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Wednesday March 8, 2006 - 12:10:41 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Global markets remain nervous.
• EUR-USD optimism has been punctured.
• JPY eyeing tomorrow’s BoJ announcement.
• RBNZ statement also due tonight.

Market Outlook

Global markets were slightly calmer in Asia, helped by a pullback in US bond yields after the spike seen late Monday and the European morning yesterday, but European equity markets have continued to suffer this morning and emerging currencies are also weaker in Europe.

Against this background the majors have been largely sidelined this morning and in the current environment the market is unlikely to be comfortable in pursuing direction, especially after the failed upside attempt by EUR-USD over the past few days. It is not clear as yet whether this failure on EUR-USD is another sign of impending USD strength and a possible short-term move below key support at 1.1780 and 1.1825 or merely an another example of the market’s general lack of appetite for direction given the uncertainty about US and Eurozone rates. It is probably a bit of both, but the overriding factor we would see is that the market will not be confident in attacking the USD until there is a much greater degree of confidence in calling the peak on Fed funds. Indeed, some general upside risk will remain on the USD, especially if the data remains strong and US rate expectations build further. The US data will be key. 1.1940-75 is the main resistance area today.

It is an important 24-hours for the JPY, with the BoJ due to announce their latest policy decision tonight (see below for full discussion). Key parameters to look out for on USD-JPY today are at 118.00-50 on the topside, 117.30-116.80 on the downside.

Day Ahead
Japan – speculation has been rife about a policy adjustment at this meeting and this looks likely if BoJ board members can agree on a framework that will guide future policy. Without such a framework, any adjustment to the quantitative element of the current policy regime would be seen as irresponsible and would provoke anger in government circles, especially at the MoF. However, stories have been materialising in the media (likely officially prompted) about the nature of such a framework - imposition of a cap on the o/n rate, a commitment to keep on buying JGBs and the formation of a reference range for CPI and this suggests that an agreement may be achieved. If this is the case there is no reason why they shouldn’t move to start dismantling quantitative targets, although there may also be some slight uneasiness about changing money market rules until the run-up to fiscal year end (Mar 31) is out of the way.

While officials have been viewing such an event with some trepidation, the elimination of the uncertainty about what will happen on rates subsequently (the framework described above would suggest that rates will remain close to zero for some time yet) should be a positive for Japanese markets and negative for the JPY. A failure to move tomorrow will no doubt raise speculation about them bowing to veiled threats from politicians, many of whom claim that deflation is not dead yet. However, more likely it will reflect an inability on the part of the BoJ to agree upon a guideline framework for future policy behaviour. This could also be construed as JPY negative, although the lack of confirmation about a future low interest rate structure may be seen as disappointing by potential USD-JPY buyers.

The most positive outcome for the JPY would be an abandonment of quantitative easing without setting a policy framework along the lines mooted in the media e.g. if there is no cap on the o/n rate, no reference rate for CPI or if the reference rate for CPI is low (i.e. 1% or less). In other words, leaving open the prospect of higher interest rates, although this seems unlikely.

NZ – the RBNZ announce the outcome of their latest policy deliberations tonight. Last time (January 25) they were less alarmist about NZ fundamentals and the NZD in general. On interest rates, they said that further rises were unlikely, but could not be completely ruled out until there was evidence of a sustained weakening in domestic demand. They also said that an early rate cut was unlikely, as it would probably take time for current inflation pressures to subside. It will be interesting to see whether recent softer data releases have modified this view in anyway. Probably not much, but they will most likely acknowledge the growing evidence supporting the view that a slowdown is now underway.

It is not clear whether the RBNZ will necessarily introduce anything freshly negative for the NZD, although the overall risks clearly remain to the downside. This was highlighted by news that the Swedish Export Credit Corp had cut the size of a planned NZD Uridashi issue to NZ$47m from NZ$130m. There were no reasons given for this, although it will raise speculation about possible faltering demand from Japanese investors.

Data/event EDT Consensus*

CA Housing starts (Feb) 08.15 231k
US Fed’s Poole on housing market 09.00
US Fed’s Bernanke speaks to community bankers 12.00
NZ RBNZ rate announcement 15.00 7.25%
AU Employment (Feb) 19.30 +10k
AU Unemployment rate (Feb) 19.30 5.3%
JP BoJ policy announcement

Latest data Actual Consensus*
US Consumer credit (Jan) +$3.9bn +$5.0bn
US ABC consumer conf (w/e Mar 5) -9 -12 last
AU RBA rate announcement 5.5% 5.5%
JP M2 plus CDs (Feb) y/y +1.7% +2.0%
JP Bank lending (Feb) y/y +0.2% 0.0% last
GB N’wide consumer confidence (Feb) 94 98 last
* 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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