Financial Markets Review by Lloyds TSB

Currency volatility remains intense, as should be expected at a time of severe economic stress. It is still not clear what the timing, intensity and strength of economic recovery will look like, though some trends, which we highlight below, are beginning to emerge.

Summary of main changes to exchange & interest rate forecasts

Currency volatility remains intense, as should be expected at a time of severe economic stress. It is still not clear what the timing, intensity and strength of economic recovery will look like, though some trends, which we highlight below, are beginning to emerge. Further, the overlay of a financial market crisis on the economic crisis has led to a huge injection of public liquidity that is having an additional distorting effect on underlying financial market activity and trends. For instance, it is not clear what equity market activity or bond market yields would be like if there were to be a sudden withdrawal of public-guaranteed debt issuance and liquidity. Moreover, it is not obvious that the withdrawal of some of this liquidity currently in the markets is being factored into trading strategies.

Despite these caveats, however, it does appear that the worst of the economic downturn is over, and so attention is turning to the economies that will offer the best investment returns as recovery resumes. Our view is that significant challenges remain and it was no surprise that the Bank of England and the US Fed have signalled this, by maintaining quantitative easing programmes alongside ultra low interest rates. We remain of the view that the fundamental problems in the Japanese and German economies imply that their currencies will fall versus the US $ in the next twelve months. Recovery in these economies will be almost entirely dependant on world trade growth, as domestic savings stay high.

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