FX Technical Strategy Weekly

Rumours of a hike in the US discount rate on Thursday proved unfounded but served as the starting shot of a rally in the dollar index, with monetary tightening in India on Friday triggering subsequent profit taking in commodity currencies.

Market Outlook:

Rumours of a hike in the US discount rate on Thursday proved unfounded but served as the starting shot of a rally in the dollar index, with monetary tightening in India on Friday triggering subsequent profit taking in commodity currencies. Accompanied by the increased aversion for EUR and GBP, the stage looks set for the dollar index to test the upper end of the trading range over the week ahead. Long high yield and commodity currency strategies have been crowded but understandably continue to attract decent sponsorship from the global investor community backed by falling volatility, a stellar run in equities and superior yield differentials in the G10. The CAD in particular should continue to do well as speculation builds of an earlier rate hike by the Bank of Canada. Dithering by officials at the EU Summit next week and failure to close ranks over Greece threaten to spark a wave of EUR selling, with the USD and CHF well positioned to make the most of EUR aversion and diversification flows. Hawkish comments by the SNB have sown confusion whether the Bank has now dropped its premise, repeated only two weeks ago, that it stands ready to curb Swiss Franc strength. A brief positive interlude for GBP came to a brutal halt as participants sell at better levels ahead of the Budget and February data releases of CPI and retail sales.

Recap

• The EUR dropped vs G10 currencies this week as disagreement emerged between France and Germany over assistance to Greece. The single currency shed 2.7% vs the NZD, 1.9% vs the USD and 0.8% vs GBP. Pro-risk sentiment and superior rate differentials for the commodity currencies boosted demand for the NZD, AUD and CAD. The CHF gained 1.4% vs the EUR and 0.7% vs the GBP, taking out key 1.44 and 1.60 technical support levels, boosted by hawkish SNB comments. For GBP/USD, the rally up to 1.5389 from the March 1 low (1.4784) faded on Thursday and sparked heavy selling on Friday, sending the cross plummeting below 1.51 as investors clear the decks ahead of the Budget.

• UK economic data surprised positively on claimant count (fall of 32,300 in February), public finances (smaller borrowing estimate in February) but disappointed on the outlook for industrial trends (weaker March CBI headline, offset by rising export orders). GBP/USD dropped three big figures from Wednesday’s 1.5389 high to slump to 1.5022. GBP/EUR finished the week 0.5% higher at 1.1097.

• UK 10y yields fell below 4%, helping the 2y/10y curve to bull flatten below 275bp and 10y swap spreads to tighten to -8bp. All eyes next week are on the Budget and the gilt issuance remit for 2010/11. We look for a decline in issuance from £220bn in 2009/10 with, possibly, a higher frequency of syndicated sales and mini-tenders.

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