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Tuesday November 1, 2005 - 12:19:17 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD awaiting fresh cyclical signals.
• German coalition validity thrown into doubt.
• US ISM manufacturing and FOMC meeting feature today. Funds rate moving closer to neutrality.

Market Outlook

EUR-USD has stabilised during the European morning with the market still showing little appetite for any fresh direction. The area around 1.2050 has once again proved to be a significant pivot point and this area – running from 1.2025-75 will remain important in the short-term. Key today is whether the market can garner any fresh momentum on the US rate story. ISM manufacturing and the FOMC announcement will be watched closely in this regard, while the performance of the US equity market and oil prices will also influence sentiment about US economic performance. NYMEX crude closed below $60 yesterday for the first time since July, while a very promising day for US stocks yesterday was pegged back after the close by a poor report from Dell.

If fresh US cyclical impetus cannot be mustered there is a chance of the EUR recovering as attention switches to the likelihood of a hawkish ECB message on Thursday, although this scenario has been undermined a little by developments in Germany, where the coalition government is in danger of falling apart.

The resignation of SPD chairman Muentefering after the party failed to back his candidate for SPD general secretary raises doubts about whether Muentefering is now a suitable voice for the SPD in pursuing coalition negotiations. As the CDU has pointed out, the SPD legislature needs to be behind what is agreed upon and the latest developments raise some issues over this. The candidate that was chosen for the general secretary post, Andrea Nahles, is a known left-winger and this would appear to represent a vote of no confidence in the coalition by the SPD membership. CSU head Stoiber signaled this morning that he was now unlikely to take up a cabinet post, after yesterday describing Muenterfering as a cornerstone of the coalition. If there is a source of comfort for the EUR it is that the economic data is performing well despite the ongoing mess in Germany, although it is likely to remain a constraining factor. Overall, direction may continue to prove difficult for EUR-USD this week. USD-JPY remains the more likely mover having established itself back above 115.00. There remains room close to 117.50 before it runs out of steam in the short-term.

Data releases this morning included PMI manufacturing releases in the UK and the Eurozone that were pretty much in line with market expectations. The Eurozone PMI rose to 52.7 (highest showing since September 2004) from 51.7, reflecting the improvements seen in other data. The UK reading of 51.7 is still quite low but is the highest recorded since December 2004. The CBI retail survey showed 18% of retailers reporting a y/y fall in sales volumes. This is up on the all-time low of -24% seen the previous month, but is still a very weak number. However, the Nationwide house price data reported this morning was strong. GBP has been looking fairly well supported after the multitude of M&A interest reported yesterday, but 0.6764 needs to give way on EUR-GBP to suggest more downside. Having rebounded a little, 0.6780 is now intra day support.

Day Ahead
US – ISM manufacturing and the FOMC announcement feature today. Last month’s ISM was stronger than expected and exceeded the non-manufacturing PMI by 6.1 points, the biggest margin since the non-manufacturing survey began in 1997. This gap should at least close and possibly reverse this month, although it is likely to be predominantly due to a recovery in the non-manufacturing number rather than a steep fall in the manufacturing ISM.

The FOMC are expected to deliver a 25bp rate hike and forcefully put across the message of the need for vigilance in addressing current upside risks to inflation. The bigger uncertainty is whether they change the language they use in describing current and future policy actions. Thus far it has been termed as a removal of policy accommodation, although as we have mentioned ahead of the last couple of meetings, this will ultimately come to an end when some members feel that rates are in neutral territory. Neutrality is a vague concept, although longer-term averages for the real funds rate can be a useful guide. The 10-yr average shown in the chart is currently at 2.20% and after today’s 25bp hike the current real funds rate will be 2.00%, so it is getting close. 15-yr and 20-yr averages stand at 1.96% and 2.37% respectively. Overall, the market will likely be left with the message that tightening will continue into next year.


Data/event EDT Consensus*

US Chain store sls (w/e Oct 29) w/w 07.45 -0.2% last
US Redbook sls (w/e Oct 29) m/m 08.55 +1.0% last
US ISM manu (Oct) 10.00 57.0
US FOMC meeting outcome 14.15 4.0%
US ABC consumer conf (w/e Oct 30) 17.00 -19 last
AU RBA rate announcement 17.30 5.5%
JP Monetary base (Oct) y/y 18.50 +2.3%
AU Building approvals (Sep) m/m 19.30 +4.0%

Latest data Actual Consensus*
CN PMI manu (Oct) 54.1 55.1 last
GB N’wide house prices (Oct) m/m +1.3% +0.2%
SE PMI manu (Oct) 57.7 55.8 last
CH PMI manu (Oct) 56.8 57.0
IT PMI manu (Oct) 52.0 51.8
FR PMI manu (Oct) 52.5 53.2
DE PMI manu (Oct) 53.1 52.5
EU PMI manu (Oct) 52.7 52.7
GB PMI manu (Oct) 51.7 51.6
GB CBI retail trades survey (Oct) -18 -24 last
* 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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