FX Strategy Weekly by Lloyds TSB

The preference of investors to buy USD/G10 on dips ahead of the G20 meeting following supportive comments by US Treas Sec Geithner indicates that the phase of USD weakness may at least be temporarily exhausted. • Market Outlook

=> GBP: prel Q3 GDP to seal Nov MPC QE vote?

=> AUD vs CAD: correlation switches

The preference of investors to buy USD/G10 on dips ahead of the G20 meeting following supportive comments by US Treas Sec Geithner indicates that the phase of USD weakness may at least be temporarily exhausted. Having said that, currencies remain in a state of flux and USD selling may well still be the preferred course of action if central bank discussions this weekend come to nothing and discord over external imbalances and exchange rate coordination remain subordinate to individual economic interests. However, with QE2 in the US now fully discounted and risk reversals showing demand for USD puts stalling, a widening in EU peripheral spreads and profit taking in risk could tempt investors to trim USD short positions as the Nov 3 FOMC and Midterm elections approach. With S&P 500 and CRB indices running out of steam near 6-month highs, money could be taken off the table in high yielders and commodity currencies.

For GB P, six consecutive weeks of decline vs the EUR lifted EUR/GBP to a 7-month high above 0.89 as UK 2y yields hit a new all-time low below 0.60%. However, a resumption of asset purchases by the MPC in November is not a foregone conclusion and so a decent print for preliminary Q3 GDP on Tuesday (consensus 0.4% q/q) may force GBP bears to cover. For EUR/GBP, the question is whether EUR bulls are comfortable with a re-widening of peripheral bond spreads and more selective buying of EUR government debt. The ECB stated its opposition against the German/Franco accord to delay sanctions to 6 months for governments in breach of public deficit targets. The elevated correlation of EUR/USD vs GBP/USD with equities does bode well for further EUR/GBP gains up to 0.9140 if stocks can hold their ground. Other UK data next week features Nationwide House prices, CBI distributive trades survey and M4 lending ex-OFCs.

In the high yield and commodity arena, focus will be on CPI data from Australia on Wednesday. With just one week to go the RBA meeting, a stronger set of q/q price gains will tempt the balance towards a 25bp rate hike, in so far this has not been discounted. A fall in AUD/USD correlation with 2y swaps spreads indicates however that direction in risk assets should overwhelm swings in short-term rates. This is in contrast to USD/CAD where a correlation of 0.71 for 2y spreads tops that of the S&P (0.17) and CRB (-0.04) indices. In other words, as long as risk assets continue to do well then AUD/CAD should be in a position to move further above parity, targeting 1.0450 resistance.

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