FX Strategy Weekly by Lloyds TSB

A rally in risk assets was accompanied by a fall in ST volatility this week, boosting demand for AUD, NZD and CAD. A rejection of key resistance targets and a lack of conviction in stocks leaves many participants pondering whether to further reduce risk exposure until clearer trends emerge. Tactical view:

= EUR/CHF: lurch lower as SNB decides?

A rally in risk assets was accompanied by a fall in ST volatility this week, boosting demand for AUD, NZD and CAD. A rejection of key resistance targets and a lack of conviction in stocks leaves many participants pondering whether to further reduce risk exposure until clearer trends emerge. The performance of sovereign debt and talk of a yuan reval will dictate near-term direction, though Q2 corporate updates from the US will soon appear on the radar as we move into the second half of June. A more hawkish inflation message from the SNB next week or a decision to drain liquidity could cause selling of EUR/CHF to resume. We continue to treat rallies in EUR/G10 with suspicion and reiterate our medium-term EUR/USD target of 1.15.

• Recap

• The fx summary virtually reads like a copy of two weeks ago with the AUD outclassing the G10 table backed by a relief bounce in risk assets and a recovery from technically oversold conditions. The currency rallied 2.9% vs the USD through 0.84 and gained 2.6% vs the JPY and 2.5% vs GBP below 1.72. Supportive comments by China briefly lifted EUR/USD over 1.21 but the cross ran into profit taking on Friday. A poor overall performance for GBP resulted in sterling losing ground against all but two currencies of the G10, namely the USD and the JPY. GBP/USD hit a 1.4759 high on Friday but reversed sharply into the close to finish below 1.4550, near the middle of the 4-week trading range. EUR/GBP bounced off a 0.8211 low to close over 0.83.

• The BoE left Bank Rate on hold at 0.50% and the asset purchase limit was also left unchanged, at £200bln. Inflation expectations accelerated to 3.3% from 2.5% according to the quarterly BoE survey, but proved no fillip to GBP or a concern to gilts as risk aversion drove yields lower. The UK global trade deficit narrowed to £7.27bln in April from £7.52bln in March. Input prices fell a smaller than forecast 0.6% m/m in May. Output prices rose 0.3% m/m (up 0.1% excluding energy). Manufacturing output fell 0.4% m/m in April, registering its first drop in three months. Confidence in economic recovery was buoyed by solid NIESR GDP data. Covering the three month period to May, GDP rose 0.6% q/q. Data for the quarter to April was revised up to 0.7% from 0.5%.

• UK 5y swaps closed below 2.50% after running up to a high of 2.57%. 3mth Libor held steady at 0.73%, causing the 3mth Libor/5y swaps curve to flatten to 176bp. The 3mth Libor/ois spread widened a fraction to 24bp. The 2y/10y swaps curve flattened to 194bp, the lowest since last October. Profit taking after a solid new 10y auction pushed 10y gilts to 3.58% on Thursday, but buyers returned on Friday, squeezing yields back below 3.50%. National Express (225mln) and KFW (800mln) issued sterling paper.