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Friday February 24, 2006 - 11:35:16 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• JPY remains in the ascendancy on liquidation fears.
• This could spell more volatility for both the JPY and those assets that have seemingly benefited from the so-called JPY ‘carry trade’.
• EUR-USD stuck in range – but still downside risk.
• US durable orders feature today.

Market Outlook

The JPY remains strong, buoyed not only by ongoing talk of a BoJ policy shift, but also the fear of a general liquidation of short JPY positions. This is not only related to spec positioning, but also to fears of an unwinding of the JPY carry trade. These sort of arguments could be a recurring feature over the next couple of months with the ECB and the Fed set to raise rates and speculation likely to continue about the possibility of similar moves in Japan. In other words, a general squeeze on global liquidity.

A proxy for fears of carry-trade unwinding will be the performance of assets that have been on the (positive) receiving end of that trade e.g. high-yielders, emerging market assets and commodities. Indeed, many high yielders such as the NZD and ISK have already been showing signs of strain. However, while corrections in all of these markets are a possibility in a world of rising interest rates (in the NZD’s case the outlook does look grim) in many cases the damage is unlikely to be permanent. First of all, interest rates are unlikely to travel that high. Secondly, commodity markets are likely to be well underpinned by the China factor and improving fundamentals should also support many emerging currencies. Mexico and Brazil, for example, yesterday announced large scale buybacks of ‘old’ outstanding debt - $5bn in the case of Mexico, $6.6bn for Brazil – to eliminate the costly service payments on these maturities. This marks genuine progress in addressing some of the longer-term financial issues that have haunted such currencies, especially the BRL, in years gone by.

Overall, we would still see there being slow progress by the BoJ to a situation where they actually raise interest rates, but fears of an eventual normalisation in Japanese rates will clearly have the potential to intermittently influence market sentiment. This will make for volatility, but perhaps not that much in the way of direction. The move overnight below 116.75 on USD-JPY is a possible danger signal about a ‘liquidation’ phase becoming dominant and there remains some downside risk to 115.90 and the 114.50-115.00 area in the next week or so. However, we would still see the JPY as being ultimately undermined by very low interest rates. The 116.75 level was won back for a time in European trading but 117.25 and 117.40 are the other barriers that need to be scaled to generate an intra-day recovery.

EUR-USD meanwhile remains stuck in its recent range and even a weakening USD-JPY has not been enough to push it higher on a sustainable basis. This suggests that the risks remain to the downside, but 1.1850 needs to break to get this going again. Above 1.1974 is required to prompt some stabilisation.

Swedish manufacturing and consumer confidence data were both a touch below market expectations, but remain at fairly high levels compared to recent years. Still, with rate hike sentiment under attack, the market needed more than this and EUR-SEK tested higher after the data. 9.43 is still acting as good resistance, but there is a reasonable chance of it moving into the 9.43-9.50 area for a while in the short-term.

The Swiss KOF indicator came out stronger than the published market consensus, but there was little in the way of sustained market impact. The data underpins expectations about a 25bp rate hike by the SNB on March 15. However, it seems clear that the SNB are going to pursue such movement in a non-spectacular fashion. Below 1.5570 is needed to suggest a short-term top on EUR-CHF.

Day Ahead
US – durable orders data is due and while this series has the
potential to be volatile on a m/m basis the overall trend remains
up (see chart for 3-mth average). A weak outcome today would
not be enough to undermine this trend, but a strong report
would further bolster US rate sentiment ahead of the key
releases scheduled for the next couple of weeks.

Data/event EDT Consensus*

US Durable orders (Jan) m/m 08.30 -1.2%
US Durables ex-transport (Jan) m/m 08.30 +0.5%
US Fed’s Poole speaks 13.00

Latest data Actual Consensus*
AU House prices (Q4) q/q +2.1% +0.8%
DE Import prices (Jan) y/y +6.8% +6.6%
SE Trade balance (Jan) SEK15.3bn SEK9.1bn
SE Manufacturing confidence (Feb) +2.0 +3.0
SE Consumer confidence (Feb) +17.0 +20.0
IT Business confidence (Feb) 92.3 93.0
GB GDP (Q1, 2nd est) q/q +0.6% +0.6%
CH KOF indicator (Feb) +1.30 +1.25
* 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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