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Thursday February 2, 2006 - 11:35:01 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD continues to improve, breaking key levels against USD-JPY.
• EUR has been undermined by yesterday’s French manufacturing PMI. Risk to 1.1970-1.2000 short-term
• EUR-GBP makes new lows for the year.
• ECB meeting and US jobless claims feature today.

Market Outlook

The USD has remained strong through the night and this could extend further in the short-term. The move in USD-JPY is significant, breaking above the Dec 30 high at 118.16 and 118.38 (the 61.8% retracement of the Dec to Jan move lower). If such levels can hold today a push back up towards the December high of 121.38 would look likely, but initial resistance should come in at 119.50-120.00.

EUR-USD has shown little ability to bounce at all this week, other than in the immediate run-up to the FOMC announcement and this also suggests more weakness in the short-term. The market is likely to test the 1.2000 level today or tomorrow and possibly the 100-day moving average at 1.1969. It was the break of the 100-day moving average on January 4 (1.2010 at the time) that generated the momentum for the firmer tone seen over the past month. If this were to give way it would be a negative signal. US data in the short-term will be critical as any strength will increase the likelihood of the funds rate continuing higher to 5% in Q2, something which the market has not yet discounted. USD performance in general may also be influenced by the USD index, which is currently flirting with the recent range highs around the high 89.60s. A break above here would be another USD positive development.

Also note that the EUR-USD move over the past 24 hours has not just been about the USD. It also reflects the market readjusting its expectations about the run-up to today’s ECB meeting after yesterday’s disappointing PMI manufacturing data. The weakness in the French PMI (falling to a seven month low of 50.7) was particularly negative, significantly reducing the chance of a run-up in EUR-USD ahead of today’s ECB meeting. The weakness in the EUR was also reflected in EUR-GBP, which managed to break out of the 0.6810-0.6910 range that has held it so far in 2006. Unless something hawkish comes out of today’s ECB meeting, there is now risk to 0.6750.

Day Ahead
Eurozone - the ECB is unlikely to raise rates today, as there does not appear to have been the necessary signalling from various members. However, this may just reflect the lack of full agreement (at the last meeting) amongst members about how far and how quickly they need to raise rates. The risk of a sudden agreement and a rate hike cannot therefore be ruled out, but it seems highly unlikely. Furthermore, yesterday’s manufacturing PMI data, especially the downturn in the French number, is the sort of data development that may lead some members to baulk at the prospect of more tightening in the very short-term.

The mood of the council will be reflected in Trichet’s comments and he has so far been careful to leave all options open. He has said very little about the prospect for future policy settings, merely confining himself to observations about what is happening to various key indicators like liquidity growth, CPI and economic activity in general. A stronger hint about future tightening would be a sign of agreement on the council and an indication of a March rate hike. Alternatively, if Trichet retains a matter of fact/non-committal approach then this may once again reflect the lack of a firm consensus, but all options would still be left open for March.

US - weekly jobless claims data is due in the US and this has started to attract some attention since the turn of the year. The fall in claims in early January was initially put down to typical turn-of-year volatility, but the improvement has stuck (see chart), suggesting that the demand for labour has been turned up a notch. Some will say that the labour market is a lagging indicator of activity, reflecting the strength in output in months gone by as opposed to what may happen in coming months. However, while this is strictly true, if employment does start grow faster then so will aggregate income and this would be an important dynamic for sustaining/boosting consumer demand, which in turn would boost output i.e. the Keynesian multiplier.

Productivity and unit labour cost data is also out and after the weakness in Q4 GDP a weak productivity/strong unit labour costs outcome is mathematically assured. However, even the FOMC has played down the significance of the Q4 data so the market is unlikely to take it to heart too much.

Data/event EDT Consensus*

US Challenger layoffs (Jan) 07.30 108k last
EU ECB meeting outcome 07.45, press conf 08.30 2.25%
ZA SARB rate announcement after 08.00 7.0%
US Productivity (Q4, prel) saar 08.30 +0.5%
US Unit lab costs (Q4, prel) saar 08.30 +3.5%
US Initial claims (w/e Jan 28) 08.30 293k
US Continuing claims (w/e Jan 21) 08.30 2581k last
AU Retail trade (Dec) m/m 19.30 +0.5%
AU Trade balance (Dec) 19.30 -A$1.8bn

Latest data Actual Consensus*
JP Monetary base (Jan) y/y +1.4% +1.1%
AU Building approvals (Dec) m/m -3.5% -0.7%
ES CPI (Jan) y/y +4.2% +4.0%
NO Unemployment rate (Jan, nsa) 3.3% 3.4%
EU PPI (Dec) y/y +4.6% +4.6%
* 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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