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Tuesday November 8, 2005 - 11:35:16 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
More general USD strength likely short-term.
EUR-USD moves below 2004 low next support at 1.1589. Short-term outlook very negative.
ECBs Mersch offers hawkish tone on rates.
Few events of significance on todays schedule.

Market Outlook

There was only a modest recovery attempt from EUR-USD yesterday, encouraging more selling overnight and a further deterioration in the already negative technical picture. The 2004 low at 1.1759 broke in Asia and as one can see from the chart, the formation is extremely negative. EUR-USD has managed to stabilise a little during the European morning, helped by some ECB comments (see below), although short-term risks remain to the downside. 1.1775 and 1.1865 are levels that need to be won back to progressively stabilise the situation.

Apart from the lows highlighted at 1.1375 and 1.0765, there should also be some support at 1.1589 - 38.2% retracement of the move from 0.8230 (2000 low) to 1.3666 (2004 high) and this is the first target. However, there is clearly a danger that negative momentum will build very quickly in the short-term. Many technicians will now be calling for an ultimate move to the 1.00-1.05 area. Whatever the concerns about longer-term USD ills relating to the balance of payments, which will likely resurface next year, from a short-term perspective short EURUSD positions are strongly favoured. The latest IMM positioning data showed spec accounts small long EUR-USD and while this is now clearly out of date (last Tuesdays close), it suggests that there is little in the way of positional overhang to prevent EURUSD downside.

The French riots are also not helping the EUR, while talk of a German SPD/CDU deal involving a hike in both VAT and the top rate of income tax may also raise some questions about the German economic outlook and possibly the ECBs rate hike appetite. Other than this the economic data has been positive and if this were to progress further the ECB could justify a rate hike. Indeed, comments by the ECBs Mersch this morning reported on Market News, boosted rate expectations and also pushed the EUR higher for a while. He said the central message from last weeks meeting and press conference was that the ECB could raise rates at any time and that at the next meeting in December the ECB would also have the new staff economic projections. This has been taken as a veiled threat about the possibility of a rate hike in December, something that was seen as less likely after last weeks meeting. Given the
diversity and size of the ECB council it is not clear whether Mersch speaks for the majority, although it will provide some potential support for the EUR as the next meeting comes into sight.

Central bank diversification also remains an issue. As mentioned on Friday, there is of course no obligation for central banks to protect any levels on EUR-USD. In fact the lower EUR-USD is, the better the terms for them to diversify. However, any indication of stability after sizeable downmoves is likely to attract some CB interest and on the days when this occurs the price recoveries could be sharp. This in itself could potentially slow the EUR-USD downmove.

USD-JPY has been steady overnight, probably because the JPY has suffered already against the USD following its own technical break above 115. European currencies are now starting to play catch-up. However, short-term upside risk remains on USD-JPY while above 117.45. Resistance comes in at 118.41 (50% retracement of the 2002 to 2005 downmove from 135.14 to 101.68.

Other European currencies like GBP and the CHF are at risk against the USD in the short-term. USD-CHF now looks to have cleared the resistance area at 1.3080 and has scope up to 1.3230 initially ahead of 1.3805. Cable has fallen below short-term support at 1.7390 and now looks vulnerable to the 2005 low at 1.7273. Any move below that level would leave it open to a move into a range running from 1.66-1.71. The AUD has risk to 0.7225 ahead of 0.7000 and 0.6830, while the NZD ispotentially looking at 0.6686 ahead of 0.6410. As noted yesterday, the CAD will be vulnerable initially in an environment where the USD is moving quickly, not least because of the short USD-CAD positioning still in place. The growing threat of an election, even though such an event will ultimately mean little for CAD fundamentals, may also not help in the short-term. The move above 1.1925 this morning raises more liquidation risk to 1.2030 ahead of the 1.2160-1.2240 area.

Data/event EDT Consensus*

US Chain store sls (w/e Nov 5) w/w 07.45 +0.4% last
CA Housing starts (Oct) 08.15 225k
US Redbook sls (w/e Nov 5) m/m 08.55 +1.3% last
US ABC consumer conf (w/e Nov 6) 17.00 -21 last
AU Consumer sentiment (Nov) 18.30 -1.6% last
JP M2 plus CDs (Oct) y/y 18.50 +2.1%
AU Housing finance (Sep) m/m 19.30 +2.0%

Latest data Actual Consensus*
GB BRC retail survey (Oct) y/y -0.2% -0.8% last
GB NIESR GDP (3mths to Oct) q/q +0.4% +0.3% 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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