FX Strategy Weekly

Market Outlook

Tactical view:

= PMIs to test bullish GBP/USD trend, GBP/CAD target 1.65

Dollar weakness coloured G10 fx markets in July but a stabilisation in speculative positioning begs the question if the currency is due for some reprieve in August. The path to a USD bounce remains uneven at best, but as the tide of positive Q2 corporate earnings subsides and scepticism surrounding EU peripheral spreads lingers, we wonder if safe haven flows could make a surprise return. Dovish statements by the BoE have so far been disregarded by GBP bulls but as the policy stakes are gradually raised, we think there is a possibility that GBP exposure is gradually reduced from technically overbought levels. The week ahead is dominated by the PMIs and US non-farm payrolls. Holiday disrupted trading conditions are likely to characterise daily flows. Demand for carry may keep the AUD underpinned even assuming for no change in RBA policy.

Recap

A strong week for the pound capped the month of July, with GBP taking weak consumer confidence and housing data in its stride. GBP rallied vs its G10 peers with the exception of the JPY and CHF, netting gains of 2% vs the NZ$, 1.9% vs the USD (topping 1.57), and 0.6% vs the EUR. The NZ$ underperformed the G10 after the RBNZ raised interest rates to 3% but warned of a slower pace of policy tightening in the months ahead. The rally in EUR/USD ran out of steam at 1.3107 and a negative report by Moody's on Spain caused profit taking to set in, dragging the cross back below 1.30 into Friday's close.

US Q2 GDP was in line with forecast at 2.4% annualised. An upward revision for Q1 to 3.7% vs 2.7% previously on the back of stronger inventories highlighted scepticism surrounding the durability of the recovery. The core PCE index accelerated to 1.1% vs 0.7%. In the UK, data confirmed the recent slowdown in housing market activity with prices dropping 0.5% m/m in July (Nationwide) and an easing in mortgage approvals to 47,600 from 49,500. The CBI reported a surge in reported retail sales to +33 in July from -5 in June, marking the biggest gain in three years. The MPC testimony to the TSC brought no change in policy perceptions and means next week should see the BoE keep BR and the APF unchanged.

Gilt yields and swaps shot up to one-month highs over the first part of the week but dovish MPC commentary on growth and month-end extension buying drove yields back down with the breach of key support levels triggering additional support. 10y yields hit a 3.52% high but ended the week at 3.33%, after piercing support levels and 3.45% and 3.40%. 5y swaps initially firmed to 2.62% but three days of lower rates followed and led swaps to close at 2.41%. The 3mth Libor/Ois spread widened 2bp to 25bp, the highest since last September. The 2y/10y swap curve ended the week close to flat at 200bp after having widened at 204bp. The 10y swap spread rose 3bp to 5bp. A £6.0bln syndicated 2040 IL auction was sold at a yield of 1.02%

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