FX Strategy Weekly by Lloyds TSB

The dollar index recovered all of its early April losses this week, clawing its way back up over 82.0. We look for the index to stay supported near term, possibly aided by the FOMC next week. Market Outlook

The dollar index recovered all of its early April losses this week, clawing its way back up over 82.0. We look for the index to stay supported near term, possibly aided by the FOMC next week. Though the words ‘extended period’ should stay in the FOMC statement next Wednesday, a more upbeat read on the economy and possible commentary on the timing of asset sales could bolster dollar sentiment. GBP crosses continue to trade quite well this month, shrugging off concerns of a hung Parliament and outperforming vs virtually all G10 currencies except the CAD. Above forecast UK March CPI data, arguably tempered by a below forecast 0.2% q/q increase in Q1 GDP, supports our view that the BoE may change tack in May as it revises up its inflation projections vs February. A departure from the ultra-dovish policy stance appears increasingly likely and could offset some of the prevailing bearish influence associated with the outcome of the general election. Though profit taking ahead of May 6 is probable, a bear flattening of the short sterling curve argues for buying GBP dips. We remain medium-term EUR bears and favour selling a relief bounce vs the G10 until details of a Greece bailout including a possible debt restructuring are published. The exposure of several EU states to Greek debt and fears of contagion through the periphery cloud the near-term outlook and should keep the single currency on the back foot.

Recap

• The JPY overtook the EUR as the worst performer of the week in the G10, with higher stocks promoting short JPY exposure vs high yielders and commodities. USD/JPY finished the week over 2% high above 94.0. The EUR shed further ground as Greek bonds slumped and the cost of insurance against Greek default surged to a new record high. An EU/IMF bailout now only appears a matter of time and should help Greece past the 8bln eur debt refunding in May. GBP experienced a mixed performance, losing 1.1% vs the CAD and 0.1% vs the USD, but ended the week 2% higher vs the JPY and 1.1% vs the EUR.

• UK inflation data surprised to the upside in March. CPI accelerated to 3.4% y/y vs 3.0% and RPI rose to 4.4% y/y from 3.7%. Q1 GDP came in below forecast at 0.2% q/q, whilst the March claimant count rate fell to 4.8/% from 4.9%. March retail sales rose a smaller than forecast 0.4%. Public finances figures showed a smaller than expected rise in FY 2009/10 public borrowing to £152.8bln, £13.2bln below the Treasury forecast.

• UK 5y swaps broke out of their narrow trading range, climbing above 3.0% to a two-month high (3.06%). The 2y/10y swaps curve bear flattened below 220bp to 215bp, with 2y/10y cash narrowing through 280bp. Gilt auction drew solid demand. The short sterling strip sold off, with Dec-10 dropping below key 98.84 support.

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