FX Strategy Weekly by Lloyds TSB

Comments by ECB council member Weber on the possible extension of unlimited liquidity until year-end have not gone unnoticed, casting a shadow of the ST outlook for the EUR. In a market short of liquidity and marked by a retreat of risk • Market Outlook

Tactical view:

= EUR/GBP: return to June low?

Comments by ECB council member Weber on the possible extension of unlimited liquidity until year-end have not gone unnoticed, casting a shadow of the ST outlook for the EUR. In a market short of liquidity and marked by a retreat of risk, Weber’s comments may hasten the decline in EUR/USD from the August highs. With risk beating a retreat, the success of Japanese officials to temper the decline in USD/JPY can be questioned and indicates that the cross may be settling in a range around 85.0. The perceptible weakening of the US economy in Q2 is showing signs of spilling over in Q3 and means the USD is set to remain a safe haven magnet along with the CHF. Unrevised UK Q2 GDP data next week may add fuel for a return in EUR/GBP to the June lows.

• Recap

• UK macro data continued to impress but ran into aversion for risk, resulting in a mixed performance for GBP vs other G10 currencies. GBP/USD fell 0.4% to 1.5532, having slipped below 1.55 for the first time since July 27. GBP/EUR ended the week virtually flat at 1.2226, but potential for a move to the upside appears to be building. EUR/USD dropped 0.4% and USD/JPY stalled above 85.50, logging a drop of 0.65%. A test of the Nov-09 low still looms, though reluctance to push the cross lower on a sell-off in stocks indicates that investors have become more wary of intervention ahead of the next BoJ meeting. The CHF topped the G10 table with solid gains vs the USD and EUR.

• Early indications show that momentum from UK Q2 GDP is carried over into Q3 at least on the consumer spending side. Retail sales rose a stronger than forecast 0.9% m/m in July, posting a third successive gain. June data were revised upwards. This will dampen speculation of the MPC soon resuming its asset purchase programme. The MPC minutes showed the committee voted 8-1 in August to keep BR and the APF on hold. Discussions included both an easing and modest tightening in policy. ECB member Weber stated his preference to extend unlimited liquidity until year-end. US economic data continued to disappoint. Reports of a jump in weekly claims to 500k and a fall in the Philly Fed survey to -7.7 mean additional Fed measures and stimulus spending cannot be ruled out.

• No change in theme. Bullish seasonals and weak US macro data helped gilts to extend their stellar performance, with 10y gilt yields dropping below 3% and EU 30y yields falling below 3%. For 10y gilts, the 2.93% low of 2009 is now within striking distance. Even as investors question bond valuations, there could be further downside for yields and swaps if UK data sours. 5y swaps dropped to 2.07%. The 2y/10y swap spread tightened to 182bp, with cash compressing to 234bp. The 10y swap spread held at +5.

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