Brent spot crude probed below 127.00 in overseas trading, weighed by ongoing demand worries as well as expectations that Congress may still move to squelch speculation in energy markets. Concerns that Tropical Storm Dolly might turn into a hurricane and cause supply disruptions in the Gulf of Mexico evaporated yesterday as well.

All eyes will be on today's EIA crude oil inventory report. The market is expecting a drawdown in crude stocks, but looking for builds in both gasoline and distillate inventories. A surprise build in crude inventory would keep oil under pressure, while a bigger drawdown than the market is expecting could provide some support.

Charles Plosser, President of the Philadelphia Fed, said yesterday that the current "very accommodative stance of monetary policy will need to be reversed" to curb inflation. He added that he anticipated that the reversal "will likely need to begin sooner rather than later."

Fed funds futures fell on the comments and the dollar firmed. However, I remain skeptical that the Fed will launch a tightening campaign while the housing market is still reeling and the banking sector remains under considerable stress.

Fed funds futures for Sep show the odds of a 25bp rate hike by the end of Q3 are about 32%. However, the Dec contract is showing an implied yield of 2.32%, with a 25bp hike fully priced in and a significant chance of a half-point hike by year-end.

Paulson's standard line about a strong dollar being "very important" to the US doesn't really carry much weight anymore with the market. We've heard it way too many times and a strong dollar policy needs to be backed up by...well...policy. We haven't seen any sort of monetary policy that could be remotely construed as dollar positive for quite some time.

Mr. Paulson is convinced that Congress will approve a plan to backstop Fannie Mae and Freddie Mac this week and that will go along way toward reestablishing global confidence in US capital market. Meanwhile the CBO believes any such plan could end up costing US tax payers $25 bln over the next two years.

The market did seem to gain some comfort from reports that the GSEs may not have to tap the essentially unlimited line of credit if housing market conditions improve. I would argue that is a mighty big 'if' at this point, but the CBO puts the odds for this scenario at "probably better than 50%."

With $780 bln in GSE liabilities linked to subprime and Alt-A mortgages, the risks are considerable. If conditions in the housing market deteriorate further, the CBO estimates that propping up Fannie and Freddie could end up costing $100 bln.

Expectations of higher interest rates would normally have a negative impact on equities, so the market is obviously giving some weight to the rosier GSE scenario. I think after digesting yesterday's news further, we'll see a more moderate tone emerge. Meaning, stocks should retreat and gold should recover.

The dollar index rebounded back above 72.00 yesterday, clearing the 20-day moving average. However, in the grand scheme of things, action in the dollar is hardly a ringing endorsement of either the GSE plan or expectations of higher interest rates.

Undoubtedly there was some short-covering in the greenback yesterday, but I don't think position traders are aggressively buying dollars at this point. Let's just call the tone in the FX market 'skeptical'.

Signs of renewed weakness in the dollar are likely to spark renewed buying interest in gold. A rebound above 950/960 would be viewed as an encouraging technical signal, favoring a return to the high end of the recent range.

Gold Market Movers:

US MBA mortgage applications for the week ended 18-Jul -6.2%; purchases -6.7%, refis -5.6%.

EIA crude oil stocks for the week ended 18-Jul at 10:30ET.

Beige Book for 05-Aug FOMC meeting at 14:00ET, expected to show weakening economy and rising prices.

Canada CPI for June comes in at 3.1% y/y.

Eurozone industrial orders for May dropped 3.5%, well below market expectations.

UK BBA mortgage approvals fell to 21.1k, a new all-time low.

US housing rescue 'could cost $25bn'

Bush says Wall Street 'got drunk'

Global credit crisis takes hold in Japan

Why the credit crunch will hammer stocks as well as property

Investors rush to buy gold

Iran vows no nuclear concessions