Europe's debt crisis entered another phase last week, one which promises to be even worse than the first two. Bond spreads of peripheral eurozone sovereigns continued to widen alarmingly on Friday, with Portugal the worst casualty. Indeed, the Portuguese 10yr yield rose another 18bp at one stage on Friday to 7.19%, after jumping 27bp on the previous day. Still ringing in the collective ears of Portuguese bond-holders is Willem Buiter's recent suggestion that the country is 'quietly insolvent'.

The abject performance of PIGS' bonds occurred despite soothing words of love and support from China and some tentative buying by the ECB. Portugal is due to issue its first bonds for 2011 mid-week in what will be a key test. Der Speigel reported on Saturday that both Germany and France will soon suggest to Portugal that it asks for bailout assistance from the EFSF in order to limit contagion within other markets such as Belgium and Spain, a claim denied by the German Finance Ministry.

Separately, Handelsblatt suggested today that EU leaders may discuss increasing the size of the EFSF at their next summit in February, a proposal that Germany has argued against over recent weeks. The euro continues to struggle - overnight, it fell to a three-month low of 1.2867, now at 1.29. A major beneficiary of the euro's latest woes is the pound - EUR/GBP fell below 0.83 overnight, from close to 0.87 just a week ago. For the year-to-date, the euro is the worst-performing major currency, whereas the dollar, the Canadian dollar and the pound have been the best-performing.

US jobs market on the mend. The US labour market may still be in intensive care, but the patient's condition is gradually improving. Although the 103K increase in December non-farm payrolls was below expectations, there was much to like about this survey.

First, payrolls for the previous two months were revised higher by a cumulative 70K. As a result, the three-month average change in employment of almost 135K is well above that of the previous three months, when the average employment outcome was a loss of 30K. Second, the unemployment rate fell from 9.8% to 9.4%, although this was principally due to a 260K drop in the civilian labour force. Third, the number of unemployed declined by more than half a million to 14.5m, an outcome consistent with recent jobless claims figures. Very simply, it appears that layoffs have slowed right down to a trickle, while jobs' growth is slowly moving higher. These jobs numbers could still be regarded as tepid, but the direction of travel is in the right direction.

Dollar demand shows no sign of abating. As we have been observing in some of our recent commentaries, the renewed demand for the dollar has numerous motivations.

First, notwithstanding the powerful short-covering rally that propelled the dollar higher throughout November, there remains a significant groundswell of negativity towards the greenback. Both retail and institutional investors concentrated much of their investment activity last year on wealth protection from weak currencies such as the dollar and the euro - hence the sharp gains in gold, commodities, emerging currencies and the Swiss franc. This avoidance of the dollar seems to be fading a little, in part because confidence in the sustainability of the US recovery has grown. For instance, the gold price dropped back below $1,360 at one stage on Friday, down $65 since December 31st.

Second, investors still harbor serious doubts about the sanctity of the euro given the enormous debt refinancing-mountain ahead for both peripheral sovereigns and banks in 2011. Macro hedge funds have been very aggressive in terms of setting up fresh short positions in the euro in the first few trading sessions of this year. If Asian central banks had not been enthusiastic buyers this past week, then the euro would likely have been much lower.

Third, last week was the strongest for company bond sales in the US since mid 2009, with corporate issuance already of more than $50bn. European corporates have been keen to tap the US market, in part because of concerns over the future value of the euro, and also because of some real reluctance by European investors to buy more debt.

Finally, China is very much absorbed with bringing inflation back under control, and has been using its array of monetary policy tools quite assiduously over recent weeks with this objective in mind. Its determination has naturally triggered some concerns over what it could mean for China's economy. As a result, some commodities and commodity-based currencies have experienced a degree of profit-taking. In the short term, it is looking good for the dollar. Some intractable long term structural challenges remain, but for now those concerns are being set to one side.

China's European charm offensive. Although the euro has started the new year on the back foot, of real interest are the consistent words of support being offered by China. Last week, we had two instances where prominent Chinese officials expressed their financial warmth towards the Continent, the latest on Friday when Deputy PBOC Governor Yi Gang intoned that 'the euro and the European financial markets are an important part of the global financial system and ...will be one of the most important areas for China's foreign-exchange reserves'.

China's support for Europe, both verbal and in terms of cold hard cash, is very much consistent with its desire to reduce its dependence on the depreciating dollar. Simply put, China wants a viable, alternative major reserve currency, and it regards the euro as its best bet. Not only does Europe need the euro to survive and prosper, but so does the rest of Asia.

Trichet renews calls for stronger sanctions against fiscal miscreants. The ECB President renewed his call on Friday for stronger sanctions against those governments which break Europe's fiscal rules, on a day when bond spreads for the PIGS vs. Bunds continued to widen and Belgian and Irish CDS reached a record high.

China's trade surplus fell sharply in December. China's $13.1bn trade surplus for December was well below expectations and compares with a $22.9bn surplus for the previous month. For the year ended December, exports rose by 17.9%, and imports jumped by 25.6%. In 2010, China's trade surplus was $183.1bn, down from a $196bn surplus for the previous year. In recent months, it is possible that the dynamics of China's trade performance have started to change. It could well be that export growth is losing some momentum, possibly because competitiveness is starting to suffer somewhat because of rising inflation and accelerating wages growth. At the same time, it is possible that China's terms of trade is turning more adverse, which may explain why Beijing has been reluctant to allow the yuan to appreciate over recent months. Indeed, the yuan has lost 0.5% against the resurgent dollar in the last couple of weeks.