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Wednesday February 15, 2006 - 11:55:02 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Market waiting for Bernanke testimony.
• Current USD positive environment likely to be supported by combination of testimony and this week’s data.
• JPY still looking reasonably good.
• GBP gains some respite from data/MPC Report.
• US NY Fed index, industrial output, NAHB housing index and TIC data feature today – UK RICS house prices tonight.

Market Outlook

Apart from GBP (see below) the FX market has been reasonably steady through the night, with most now waiting to see if Bernanke reveals anything new in today’s key policy testimony. Overall, he is likely to validate the recent slightly more hawkish view of US rates (see below for full preview) but perhaps no more than that. However, the more lasting issue for Fed policy this week could be the data itself and so far this has been strong. Yesterday’s retail sales data was much stronger than expected and has led to upward revisions to many Q1 GDP estimates to 5%-6%. There are more releases today and during the rest of the week, but if this sort of GDP backdrop continues to develop over the next couple of months, calling the top in the funds rate could be a dangerous exercise. Overall, it still looks like being a USD positive environment in the next couple of months – how much so will be data dependent, just like Fed policy.

EUR-USD has so far stalled after breaking below key levels on Monday, but after having made that break the risks are clearly on the downside overall. Next support is at 1.1775-1.1810.
USD-JPY is more uncertain given the hawkish noises being made by the BoJ. Ultimately, the BoJ are unlikely to move fast on rates, but in the short-term there could be more JPY strength. A drop in USD-JPY below Friday’s low at 116.89 would mean an extension of the current move towards 115.90, although with the USD likely to show some strength there may be more latitude on other JPY crosses like GBP-JPY and EURJPY.200 and 138 are feasible near-term targets.

GBP itself has bounced back this morning following a stronger than expected set of labour market data and an MPC Inflation Report that failed to live up to its dovish billing. It seems unlikely that the labour market is suddenly going to pick-up after weakening in recent months, while the MPC Report did include some modest downward adjustments to CPI and GDP profiles. King also suggested that the risk to GDP was on the downside. Crucially, there was nothing in the report to directly encourage speculation about a cut before the next Inflation Report in May, but this may yet change with next week’s MPC minutes. Reports in the weekend press, apparently based on ‘reliable information’, suggested that the February vote was 5-4. If that is confirmed the risk of a rate cut will come back very quickly, so market nervousness may persist ahead of that release. Overall, we would still see dangers for GBP from any weakening in retail sales, as this would significantly increase the chance of a rate cut. However, today’s news has taken the sting out of this argument to a certain degree. Attention will now shift to the minutes. For the time being EUR-GBP looks even more set in its range, while cable itself will also depend upon the USD. Resistance at 1.7450, supports at 1.7330 and 1.7280.

Day Ahead
US – new Fed chairman Bernanke’s policy testimony is the main focal point, while the NY Fed index, industrial output, the NAHB housing market index and TIC portfolio data are also due. Bernanke will likely offer a fairly upbeat account of US economic prospects and the likely implication is that the risks to the funds rate remain on the upside. He is unlikely to go into any detail about how many rate hikes are still to come and will probably just reiterate the basic point that future policy is data dependent. Other issues that the market will be looking at are 1) his intentions with regard to the possible adoption of an inflation target and 2) whether he will be straighter talking than Greenspan. On the former, he is likely to indicate that this will be one of many things the FOMC will study as potentially making the policy formation framework more efficient. On the latter, even with the best intentions policy-makers find it difficult to talk straight, not least because most of the time they themselves are unsure about how economic performance and policy will develop in the medium-term. It is probably not the job of a policymaker to offer bold views given the natural uncertainties that typically exist. Indeed, the market would likely view such behaviour as irresponsible.

The data releases will also be important today. The NY Fed index has held in reasonably well over the past couple of months, while the Philly Fed index (due tomorrow) has been weaker. There is still some uncertainty about which is telling the more accurate story and the market will be looking for a more definitive sign in this week’s reports. Industrial output also features, while the TIC data will need to reveal a very unusual number to cause any excitement. The NAHB housing market index (a combination of survey measures relating to current and expected sales and the number of prospective buyer inquiries) has steadied over the past couple of months after falling sharply from late summer onwards. There could be some market sensitivity to any extreme outcomes today.

Data/event EDT Consensus*

US NY Fed index (Feb) 08.30 18.0
US TIC intl portfolio balance (Dec) 09.00 +$76bn
US Ind prod (Jan) m/m 09.15 +0.2%
US Capacity utilisation (Jan) 09.15 80.8%
US Bernanke’s semi-annual policy testimony 10.00
US NAHB housing index (Feb) 13.00 57
GB RICS house prices (Jan) 19.30 +10%

Latest data Actual Consensus*
US ABC consumer conf (w/e Feb 12) -11 -13 last
NO Trade balance (Jan) NOK35.5bn NOK30.2bn
GB Claimant count (Jan) -2.0k +7.1k
GB Average earnings (Dec) 3m y/y +3.6% +3.4%
GB Earnings ex-bonuses (Dec) 3m y/y +3.8% +3.8%
* 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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