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Wednesday February 1, 2006 - 11:34:28 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• FOMC statement alters wording on future policy possibilities but essentially all options are left open.
• US data will ultimately carry most significance in determining policy sentiment ahead of Bernanke’s policy testimony.
• EUR-USD eases back in Europe as Eurozone data disappoints.
• NZD slightly better – USD-CAD remains soft.
• Eurozone PMIs slightly disappointing.

Market Outlook

The FOMC statement doesn’t really tell us anything new and pretty much leaves all options open depending upon how the data evolves. From the initial USD reaction and media coverage it would appear that the market took it to be slightly dovish, but it is difficult to reach this conclusion with much confidence. Indeed, Fed funds futures did if anything moved very slightly in the other direction, while the 10-yr was unchanged and the USD has managed to recover this morning.

The comment about the economy “Although recent economic data have been uneven, the expansion in economic activity appears solid”, is a clear nod in the direction of the soft Q4 GDP data, but also, crucially, that they do not view it as a sign of the economic expansion being under threat. In other words, playing down the importance of this number. The comment about inflation – core inflation currently under control, but possible upside dangers – was the same as in December.

On policy, they said that “further policy firming may be needed” to attain their objectives compared to the December phraseology of “some further measured policy firming is likely to be needed”. Dropping the word ‘likely’ for ‘may’ has naturally been afforded some significance and is the main reason for the market’s apparently dovish take on the statement (‘measured’ was probably deemed unnecessary after switching to ‘may’ from ‘likely’). However, this may just be due to a desire on the part of the current FOMC to further tone down predictions about future policy because of the change in Fed chairmanship. A further hike to 4.75% in March looks likely unless there is a dramatic weakening in the data, but beyond this it is unclear. From an historical perspective, policy is not yet that tight (see chart). Ultimately, the evolution in the economic data will be of utmost importance, which is what the FOMC basically conclude – “In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.” Bernanke gives his semi-annual policy testimony on February 15.

EUR-USD did in fact record the high of 1.2188 an hour or so before the Fed announcement and traded lower after the statement (to 1.2115) before stabilising in a 1.2135-65 range through Asia. However, it has fallen back in Europe this morning, in part because of a lack of followthrough on the upside and also because of the slightly disappointing Eurozone PMI data. The fall in French manufacturing PMI to 50.7 (a seven month low) may add to the uncertainty of some ECB members about the case for further immediate rate rises. There is a danger of some further EUR-USD liquidation and below 1.2060 would expose main supports at 1.1975-1.2000. Much will depend upon today’s ISM (see below), although today’s Eurozone data may have impaired the prospects of the EUR being bid up ahead of tomorrow’s ECB meeting and press conference. Above 1.2188 (which is close to the 1.2185 level that was important in January) is required to suggest some upside movement. Friday’s US employment report and nonmanufacturing survey will also be significant in determining which way this develops, but EUR-USD downside is tentatively favoured.

The NZD managed to recover a little further following the much smaller than expected monthly trade deficit. The latter was due to a very sharp fall in imports, which may suggest that the economy is slowing (not as positive for the NZD) but moreover these numbers are not adjusted for seasonal factors and can be erratic, so another month of data should be observed before jumping to conclusions. On the NZD today, the 0.6900-25 area needs to be breached to generate more short-term relief, which may prove difficult.

USD-CAD continues to edge lower, although it is pedestrian stuff and this may relate to the close proximity of the 1991 low of 1.1191, which is likely to act as good support in the first instance. This may be affecting P&L and risk-reward factors when considering chasing the move lower. On the basis of the recent price action further downside still looks likely, but it may not be that dramatic.

Day Ahead
US – the ISM manufacturing data will be watched closely after the softer number seen last month. The December reading was of course revised up last week (to 55.6 from 54.2 initially) after annual revisions to seasonal adjustment factors and another 55-plus number will be required today to suggest that the sector is growing with some vigour.

Data/event EDT Consensus*

US ISM manu (Jan) 10.00 55.2
JP Monetary base (Jan) y/y 18.50 +1.1%
AU Building approvals (Dec) m/m 19.30 -0.7%

Latest data Actual Consensus*
US FOMC meeting outcome 4.50% 4.50%
NZ Trade balance (Dec) -NZ$0.3bn -NZ$0.8bn
US ABC consumer conf (w/e Jan 29) -9 -9 last
SE PMI manu (Jan) 57.8 57.9
CH PMI manu (Jan) 57.6 57.0
IT PMI manu (Jan) 53.5 54.3
FR PMI manu (Jan) 50.7 52.5
DE PMI manu (Jan) 55.0 54.6
EU PMI manu (Jan) 53.5 54.1
NO Unemployment rate (Nov) 4.5% 4.5%
GB PMI manu (Jan) 51.7 51.3
EU Unemployment rate (Dec) 8.4% 8.2%
* 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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