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Tuesday September 20, 2005 - 10:54:30 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• FOMC guidance about future tightening prospects will be key for the USD – robust message seems
• ZEW survey shows sharp dip in sentiment for postelection responses.
• JPY backdrop remains positive – FOMC will determine preferred route for JPY strength.
• UK RICS survey less negative on house prices - mortgage lending better.
• USD-CAD at 13-yr lows

Market Outlook

EUR-USD continues to stabilise ahead of today’s FOMC meeting, encouraged in part by the lack of followthrough selling after yesterday’s German election impasse. The arrival of Hurricane Rita in southern Florida (and the Gulf thereafter) represents a potential extra twist to the debate on Fed policy and this is also keeping the market nervous about today’s announcement. However, it is what the Fed suggests about future policy that is perhaps more important than what they do with rates today (see below for preview). The Dec Fed funds future is currently at 96.04, discounting a touch more than a 4% funds rate. Fair value for the Dec future with a 4% funds rate on Dec 13 would be about 96.07 if one takes into account the upward drift in the effective funds rate that typically happens in the days before an expected rate hike - 96.10 if this is ignored.

On balance, while the FOMC may change the language of their statement they are likely to be unwilling to abandon the message of more rate hikes to come. If this is the case the USD should benefit, although the market may be a little wary about the impact of Rita. Yesterday’s low at 1.2100 is the main support level to look at on EUR-USD and this could easily break over the coming week if the Fed’s message is robust.

The ZEW surveys were weaker than expected, with the lower balances reflecting the downturn in sentiment after Sunday’s German election. 15% of responses were received after the election and they were apparently well down from those received before the result.

In the UK, mortgage lending came in a little stronger than expected at £4.3bn, although this probably reflects the August rate cut. The July number was weaker than expected and at the time the BBA said this might have been due to many waiting for an expected rate cut in August. Evidence of the weak consumer spending backdrop was provided by the reported fall in credit card borrowing. The RICS survey last night showed the proportion of surveyors reporting lower prices falling to its lowest level (-26%) for 11 months. This probably reflects some kind of reaction to the August rate cut and further improvements are needed to suggest a softening in housing market risk. 0.6720 and 0.6750 are the main parameters to look out for on EUR-GBP today. Risk is for a break to the downside. Cont…

Another strong showing by Japanese equities suggests an ongoing positive backdrop for the JPY, although the FOMC meeting may distract initially. On USD-JPY, it is important that it stays below 111.70-80, which is looking like the top of the current trading range. If this can hold a move back to the bottom end of the current range around 108.80-109.00 looks likely. This may be more difficult if the USD does manage to power ahead against the EUR post-FOMC, in which case EUR-JPY would have the greater downside potential to short-term support at 133.50 (and possibly lower). Today’s FOMC meeting will determine which is the better route to take for exploiting likely JPY strength.

The main development yesterday was USD-CAD, falling to a 13-yr low below the November 2004 level around 1.1720. This is likely to extend further today (1.1630 next support), although it may then revisit the old support level at 1.1720 before testing down towards 1.1500. The latter is now likely to be tested at some point in the weeks ahead, although it may not be a straight line. The FOMC today and Canadian data releases in general (such as wholesale sales today, retail sales tomorrow) are potential hurdles.

Day Ahead
US – there are two issues – 1) whether they hike rates at this meeting and 2) what they signal about the future. Indeed, if rates are left unchanged but there is a clear signal that rate hikes will resume in November and December this could turn out USD positive. If they were to hike rates with the message that there may be no more to come then this would probably be taken negatively by the USD.

The risk of them leaving rates unchanged because of the hurricane remains in place, although the boldness of the headline story in the FT last week stating that they will press ahead perhaps suggests otherwise. Still, there is now another hurricane (Rita) on the way and this may yet push them into a pause. More important is the statement and whether the Fed uses the current circumstances to change its language.

The more rates go up the less accommodative policy becomes, meaning that the ‘removing accommodation at a measured pace’ reference will at some point be rendered obsolete. Indeed, some members may feel uncomfortable with describing policy as accommodative with the funds rate getting closer to 4% (although given the broader yield situation they may be more comfortable in describing overall monetary conditions as still being on the easy side). The real funds rate is approaching an area that could be considered neutral (see chart). The Fed may now be looking for an exit from this language so that theyare left in a situation where rate hikes will depend upon the data and are not dictated by a set framework.

As we discussed ahead of the last FOMC meeting, the problem with changing the language is that it could send a signal about where the Fed believes the bottom end of a neutral range to be and they may not be comfortable about offering such clarity on a concept that FOMC members themselves probably don’t agree upon. One possible exit route is to state that a considerable amount of policy accommodation has now been removed, thereby leaving some vagueness about the issue, while at the same time saying that further rate developments will depend upon the data.

Furthermore, such a statement would also run the risk of signalling a pause in the rate cycle, but if as seems likely the Fed does not want to do this, they could always make some reference to the likelihood of further ‘measured’ adjustments in the medium-term if current data trends are replicated. It is how hawkish/dovish they are about the future that will likely determine the USD reaction and this should be supportive.


Data/event EDT Consensus*

US Chain store sls (w/e Sep 17) w/w 07.45 +0.5% last
US Housing starts (Aug) 08.30 2030k
CA Wholesale sales (Jul) m/m 08.30 +0.6%
CA Leading indicator (Aug) m/m 08.30 +0.3%
US Redbook sls (w/e Sep 17) m/m 08.55 +0.5% last
NZ Consumer confidence (Sep) 09.00
US FOMC meeting outcome 14.15 3.75%
US ABC consumer conf (w/e Sep 18 ) 17.00 -20 last
NZ Current account (Q2) 18.45 -NZ$2.8bn

Latest data Actual Consensus*
GB RICS house prices (Aug) -26 -32
IT Unemployment rate (Q2) 7.9% 7.9%
GB BBA mortgage lending (Aug) +£4.3bn +£3.7bn last
GB PSNCR (Aug) £4.6bn £3.4bn
EU ZEW expectations (Sep) 31.8 41.6 last
DE ZEW expectations (Sep) 38.6 45.0
*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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