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Wednesday January 18, 2006 - 12:00:13 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Global stock market volatility could provide an additional reason for lack of USD direction.
• Very short-term time horizon on position taking likely to be maintained in this environment.
• Weak Japanese markets are not necessarily a JPY negative.
• CHF still underperforming given recent events, but it may yet prosper.
• UK labour market remains soft.
• Canadian CPI, US CPI, NAHB housing index, TIC data and Beige Book feature today.

Market Outlook

Another very sharp retreat in the Nikkei, with a further rise in oil prices and lower than expected earnings from Intel adding to the corrective activity initiated yesterday. Global equity markets in general have also weakened this morning. The JPY was softer initially in Asia, but has since recovered. If there is a saving grace for the JPY it is that hedging activity by foreign investors (selling JPY) will possibly go into reverse if stocks retreat more aggressively. Throughout the second half of 2005 investors were forced sellers of JPY (adding to hedges) to keep pace with the rising valuation of (exposure to) existing stock holdings. After the price action of the past 24 hours USD-JPY does look better supported, but 114.60-115.00 needs to remain intact. The outlook remains unclear given the noise from the stock market – 116.00 needs to break to suggest that it has further to go – next stop beyond there would be 116.40-50.

Direction for the majors has been limited so far this year given the basic uncertainty about what will happen to US interest rates over the next 3-6 months. The latest volatility in the equity markets will only add to that sense of uncertainty and further restrict likely movement in FX. When such global market volatility rears its head it can have an impact on FX via the squeezing of existing positions (players typically cut back on positioning in the face of such uncertainty). However, there is not much in the way of excess positioning out there at the present time.

If the current developments trigger a broad retreat out of emerging currencies this could actually support the USD as funds move back into a USD base. If they contribute to a dimmer view of likely economic growth, especially in the US (if oil price strength/equity weakness extend further) this could weigh on US rate expectations and undermine the USD. In this environment clear direction is difficult and money will likely be made on short-term movements where profits are taken rather quickly. The recent swings in EUR-USD within the 1.20-1.22 range show ample evidence already of the unwillingness to carry positioning for that long. A break of 1.20-1.22 is required to suggest some possible near-term movement.

If the current volatility in global markets quickly blows over and is little more than a correction, the tone of the US data releases and oil prices will be the major determinant of the USD via the impact they have on US rate expectations. Yesterday’s data was mildly encouraging in this regard and the strong prices received number in the NY Fed survey suggests perhaps that pricing power is alive and well (see chart). Further potential market-moving data is due today (see below for preview).

It is surprising that the CHF has not done better in the current environment, which is a concern in itself for any CHF longs.However, if recent events extend the CHF may eventually have its day. 1.5460-1.5520 are the key levels on EUR-CHF.

UK labour market data was generally soft, with the ILO measure of unemployment rising by 111k in the 3-mths ending November compared to the 3-mths ending August. This was the highest rise since February 1993. The data confirms the slowing in labour demand and if this gathers pace it would provide a clear fresh threat to consumer confidence. GBP was unmoved by the numbers.

Day Ahead
Canada – CPI has been very steady in recent months and has typically provided little impetus to markets.

US – CPI, the TIC portfolio data, the NAHB housing survey and the Beige Book feature today. The NAHB index (a combination of measures relating to current and expected sales and the number of prospective buyer inquiries) has been sliding sharply over the past couple of months and has been a factor fuelling concerns about what 2006 may hold in store for the housing market. However, such weakness has yet to show up in the official measures of home sales (both due next week). CPI is likely to remain subdued but anything away from +0.2% on the core measure would moderately influence rate expectations. The Beige Book will be monitored for observations about price pressures and activity in general and could influence expectations about what type of message the Fed will send on January 31. The TIC portfolio data is unlikely to have much impact unless there is a very weak or strong headline net flow number. The most interesting aspect of this data will be whether the recent recovery in foreign buying of US equities has extended any further.

Data/event EDT Consensus*

CA CPI (Dec) y/y 07.00 +2.3%
CA CPIX (Dec) y/y 07.00 +1.7%
US CPI (Dec) m/m 08.30 +0.2%
US CPI core (Dec) m/m 08.30 +0.2%
CA Manu shipments (Nov) m/m 08.30 +0.5%
US TIC net portfolio balance (Nov) 09.00 +$85bn
US Fed’s Lacker speaks 12.15
US NAHB housing index (Jan) 13.00 59
CH SNB’s Roth speaks 13.15
US Beige Book for Jan 31 FOMC 14.00

Latest data Actual Consensus*
NZ CPI (Q4) q/q +0.7% +0.8%
NZ CPI (Q4) y/y +3.2% +3.3%
US ABC consumer conf (w/e Jan 16) -13 -8 last
GB RICS house prices (Dec) +8% +8%
FR Current account (Nov) -€4.1bn -€2.75bn
GB Claimant count (Dec) +7.2k +7.9k
GB Average earnings (Nov) 3m y/y +3.4% +3.4%
GB Earnings ex-bonuses (Nov) 3m y/y +3.8% +3.9%
EU Ind prod (Nov) m/m +1.3% +1.0%
* 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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