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Wednesday October 12, 2005 - 10:37:25 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD rebounds impressively after last week’s failure.
• Short-term upside risk is clearly building – key levels and data releases are the hurdles this week.
• FOMC minutes confirm recent Fed rhetoric.
• BoE’s King speech implies averseness to rate cut, but does he speak for the MPC majority?
• Australian labour market data due.

Market Outlook

The USD strengthened significantly yesterday and moved further ahead in Asia before falling back in Europe. The market remains torn between believing that the USD is about to break significantly higher or will instead merely lapse back within recent ranges. This certainly explains the choppiness to trading over the past week or so. The price action at the end of last week suggested that this latest upside USD attempt had failed, although the manner in which it has bounced back this week is impressive, indicating perhaps that last week was no failure but merely a false start. Overall, key levels still need to break, but the risk of a further USD upmove in the short-term is high. US data during the remainder of this week (including Thursday’s trade deficit and Friday’s retail sales) are potential hurdles, but they will need to be bad to avert more USD strength.

Key levels on EUR-USD are at 1.1900 (last week’s low) and 1.1868 (Jul low). Cable has more scope for movement given that its own 2005 low is well down at 1.7273. Indeed, it has already moved below last week’s low of 1.7511 and looks more vulnerable as a result of that. The early European morning low at 1.7392 is the main support to look at today. Above 1.2000 on EUR-USD and 1.7485 on cable would suggest some minor relief for both. USD-JPY is also close to key levels at 114.80- 115.00 having traded as high as 114.75 in early European trading. There would be significant upside risk above 115.00.

The FOMC minutes were in line with comments from Fed officials in recent weeks – namely, limited impact from Katrina, higher inflation risk and the need for further monetary tightening. Dissenter Olson wanted more time to assess Katrina, so it seems likely that his dissension will prove temporary. He has the opportunity to talk further on his views about the economy in a speech today – his first since the FOMC meeting. Greenspan speaks on Economic Flexibility, which was also the title of speech he gave a couple of weeks back on the economy’s ability to cope with shocks like Katrina. A similar message seems likely today.

In a speech last night, BoE governor King maintained that all MPC members should keep an open mind on the future path of interest rates. However, it was fairly clear from his comments that his own view is that the MPC should be more concerned about CPI at the present time rather than growth, not least because there was so much uncertainty about the latter. He said that “no more than one half of the pick-up in inflation can be explained by oil prices. Other factors are at work, such as
the pressure of demand on capacity over the past two years.” He went on to say that “the problem of where to set interest rates is compounded by uncertainty about the recent levels of demand and potential output. The extent of the slowdown is unclear, with mixed messages from official output data, business surveys and data on the labour market. So there is uncertainty about the rate of spending in recent quarters, let alone where it is likely to go in the near future.” This suggests that he will be against a rate cut in November, although whether this view is shared by other members of the MPC, who outvoted him in July, is less clear. The risk of a rate cut in November remains high. UK labour data this morning did not reveal any fresh factors – earnings growth remains subdued and labour demand is fairly flat.

The AUD slid back yesterday in the face of general USD strength and a speech by the RBA’s Stevens that failed to introduce any fresh rate hike risk. Further USD strength and a weak Australian consumer sentiment number maintained the downside pressure initially overnight before it stabilized later in the European morning. Additional downside risk would open up below 0.7500. 0.7535-50 needs to be won back to stabilise the situation and this will likely require a generally weaker USD or a decent Australian employment report tonight.

Data/event EDT Consensus*

US Greenspan on economic flexibility 08.30
NO Norges Bank’s Gjedrem speaks 12.30
US Fed’s Olson spks on economy 15.45
JP M2 plus CDs (Sep) y/y 19.50 +1.7%
JP Current account (Aug, sa) 19.50 ¥1.35trn
AU Employment (Sep) 21.30 +5.0k
AU Unemployment rate (Sep) 21.30 5.0%

Latest data Actual Consensus*
US ABC consumer conf (w/e Oct 9) -19 -20 last
AU Consumer sentiment (Oct) m/m -1.6% -13.3% last
JP Consumer confidence (Sep) 45.6 49.0
GB Claimant count (Sep) +8.2k +4.2k
GB Average earnings (Aug) 3m y/y +4.2% +4.2%
GB Earnings ex-bonuses (Aug) 3m y/y +4.0% +3.9%
* 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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