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Wednesday November 2, 2005 - 12:49:03 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• The FOMC’s description of US fundamentals is USD supportive, especially if further US equity market gains/oil price falls can be generated.
• However, the market is now focusing on the ECB meeting and Friday’s employment report.
• AUD and NZD weaken.
• Norges Bank policy meeting, oil inventories feature today.

Market Outlook

The FOMC maintained a message of more tightening to come alongside yesterday’s 25bp rate hike. They retained the policy accommodation removal at a measured pace mantra and while measured pace is related to the lack of core inflation strength, the accommodation reference has become less relevant now that the funds rate is closing in on neutral territory. As noted yesterday, the real funds rate is now at 2% compared to its 10- yr average of 2.20%.

However, this was an upbeat message about economic activity – “Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, isproviding ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas.” They also warned about potential inflation pressures –“The cumulative rise in energy and other costs have the potential to add to inflation pressures,” but acknowledged that “core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.” On the face of it, they would appear to be describing a fairly sound set of fundamentals and in this regard further tightening in the near-term should not be a threat to the economy.

This is a potentially positive backdrop for the USD – more tightening with the likelihood of solid growth that could generate even more rate hike expectations. However, for today the market’s attention may switch to Thursday’s ECB meeting and the prospect of more anti-inflation sabre rattling, which is perhaps a fresher story. Nevertheless, this could quickly lose its shine if the market comes round to the view that actual ECB rate hikes may not be immediately forthcoming.

The US equity market failed to respond positively to yesterday’s upbeat FOMC message, but didn’t retreat that much either, which was significant perhaps given that all of the main US indices are close to one-month highs. Oil prices may hold the key to where things go from here and today’s oil inventories report could in turn determine whether NYMEX crude can hold the recent move back below $60 (3-mth lows). If stocks can gain some upward momentum, this should provide a better risk environment for the USD. Higher risk appetite can sometimes work against the USD if it promotes flows into emerging markets out of a USD investor base, but in this case it would likely boost the USD against the EUR, not least because it should help confidence in position-taking amongst short-term accounts. However, even if the equity market does strengthen further it may be difficult for the USD to benefit until tomorrow’s ECB meeting and Friday’s US payroll report are out of the way. The 1.2050-75 area needs to be overcome today if there is to be any extended rise in EUR-USD ahead of the ECB meeting. Support is at 1.1965-75.

The USD remained firm against the JPY overnight, where the rate differential arguments are more obvious. Risk to 117.50 in the short-term. The AUD and NZD have also been under the cosh. The RBA left rates unchanged and while this was widely expected, the AUD broke below key short-term support at 0.7440. This and the news of a terrorist threat to Australia left the AUD soft through Europe and the next big support is at 0.7365, although 0.7400 will have some psychological value. In New Zealand RBNZ governor was covering old ground when talking about the risk of a fall in the NZD, but the NZD did eventually follow the AUD lower in Europe. On the NZD, the damage was really done yesterday on the break below 0.6985, signalling a short-term top on the chart after failing to get through 0.7100-25 last week. There is now risk to the next support in the 0.6880-0.6900 area.

Day Ahead
Norway – a 25bp rate hike at today’s meeting, which coincides with the latest Inflation Report, has long been expected by the market and is consistent with the ‘small but not frequent hikes’ approach the Norges Bank declared when last raising rates on June 30 (also the time of the last Inflation Report). EUR-NOK has been attempting some downside ahead of the announcement, although unless there is an indication about a faster pace of tightening, downside looks less likely today with ECB speculation bolstering the EUR side of EUR-NOK.

Data/event EDT Consensus*

NO Norges Bank policy outcome & Inflation Report 08.00 2.25%
NO Norges Bank press conference 08.45
US Challenger layoffs (Oct) 10.00 71.8k last
US Weekly oil stocks 10.30

Latest data Actual Consensus*
US ABC consumer conf (w/e Oct 30) -21 -19 last
JP Monetary base (Oct) y/y +2.8% +2.3%
AU Building approvals (Sep) m/m +1.8% +4.0%
DE Employment (Sep) +41k +20k
DE Unemployment (Oct) -36 -19k
NO Unemployment rate (Aug, sa) 4.8% 4.7%
* 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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