FX Strategy Weekly

Market Outlook

Tactical view:

• GBP: selective gains targeted on AUD, CAD underperformance

Selling rallies in pro-risk and carry trade strategies is favoured in G10 currency markets and should translate into steady demand for safe haven harbours. We look ahead to next Tuesday when Japanese PM Kan will announce a plan to support the economy and tackle the JPY. With the SNB not explicitly targeting a level for the CHF, we wonder if safe haven dynamics may turn even more overwhelming in favour of long CHF positions. Next week also features US non-farm payrolls and the G7 meeting, promising a lively run in to September. If the relentless deterioration in the US economy observed this month is echoed in Friday's non-farm payrolls, then a precipitous sell-off in risk and AUD, CAD and NOK could follow. For EUR/GBP to progress towards the June lows, we look for resilience in the UK August PMIs and the ECB to extend unlimited liquidity operations until year-end.

Recap

Minor losses in the G10 were recorded early on but then reversed late on Friday for the CAD, NOK and AUD as risk aversion stalled and equities bounced. GBP lost ground as a result late on to close lower vs a selection of high yielders and commodities. GBP/CAD firmed over 1.64 to close 0.7% higher. GBP/AUD dropped 0.5% to 1.7285, and GBP/NOK gained 0.3%. With risk assets still in a tight spot and worries over a US economic slowdown multiplying, profit taking on rallies in high yield and commodity currencies is still favoured. USD/JPY ran into support in the 0.84 on comments by PM Kan. A 4bp widening in the 10y UST/JGB spread lifted the pair briefly over 85.0. EUR/JPY dived to a 105.44 low before veering up into the close above 108.0.

An upward revision to UK Q2 GDP to 1.2% q/q from 1.1% q/y along with a further surprise improvement in the CBI distributive trades survey in August underlined the ongoing resilience of the UK economy. This is in contrast to the US where a new salve of very weak data releases highlighted the increasingly fraught backdrop and danger of a further stalling in US activity in the second half of the year. Q2 GDP was revised down to 1.6% annualised. This puts the Fed closer to deploying additional stimulus at the September FOMC meeting to stave off a double-dip recession. Euro zone data in contrast to the US continues to paint a story of ongoing expansion in the core member states, with Germany and France reporting impressive business confidence and labour market data.

UK yields rose on a short squeeze in Treasuries on Friday but plumbed new lows earlier in the week. 5y swaps fell below 2% and 10y gilt yields dropped to an all-time low of 2.839%. The 2y/10y swaps curve flattened below 170bp, with 2y/10y gilts nearing 220bp on solid long end demand. The week ahead promises to be extremely lively as it coincides with the releases of the August PMIs and US non-farm payrolls set to dictate flows. The 10y swap spread widened to +9bp. The 3mth libor/Ois spread was unchanged at 23bp.

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