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Tuesday March 7, 2006 - 12:16:47 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Global market nervousness – USD strengthens across the board.
• 118.00-50 on USD-JPY should hold ahead of BoJ
• NZD falls sharply.
• BoC policy announcement features today – Japanese money data tonight.

Market Outlook

Lots of noise in financial markets this morning. The rise in US 10-yr yields yesterday to 21-mth highs appears to have been a key factor sparking a general move away from riskier assets – emerging currencies, global equity markets and commodities are all lower this morning. Other possible factors contributing to the nervousness include the prospect of a change in BoJ policy and the fact that we are now entering the Mar/Apr period, which has a habit of throwing up corrective moves for some markets -notably equities. Once such corrections start it is often difficult to gauge both the length and depth of such moves, although at the present time underlying fundamentals for most markets look fairly solid. One could pick areas of vulnerability, but global real rates are still low, liquidity is still plentiful and the macroeconomic climate is reasonably benign. On this basis, we would expect some support for such markets to be forthcoming. However, we are moving into an environment where interest rates are starting to threaten higher (Japan and the Eurozone as well as the US) so periods of market nervousness could become more commonplace.

For whatever reason – higher US yields or a move back in to the USD investor base – the USD has been the main beneficiary of the developments overnight. USD strength has been seen right across the board, with advances against major currencies, the NZD (see below), AUD and CAD as well as most emerging currencies.

USD resilience was already in evidence yesterday, most notably perhaps against EUR-USD, where the positive mood following last week’s technical developments has now completely evaporated. A close back above the 100-day MA at 1.1942 may offer some hope, but the price action over the past 24 hours suggests that some false hopes were generated for EUR-USD on Thursday/Friday last week. USD strength against the EUR and elsewhere suggests that the market is unwilling to bet against the USD until there is greater confidence about Fed rates peaking.

With riskier markets correcting, one would have expected this to boost the JPY (unwinding of carry-trade argument) and through the European morning the JPY has been outperforming most currencies apart from the USD. USD-JPY has remained strong, but 118.00-50 is likely to cap it ahead of Thursday’s BoJ decision. There could be noise after this, but overall more JPY weakness looks likely over the next 1-2 months.

The NZD has been one of the biggest losers, continuing down to fresh lows for this move overnight. Talk of Asian selling has spurred further speculation of a drying up of interest in Uridashi issuance (doubly worrying given upcoming redemptions). The AUD has also been hurt by the talk. The NZD price action reflects the lack of confidence ahead of Wednesday night’s RBNZ announcement, where they could acknowledge the weaker data now emerging. Next support is at 0.6410 ahead of 0.6240. Downside remains favoured in the next 1-2 months, but there could be a pullback at some point this week.

Day Ahead
Canada – all eyes will be on the BoC announcement (where a 25bp hike is generally expected) to see whether it supports expectations of further tightening this year. At their last meeting in January they said that ‘some further modest increase in the policy interest rate would be required to keep aggregate supply and demand in balance and inflation on target over the medium-term’. A big question today is how this phrase is changed, if at all. There are three alternatives - 1) It is left unchanged – mildly CAD positive, 2) it is modified to something like ‘a further modest increase may be required’ – CAD neutral/negative or 3) simply that future policy will depend upon the data – CAD negative. Some combination of 2) and 3) would be CAD neutral/negative. Option 1 seems increasingly likely given the solidity of recent data and this would spark some CAD strength, although USD-CAD downside progress (favoured for this year) is likely to remain slow until the USD weakens in general. Any comments they make warning about the possible impact of CAD strength will also affect the market reaction. Last week’s low at 1.1300 is likely to remain intact and the 1991 low at 1.1191 remains the major discouragement to USD-CAD shorts. Next level on the topside is at 1.1450.

Japan – M2 and bank lending data is due tonight. The y/y growth rate for bank lending moved out of negative territory last month for the first time since the late 1990s. One of the main reasons for the sudden stabilisation in the y/y rate (it was still -1.9% in Q3) is the fact that the measure is no longer being depressed by the elimination of bad loans. The normalisation of the trend in bank lending is further evidence that quantitative easing policies are no longer required. The level. of bank lending has been rising since the middle of last year, so positive y/y growth rates should now follow.


Data/event EDT Consensus*

US Chain store sls (w/e Mar 4) w/w 07.45 +1.5% last
US Productivity (Q4, final) saar 08.30 -0.1%
US Unit lab costs (Q4, final) saar 08.30 +3.0%
US Redbook sls (w/e Mar 4) m/m 08.55 0.0% last
CA BoC policy announcement 09.00 3.75%
US Consumer credit (Jan) 15.00 +$5.0bn
US ABC consumer conf (w/e Mar 5) 17.00 -12 last
AU RBA rate announcement 17.30 5.5%
US Fed’s Moskow speaks 17.45
JP M2 plus CDs (Feb) y/y 18.50 +2.0%
JP Bank lending (Feb) y/y 18.50 0.0% last
GB N’wide consumer confidence (Feb) 19.01 98 last

Latest data Actual Consensus*
GB BRC retail survey (Feb) y/y +0.6% +0.2% last
CH Unemployment rate (Feb, sa) 3.5% 3.6%
SE GDP (Q4, sa) q/q +0.7% +0.9%
DE Manu orders (Jan) m/m +1.4% +1.3%
* 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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