FX Strategy Weekly by Lloyds TSB

A correction in government bond prices and resulting rise in yields on the back of positive global macro data caused JPY crosses to stall over the past week and helped commodity and higher yield AUD, NZD, and CAD to consolidate early September gains. The leadership contest in Japan takes place next week and could add to speculation of BoJ intervention if Ozawa replaces PM Kan. We have included two pages illustrating G10 currency performance during the last period of BoJ intervention in 2003 and 2004. • Market Outlook

= GBP/USD adrift and decoupled from risk, downside favoured

A correction in government bond prices and resulting rise in yields on the back of positive global macro data caused JPY crosses to stall over the past week and helped commodity and higher yield AUD, NZD, and CAD to consolidate early September gains. The leadership contest in Japan takes place next week and could add to speculation of BoJ intervention if Ozawa replaces PM Kan. We have included two pages illustrating G10 currency performance during the last period of BoJ intervention in 2003 and 2004. Narrow trading ranges in EUR and GBP vs the USD belie a generally more volatile/averse profile for EUR and GBP crosses vs the G10 as investors re-adjust to developments in the EU periphery and growing signs of weakening UK activity in Q3. BoE governor King speaks next week and will be the highlight of a packed data calendar featuring CPI, employment and retail sales. In Switzerland, we doubt that the SNB will reintroduce a policy of Franc intervention. Our second special note discusses medium-term perspectives for USD and GBP.

• Recap

• Another week of range trading in FX saw USD/JPY fall to a 15-year low before recovering to end the week 0.10% higher. The dollar reversed declines versus EUR, CHF, NOK and SEK, though it continued to fall against AUD, which benefited from strong jobs market data and its correlation with equities. The CAD also firmed, supported the BoC rate hike. Like USD, GBP too fell against all three commodity currencies but rose against the rest. GBP/USD had a volatile and directionless week that saw it dip below 1.53 and rise above 1.55, ending the week virtually flat. To varying degrees, EUR weakened universally after fears surfaced about the robustness of bank stress tests.

• UK data for July manufacturing and industrial production came in positive, though the trade deficit printed a post-War record above £8.5bln. The BoE stood pat leaving both the base rate and asset purchases unchanged. US economic data surprised to the upside with both the trade balance and jobless beating market consensus, though the Fed Beige Book recorded weakening activity in most Districts over the inter-meeting period. In Japan, machine orders surged and Q2 GDP was unrevised, though the trade and current account surpluses widened which may over time cause JPY to strengthen further. It was a quiet week for Euro area data releases. ECB member Stark warned that German banks may require over 100bln eur in extra capital.

• Benchmark 10-year yields in the UK, US and Germany rose 11bp, 9bp and 4bp respectively, recording a 2nd successive gain as rally in stocks broadened and corporates issued debt. A poorly received US 30y auction sent investors scrambling out of the long and ultra-long end, causing curves to steepen. 30y gilt yields have now risen 33bp since late August. The UK 2y/10y swap curve steepened and hit key resistance at 184bp. Scottish and South, and Abbey issued in sterling. The 2047 IL auction was covered 2.04 times.

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