[LehmanBr]

FX Markets have been hesitant recently and generally range-bound amid the typically thin liquidity of summer. Even as financial markets continue to slowly but consistently heal, currencies have not made a decisive move. Such lack of direction has led to exceptionally challenging trading conditions, despite a relatively constant run of macroeconomic data that have been surprising on the upside.

Traders still look for USD to drop against most G10 near-term
Despite the lack of firm market direction thus far, the broad forecast views are that 1.45 for EUR-USD for the end of Q3 and 1.50 at the end of Q4. It is expected that the combination of relative normalization in financial markets, as well as genuine improvement in the real macroeconomic data, will continue to fuel general USD weakness across the board through the remainder of the year. The lack of a pullback on the risk front and further capital flow returning to emerging markets should result in a continuation of a diversification demand bid for EUR-USD.

The one exception in the weaker USD call within G10 remains JPY, which has remained stubbornly strong because of factors such as rate differentials, as well as HIA repatriation flows. Some continue to expect USD-JPY to move to higher targets toward the end of the year (105 by December 2009) as Japanese investors go overseas in search of returns. However, the recent electoral victory of the Democratic Party of Japan (DPJ) does not push market to shift the JPY views either way. A number of previous DPJ comments around diversification of assets away from USD had caused some market jitters. But analysts do not expect a material change in FX policy, including FX reserve management policy, especially given how the DPJ has since walked back such comments.

Policy limelight
Macro policy news has generally been neutral to shorter-term forecast for USD weakness, primarily because most of the recent events have been expected. On the monetary front the reappointment of Ben Bernanke for a second term as Fed chairman also was not much new in the way of USD views in either direction, as another term for Bernanke had been the general market expectation. Meanwhile, the announcement of the nonpartisan Congressional Budget Office of a roughly $8.7tn cumulative deficit over the next 10 years was also greeted without much short-term market reaction.

The weeks ahead resume important macro events, highlighted by the usual US payroll number. Perhaps more importantly, each G10 central bank will be slated to announce rate decisions in September. Of course, markets do not expect any of them to announce anything in terms of actually hiking rates, and generally expect them to stay on hold for the rest of this year. But clearly there is still clear anxiety around the need to roll back loose policy, even if the recovery still exists only in nascent form. Some central banks are in a relatively more accommodative mindset, such as the Federal Reserve, the Bank of England and the Swiss National Bank. On the other side, economist expects the Reserve Bank of Australia may well hike as soon as November. Such aggressiveness is one reason why people remain positive on AUD.