FX Strategy Weekly by Lloyds TSB

Resilience in high yield and commodity currencies took us by surprise as demand for risk staged an early September comeback and US payrolls proved better than feared. However, with the outlook for the US not ceasing to cloud over (services ISM, new manufacturing orders) but Washington mulling tax breaks • Outlook

= JPY: heading for BoJ intervention?

Resilience in high yield and commodity currencies took us by surprise as demand for risk staged an early September comeback and US payrolls proved better than feared. However, with the outlook for the US not ceasing to cloud over (services ISM, new manufacturing orders) but Washington mulling tax breaks, demand for AUD and NOK will stay sensitive to incoming US data and broader appetite for risk. The week ahead features central bank meetings at the BoJ, Bank of Canada and RBA. BoJ intervention may prove the only effective ammunition to reverse demand for the JPY, but may be delayed until after September 14. The emergence of cracks in the UK do not spell good news for GBP and confirmation of softening industrial activity next week could see sterling extend one of the worst starts to a month since January. We look for the BoE to stand pat on BR and APF target. Our special note this week discusses the outlook for the JPY and CHF.

• Recap

• USD fell against most G10 currencies as risk appetite resurfaced in the lead up to Friday’s non-farm payroll numbers and major equity and commodity markets rallied strongly. GBP continued to lose ground and dropped against every G10 currency. Among the most watched currency pairs, after dropping initially during the week, EUR/USD rallied 1% to 1.2886. GBP/USD recovered to 1.5444 after slumping by 1.3% at one stage to 1.5327, finishing the week down 0.6%. JPY remained firm against USD (+0.9%), GBP and especially EUR against the backdrop of continuing speculation about possible policy intervention by the BoJ, possibly after the September 14 DPJ leadership challenge.

· UK economic indicators showed significant slowing of activity. While, on the one hand, PMI surveys for manufacturing, services and construction showed a synchronised slowing of activity, on the other hand, the housing market saw the first back-to-back drops in average prices (down 0.9% m/m after falling 0.5% on Nationwide’s index). In the US, the uncertain economic picture got even harder to interpret. The ISM manufacturing index rose from the previous month (56.3 vs 55.5). The most significant release of the weak, Aug non-farm payrolls, came in better than consensus (-54k), but enthusiasm was tempered by a softer non-manufacturing ISM (51.5 vs 54.3 last) and decline in new orders.

· All major bond markets fell as risk assets posted handsome gains. Benchmark 10-year government bond yields finished the week higher for the UK (+11bp), Germany (+22bp), Japan (12bp) and the US (18bp). The sharp rise may be a reversal from overbought conditions (prices) after yields hit new all-time lows in late August. The major swap curves ended steeper with the 2y/10y spread widening 10bp in the UK, 11bp in the US and 18bp in Germany. The GBP 3mth libor/OIS spread was unchanged at 23bp. The 2014 auction was covered 1.69 times (0.7bp tail). Thames Water issued £300mln of 2030 paper at 250bp over gilts. The FTSE rallied 5.3% to close over the 200d MA at 5,400.

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