FX Strategy Weekly by Lloyds TSB

A total breakdown in equities played out negatively for GBP considering the big jump in volatility with stocks in April. Tactical view

= Buy GBP dip on relief bounce in stocks, BoE QIR

= New trading range for EUR crosses

A total breakdown in equities played out negatively for GBP considering the big jump in volatility with stocks in April. With no clear indication on what political Parties will form the next government, we remain cautious and reluctant to buy GBP on dips. The dark clouds hovering over equities add to the uncertain outlook and may keep GBP on the defensive near-term vs the G10 until risk appetite returns. The sovereign debt crisis should not have a major impact on the way the BoE delivers its rate decision on Monday and Q2 Inflation Report on Wednesday. The sharp fall in equities and rise in libor rates are a bad sign and will force the BoE to navigate the sovereign headwinds carefully, with upward revision to inflation projections likely to spark a minor reaction.

Recap

• GBP came under attack following a dramatic sell-off in global equity markets and a much closer election result than hoped, losing 5.5% vs the JPY, 3.3% vs the USD. GBP did rally however vs other G10 currencies including the AUD, EUR, NOK and SEK. We remain cautious on buying GBP dips at this stage considering the political uncertainty, but a subsiding of risk aversion in equities offers attractive entry points for a short-term rally. The EUR suffered a heavy blow vs the USD, diving to a 1.2529 lwo on Thursday, before clawing back some ground to end the week at 1.2722. Key support in the 1.4320 area finally gave way in EUR/CHF, and dragged the cross to a 1.4006 low, with the SNB

• Solid PMI data underscored that the UK economic recovery remains intact as we move towards the middle part of Q2. We look for confirmation in the labour markets stats next week that companies are stepping up hiring, though this may be offset by reduced public sector employment. The Halifax reported a 0.1% m/m drop in house prices in April. The US economy added 290,000 jobs in April, the biggest gain since Mar-06. The ECB kept interest rates on hold at 1%.

• UK 5y swaps eased back form a 2.90% high to close the week at 2.85%. The long-end of the curve outperformed the front-end for a 2nd week running, compressing the 2y/10y swap spread to 206bp. Gilts underperformed Treasuries and bunds, whilst UK 5y CDS rose over 100. 10y swaps spreads widened to -12bp, bouncing off a -20bp. Dec-10 short sterling sold off to a 98.64 low before closing at 98.78.

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