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Wednesday August 31, 2005 - 11:16:40 GMT
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Forex:Mellon FX Daily - U.S. Edition

Key Points
• Oil prices continue to cloud FX market perceptions.

• More soft AUD data, UK consumer confidence weaker.

• Canadian GDP could influence BoC rate hike expectations. US GDP and Chicago PMI also due.

Market Outlook

Monday saw a downgrade in the expected force of hurricane Katrina, but during the course of yesterday it became clear that the damage inflicted had been fairly devastating, raising fears about the price of insurance, especially for oil operators in the Gulf. This has kept NYMEX crude above $70 p/b and fears about the impact of higher energy prices therefore remain in place. The degree of uncertainty this creates about future economic growth prospects will continue to discourage position taking in the FX market and this reduces the prospect of a range breakout for EUR-USD in the short-term. The main levels come in at 1.2125 and 1.2345, while 1.2160 and 1.2270 are the closer parameters of interest. USD-JPY has some risk up to 112.00-35.

As mentioned yesterday, the USD does perhaps have most to lose if growth and rate hike prospects are downgraded, as a fair degree of tightening is currently priced in (see below for more on Fed funds futures). The market may be more vulnerable to weak data this week as it would play on current fears about the impact of oil prices. Strong data would do little to eradicate such fears. However, a supporting factor for the USD is the flow out of emerging Asia back into a generally USD investor base. Weak US data would also further damage sentiment about growth prospects in Asia.

More mildly disappointing data for the AUD last night, with m/m growth in private sector credit the lowest since October 2002 and building approvals (admittedly volatile) falling sharply. Key today will be 0.7460. Below there would trigger a test of the key 0.7365-0.7400 area.

The CHF benefited from the stronger than expected KoF indicator, which again added weight to the argument that the downcycle in place since the middle of 2004 is now about to lift. However, the market may be loath to draw such conclusions with oil prices ramping up to new highs. A move below 1.5465 on EUR-CHF would allow additional CHF outperformance.

UK consumer confidence was weaker than expected, although market impact was fairy limited. Confidence remains well above the negative levels that have been place in previous bad times for the economy, despite all the talk of weak retail spending and a softening housing market. However, this does of course raise the question as to what will happen to retail spending if confidence were to fall back more sharply, perhaps because of a further weakening in house prices or the onset of rising unemployment. The desire to head off the development of such a negative dynamic is one reason for the recent rate cut. EUR-GBP is off the highs, but there is risk up to 0.6870-0.6900 while above 0.6835.

Day Ahead
US – Chicago PMI and the 2nd estimates of Q2 GDP and the core PCE price index are released. The market is already shifting its concern to what will happen to growth in Q3 and Q4 as a result of higher energy prices and the impact this could have on Fed policy. The Dec Fed funds future is currently discounting a rate of 4.03% compared to a recent closing peak of 4.10% and while this is just a modest fall it does represent a fairly significant reduction in odds in favour of a Dec 13 25bp rate hike. The Fed fund future does of course represent the daily average of the effective funds rate during the course of a particular month. Fair value for a 25bp hike on Dec 13 would be represented by the Dec future trading at 4.14% (95.86), while fair value for unchanged would be 4% (96.00).

Canada – GDP data will need to be unexpectedly weak to damage expectations about a BoC rate hike next Wednesday. The recent strength in oil prices is a double-edged sword as far as Canada is concerned, but the negative impact on the consumer and the non-energy sector is something the BoC will be aware of. This should only affect the tone of the message that accompanies next week’s 25bp hike rather than the hike itself, although there could be some more nervous moments if oil prices advance further between now and Wednesday. USDCAD rose yesterday, with some position liquidation driving the move. Further USD-CAD downside to the 1.17-1.18 area (possibly lower) is favoured in the weeks ahead but the BoC meeting needs to be seen before this can develop.

Data/event EDT Consensus*

US GDP (Q2, 2nd est) saar 08.30 +3.4%
US Core PCE prices (Q2, 2nd est) saar 08.30 +1.8% (1st est)
CA GDP (Jun) m/m 08.30 +0.4%
CA GDP (Q2) saar 08.30 +2.4%
US Chicago PMI (Aug) 10.00 61.0
US Fed’s Santomero spks on econ 12.45
AU Private new capex (Q2) q/q 21.30 +3.5%

Latest data Actual Consensus*
US ABC consumer conf (w/e Aug 28) -12 -9 last
JP Ind prod (Jul, prel) m/m -1.1% -0.5%
AU Building approvals (Jul) m/m -8.9% -1.0%
AU Private sector credit (Jul) m/m +0.5% +0.9%
AU Current account (Q2) -A$12.6bn -A$13.6bn
JP Housing starts (Jul) y/y +8.3% -1.3%
DE Retail sales (Jul) m/m -0.6% +0.4%
FR Unemployment (Jul) -30k -5k
SE Consumer confidence (Aug) 14.2 9.0
DE Unemployment (Aug) -12k -20k
IT Retail sales (Jun) m/m -0.2% -0.4%
EU GDP (Q2) q/q +0.3% +0.3%
EU CPI (Aug, flash est) y/y +2.1% +2.2%
GB Consumer confidence (Aug) -4 -1
CH KOF leading indicator (Aug) 0.71 0.58
* Consensus unless stated

2005, Mellon Financial Corporation Note: Although obtained from sources believed by us to be reliable, Mellon Financial Corporation and its affiliates cannot guarantee the accuracy or completeness of the information upon which this report is based. This report does not purport to disclose the risks or benefits of entering into particular transactions and should not be construed as advice in any specific instance. The views in this report constitute our judgement as of this date and are subject to change without notice.
Ian Gunner 44 20 7163 5996 06.40 EDT Monday May 31 2005


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