can sustain a rally when the world's second largest economy remains in such a precarious position.

China is important to the financial markets not just as a major source of demand but also because of its huge FX reserves. If growth slows then its reserves will inevitably shrink. FX reserve diversification from China is considered one of the reasons why the euro has managed to hold up so well during the sovereign debt crisis. Now that China is slowing an important source of demand for the single currency may start to fade.

Rather than cause an outright collapse in the euro, it has caused choppiness as investors try to assess how severe a Chinese slowdown could be. In contrast, base metals and the Aussie dollar have been hit hard. AUDUSD fell nearly 2% last week. The market was behind the curve regarding China and now is rushing to price in weakness. The euro hasn't been as affected by this. However, if Chinese data continues to under-shoot expectations then the euro may not be saved.

As we have pointed out in recent reports, the daily EURUSD chart may be starting to form a head and shoulders pattern. Thus, if we fail to break 1.33 (what could be the top of the right shoulder) in the coming days then we may head back towards 1.3150 ? the neckline support ? and then 1.30.

But are concerns about China overdone? The market will eventually price in a slower pace of growth for China and there are some signs that it could be lagging smaller Asian economies. For example, Last month Singapore's PMI moved back into expansionary territory and Thailand has seen its economic data strengthen in recent weeks. Added to this, the US is still strengthening and the labour market is picking up, which could cushion the blow from a slowdown in Europe.

AUDUSD is still at risk from negative Chinese data surprises, but there are some tentative signs that the Aussie may be forming a base after a tough couple of months. The relative strength index in the daily chart has turned higher in recent days and the 100-day simple moving average held as good support. If China starts to show signs of life then the Aussie is poised to reverse recent losses.

What's driving the dollar?

The dollar index has traded within a relatively tight range this past week and looks set to post a weekly decline as U.S. Treasury yields back off after their recent rally. 10-year yields were rejected after testing near the 50-week simple moving average which is just shy of the October highs around 2.41%. The yield on the 10-year note has fallen to around 2.24% at the time of writing and continues to be supported technically while above the 200-day SMA that currently comes in around 2.18%. As yields declined so did the dollar, but not to the same extent as the drop in yields is partly due to risk averse investors seeking safety in Treasuries and therefore buying dollars. There are two main forces driving U.S. rates and the dollar in the current environment ? global risk sentiment and U.S. economic data surprises as they relate to Fed policy expectations.

Last week we noted a potential shift in drivers as the continued trend of positive U.S. fundamental data has reduced expectations of further monetary policy easing by the Fed thereby boosting yields and supporting the greenback. We also highlighted the return to a relatively calmer environment in sentiment with the removal of a tail risk after the completion of Greek debt restructuring. In recent days, risk aversion has resurfaced amid a deteriorating global growth outlook. PMI's released in Europe and China disappointed markets and elevated worries about a hard-landing in China and a deeper recession in Europe. This prompted investors to flee risky assets in favour of safe havens. As a result of increased demand in U.S. Treasuries, yields declined. The buck gained significantly against the commodity currencies, AUD, NZD, CAD, and NOK as fears of a sharper than expected global slowdown put pressure on the growth sensitive currencies and weighed on commodity prices. While the dollar remained in ranges against the CHF, EUR, GBP, and SEK, it was significantly weaker against the other safe haven ? the Japanese yen.

There are several Fed speakers scheduled next week including Bernanke, Dudley, Lacker, Lockhart, Yellen (all FOMC voters), Bullard, Plosser, and Fisher (non voters). Economic data due out includes the final revision to 4Q GDP (exp. 3.0%), consumer confidence indicators, durable goods orders as well as personal income and spending. We will be watching for data surprises as well as any shift in tone from Fed officials as USD drivers. Technically, the dollar index is likely to remain range-bound while support holds around 79.40 ? where the 50% retracement of the rally from 2012 lows to March highs and the daily Kijun line converge ? while resistance is seen at the convergence of the cloud top and Tenkan line (currently around 80.00). A sustained break of these noted levels would likely provide direction moving forward.

Yen strength may provide an opportunity

The yen outperformed in the G10 space last week amid increased risk aversion and positive Japanese data. The country posted a surprising trade surplus of +