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Thursday January 12, 2006 - 11:40:57 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD soft ahead of today’s key events – further weakness likely short-term unless ECB disappoints. 1.2200 area key barrier/trigger on EUR-USD.
• USD-JPY threatening 113.50-75 area.
• NOK suffers against SEK.
• UK MPC meeting, Canadian trade, ECB meeting and US trade feature today.

Market Outlook

Apprehension about today’s ECB meeting and US trade data has continued to weigh on the USD overnight and this could extend further in the short-term. The trade data comes at a sensitive time for the USD with the market beginning to question the likely future strength of US interest rate arguments. In addition, the tone of the ECB presentation will determine sentiment about how vigorously rate arguments might develop in the Eurozone (see below for more). Relative interest rate arguments more than the trade data will likely determine USD direction over the next 1-2 months.

Failing any disappointments today from the ECB, EUR-USD looks set to test higher in the short-term and a break above key levels around 1.2200 would provide room up towards 1.25. The important technical levels are as follows – 1.2180 (last Friday’s high), 1.2203 (Oct 6 high) and 1.2205 (200-day moving average). Main support is 1.20, in part because 1.2002 is the 100-day moving average. However, this more positive view on EUR-USD could easily be reversed through February as the market is quite likely to firm up expectations of a further Fed rate hike on March 28.

If there is a potential short-term complication for EUR-USD it could come via EUR-JPY. USD-JPY moved below 113.75 in Europe this morning and downside risk would increase further below 113.50 (61.8% retracement of Sep to Dec upmove). If this does happen it is important for EUR-JPY to stay above 137.35-50, otherwise it would have negative momentum of its own with possible negative consequences for EUR-USD.

Swedish CPI was in line with market expectations, although the SEK has strengthened against the EUR this morning, in part because of strong cross trade against the NOK. There was a decisive move lower on NOK-SEK yesterday, breaking below support at 1.1640 and this has been built upon this morning – supports now at 1.1500 and 1.1420. EUR-NOK has also moved above key levels around 8.07 and as long as it stays above the 8.03-8.07 area there is upside risk to 8.14. The NOK should eventually recover, but there is clearly some risk of a further deterioration in the short-term. Tuesday’s weaker than expected Norwegian core CPI data set the scene for this latest development. The data has raised major doubts about the chance of an acceleration in the pace of Norges Bank monetary tightening in the months ahead and this contrasts unfavourably with the SEK from a short-term perspective, with the Riksbank set to raise rates next week. Support on EUR-SEK is at 9.27- 9.30.

Day Ahead
UK – the MPC meeting is likely to see rates being left unchanged, meaning that no statement will be made. The market will have to wait for the Jan 25 release of the minutes to see whether any other MPC members have followed the lead taken by Nickell in December in voting for a 25bp rate cut. The inflation outlook is clearly improving in relation to the risks identified a few months ago, but signs of strength in the housing market and a better than expected retail period over Christmas may lead most to wait for more information. This could easily extend beyond the February meeting and into Q2.

Eurozone – the ECB meeting is likely to see rates being left unchanged, although markets will be looking for indications about what is planned for the months ahead. In recent times, the ECB has been keen to quell speculation that a series of rate hikes is ‘pre-planned’ and it will be interesting to see whether they now start to build a platform for a further move before the end of Q1. The desire to leave such options open suggests some kind of rhetoric supporting the possibility of further modest tightening. The strength of recent data releases also suggests that Trichet will adopt an upbeat tone. If he fails to do so the market will be disappointed.

US – the trade data could exert an influence given growing market concerns about the possibility of fading interest rate arguments being replaced by balance of payments factors. How the USD responds to this release will be a good test of underlying sentiment. Last month saw a blowout deficit number of $68.9bn, with imports (+2.7% m/m in both Sept and Oct) continuing to advance with strength. This is the problem when such a huge deficit already exists. Even if exports match the percentage growth rate in imports, this will still mean a widening deficit.

Canada – trade data should again demonstrate the solid external market conditions for the Canadian economy. Exports have been strong in recent months. BoC deputy governor Kennedy talks about the BoC’s Monetary Policy Framework, although it is not clear she will say anything different on the outlook for rate policy.

Latest data Actual Consensus*

JP M2 plus CDs (Dec) y/y +2.0% +2.2%
AU Employment (Dec) +2.1k +9.0k
AU Unemployment rate (Dec) 5.1% 5.1%
SE CPI (Dec) y/y +0.9% +0.9%
SE CPU UND1X (Dec) y/y +1.2% +1.2%
GB Ind prod (Nov) m/m +0.6% +0.6%
GB Manu output (Nov) m/m +0.4% +0.5%
* Consensus unless stated

Data/event EST Consensus*
GB MPC rate announcement 07.00 4.5%
EU ECB meeting outcome 07.45, press conf 08.30 2.25%
US Trade balance (Nov) 08.30 -$65.9bn
US Import prices (Dec, nsa) y/y 08.30 +7.0% last
US Imp prices ex-petrol (Dec, nsa) y/y 08.30 +2.6% last
US Initial claims (w/e Jan 7) 08.30 320k
US Continuing claims (w/e Dec 31) 08.30 2718k last
CA Trade balance (Nov) 08.30 C$7.0bn
CA Exports (Nov) m/m 08.30 +1.0% last
CA BoC’s Kennedy speaks 13.00
US Federal budget (Dec) 14.00 -$2.1bn
GB NIESR GDP (3mths to Dec) q/q 19.01 +0.4% last
JP Machinery orders core (Nov) m/m 00.00 +5.4%

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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