Financial Markets Review by Lloyds TSB

A run of better than expected economic data has meant that financial market sentiment has shifted from worrying about how bad the economic downturn is going to be, to looking for when recovery will start.

Summary of main changes to exchange & interest rate forecasts

A run of better than expected economic data has meant that financial market sentiment has shifted from worrying about how bad the economic downturn is going to be, to looking for when recovery will start. This is a big shift and explains why equity markets have bounced back and why long term bond yields have risen, and why some key commodity prices, including oil, are rising quickly.

Currencies are reflecting this change to some extent, with high yielding commodity currencies picking up particularly strongly. Our view is that the US$ is being sold too aggressively too soon, as the US will be the first of the major economies to benefit from global recovery.

We believe the US$ looks well placed to strengthen against its main trading counterparts over the next 6-18 months, primarily reflecting the prospect of a swifter return to economic growth in the US. There is a real possibility that the US economy may emerge from recession as soon as the third quarter of this year, well ahead of the euro zone, Japan and the UK. We forecast €/$ at 1.25, £/$ at 1.38 and $/Y at 107 at end 2009.

Rising government bond yields, in part reflecting sharply higher projected issuance, suggest that major global central banks will be required to do more quantitative easing than originally anticipated. However, money supply will have to be reduced aggressively and interest rates raised on signs of recovery to maintain price stability. We forecast that there will be no rise in official interest rates in the UK, US and euro zone until H2 2010.

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