FX Strategy Weekly by Lloyds TSB

Intervention by the BoJ and a surprisingly brutal reaction to SNB forecast revisions caused trends to shift in G10 currency markets over the past week and threaten to compound volatility over the coming days as the FOMC meets to discuss monetary policy and in the UK the Sep MPC meeting minutes are published. • Market Outlook

= USD: relief bounce on FOMC?

Intervention by the BoJ and a surprisingly brutal reaction to SNB forecast revisions caused trends to shift in G10 currency markets over the past week and threaten to compound volatility over the coming days as the FOMC meets to discuss monetary policy and in the UK the Sep MPC meeting minutes are published. The USD may be in a win/win position going into the FOMC. If the Fed are downbeat, the USD may benefit from a risk sell off, while if they are more positive, it may benefit from a back up in US yields as QE2 fears are put on the back burner. With the EUR suddenly back in favour and central bank intervention forcing investors to trim long JPY and CHF strategies, predicting flows under a ‘risk off’ scenario is not straightforward. Even though correlations with risk have rebounded, we are alert to retracements in EUR crosses as talk of debt restructuring flares up in the periphery and risk reversals signal a possible counter trend move.

Recap

• The BoJ intervened to weaken the yen through alleged unsterilised sales of JPY (tbc next week). The yen jumped in response from a low of 82.88 to the end-of-week highs in the region of 85.80 to the dollar. Despite strengthening against JPY, USD weakened against GBP and EUR as speculation persisted regarding QE2 amidst a slew of weak macro UK numbers. It was a strong week for GBP as it strengthened vs all G10 currencies from oversold levels. The EUR too rallied against G10 currencies except GBP, with concerns over Ireland causing a wobble on Friday. The SNB kept the policy rate unchanged but downward revisions for 2011/12 CPI sparked aggressive unwinding of long CHF positions causing EUR/CHF to spike 300pips before eventually settling below 1.32.

• It was another week of soft indicators for the UK economy with a weak RICS survey and a surprise decline in August retail sales. CPI inflation surprised on the upside as it stayed unchanged at 3.1% and BoE quarterly Inflation Expectations also rose. Amidst elevated inflation levels, MPC minutes next week are much anticipated but may not bring much clarity on the outlook for monetary policy. On the other hand, data in the US somewhat alleviated double-dip fears with rising retail sales and inventories, surveys showing stable confidence (though Michigan survey down) and declining initial claims to 450k. Core annual CPI fell below 1% in August to 0.9%, causing disinflationary worries to resurface. Euro zone industrial production was flat on the month and the ZEW survey showed declining economic sentiment.

• A turbulent week for government bonds dominated by mixed 2020 and 2030 gilt auctions and stronger CPI ended with yields closing at the lower end of the range. The front-end and belly of the curve outperformed the long-end, resulting in a steeper 2y/10y curve (through 240bp for gilts) and 10y/30y (103bp). The 2y/10y swap curve held steady in a range around 182bp pivot. 5y swaps climbed 7bp to 2.24%, retracing from an earlier 2.31% high. A busier than usual week of late for corporates brought sterling issuance from Bank Nederlandse Gemeenten (£200 mln 2015), EDF (£1.0bln 2050) and Co-op Bank (£400mln 2017). Co-op Bank (£400mln 2017).

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