The markets really are feeling good about themselves at the moment. In Germany the ZEW confidence figures released last week showed a huge increase in confidence from German investors. The figure surprisingly came in at a three-year high. \

In the US the fall in the Volatility Index (VIX) is an indication that volatility is reducing; markets are still inching up but it really feels as if there will be some sharp moves soon. The VIX is just below its level on 12 September, the day before Lehman Brothers went to the wall.

If you like this type of indicator then perhaps you should look at the Credit Suisse Fear Barometer which is up just above 16 – interestingly, a level which over the past year has seen significant falls in equities very soon after it was broken. The important thing here is to try to feel the market's pulse and look at as much data as possible. One indicator alone will not do.

Equity markets were trading fairly strongly for the first couple of days last week, with the Dow Jones getting fairly close to 8,600 on Wednesday evening. However, when the US Federal Reserve published the minutes of its last FOMC meeting, markets quickly headed south.

For those who believe the worst is over, the minutes really didn't make for pleasant reading. They showed that policy-makers saw "significant downside risks" to the outlook for the economy and were not convinced the so-called stabilisation would persist. Fed members downgraded their outlooks on most economic indicators. They are predicting a more severe recession this year and don't expect as rapid a pick-up in 2010. They also mentioned that the global financial system was still "vulnerable to further shocks".

On Thursday morning the Standard & Poor's ratings agency announced it had downgraded the United Kingdom's outlook from stable to negative. This leaves Britain's AAA debt rating in a precarious position. If this happens the UK would join the likes of Greece, Spain, Portugal, and of course Ireland.

The reasons for the downgrade are very clear. Like the aforementioned scorned nations, the UK's dire exchequer balance is of significant concern to its creditors. The budget deficit is expected to reach £175bn this year, which is more than 12% of its forecasted GDP. This is likely to be a continuation of a trend in national downgrades which, not so long ago, very few would have contemplated.

The market reacted sharply to the ratings announcement. We saw a massive 200-point tumble in the GBP/USD. It fell from $1.58 to $1.56 in the blink of an eye. The EUR/GBP moved with similar ferocity, shooting up more than 100 points back above the £0.88 level.

Dollar continues to take a beating

With last week's continued rise in economic optimism, the greenback took a bit of hammering as investors continued to move away from the supposed 'safe haven' currency. Tuesday's German ZEW confidence figure, which showed investor sentiment had risen to a staggering three-year high, was typical of the news flow early in the week.

At the time of writing EUR/USD is up around 2% for the week and importantly broke through the key resistance level $1.3740, which was the last peak in March.

Without wanting to sound like ECB president Jean-Claude Trichet, a weekly close above this level should be monitored very closely. If this does happen then there is room for a further move on the upside, with $1.40 being the next obvious target. This level should be hard to break through on its first attempt, but further attempts should see a move up to $1.4140 where a turnaround may be expected.

At current levels though going long EUR/USD is not great risk-reward, and from looking at the EUR/USD chart there tends to be a lot of erratic moves (in the short term) which makes life a little more difficult for a trader.

A 'safer' trade may be to look at EUR/GBP. Sterling has been on an incredible bull run of late, but it seems ready to take a bit of breather, especially after the S&P downgrade and persistent bearish IMF comments. The currency pair does tend to trade in a range, although it has been in a short-term downtrend of late. It now trades around £0.876, and it would be no surprise to see it back above £0.9 very quickly. A more patient trader would wait for an entry point around the £0.87 handle but then of course you risk missing the move.