FX Strategy Weekly by Lloyds TSB

Risk assets continue to demonstrate very choppy and occasionally counter-intuitive price action, keeping volatility in major G10 crosses above recent norms. US non-farm payrolls data

• Market Outlook

Tactical view:

= Risk sentiment fragile

= Will CAD capitalise on blockbuster NFP gain, BoC rate hike?

Risk assets continue to demonstrate very choppy and occasionally counter-intuitive price action, keeping volatility in major G10 crosses above recent norms. US non-farm payrolls data, consensus +500k, should direct price action next week but with the Fed sidelined, concerns over counterparty risk, liquidity and sovereign debt will again determine appetite for risk strategies. A rate hike by the Bank of Canada and strong US employment data means the CAD is well positioned to outperform in the G10, unless this week’s bounce in equities proves nothing more than a dead cat bounce and the tentative reversal in leading macro data is repeated, prompting participants to see refuge in the USD and JPY..

• Recap

• The AUD outclassed its G10 peers this week backed by a relief bounce in risk assets and a recovery from technically oversold conditions. The currency clawing back partial losses of recent weeks, logging gains of 3.6% vs the EUR, 3.3% vs the JPY and 1.4% vs GBP. The EUR fell across the board, though comments by China on the EUR as a key currency in its reserve holdings helped EUR to contain losses vs the USD to 1.7%. A reversal in risk briefly lifted the FTSE back over 5,200, but confidence remains shaky as rising libor and tightening in money market spreads leak into confidence and economic data is showing signs of turning over at the start of Q2. GBP gained 0.3% vs the US but fell 0.6% vs the EUR, staying within the narrow confines of recent trading ranges.

• UK Q1 GDP was revised up to 0.3% q/q vs 0.2% q/q, supported by stronger data for business investment (first gain since Q2-08) and manufacturing output. Consumer confidence fell in May to -18 vs -16 in April, a 5-month low. The biggest surprise was the major reversal in the CBI distributive trades survey from +15 in April to -17 in May. Retailers are clearly anticipating sales volumes to deteriorate over the next three months, even without discounting a possible rise in VAT. MPC member Posen hinted that more QE could be possible and that asset purchases would not necessarily cause higher inflation.

• UK 5y swaps bounced off the 2.43% low, briefly climbing over 2.60%. With 3mth Libor edging up just 1bp to 0.71%, the 3mth Libor/5y swaps spread widened to 186bp. The 3mth Libor/ois spread widened to 22bp, the highest since last September. The 2y/10y swaps curve steepened to 206bp. Profit taking lifted 10y gilts briefly back over 3.60% but reversed back to 3.57% into Friday’; close on weaker stocks and month-end extension buying. The 10y UK/EU swap spread shot up 12bp to 59bp. The 4bln 2050 IL was priced yesterday at 1bp over the 2047 IL, or a real yield of 0.76%.

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