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Thursday March 16, 2006 - 11:50:51 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD remains soft – 1.2100 is key today for EUR-USD and USD in general.
• Cited sources suggest ECB move to neutral rates.
• Market confidence in calling funds rate peak still patchy.
• Upside risk growing on EUR-GBP.
• NZD softens after PM comments – PMI better but still soft.
• Features today include Norges Bank meeting, Canadian CPI, SNB policy outcome, US CPI, housing starts and Philly Fed.

Market Outlook

The USD remains fairly soft but crucially EUR-USD has not managed to push through the resistance area running from 1.2050-1.2100. If it can do so the market would be looking for more gains up to 1.2240 and 1.2350, but we still have doubts about how much appetite there will be to pursue a weaker USD until there is more evidence of a peak in the funds rate.

The main story this morning was a Market News report citing ECB sources as saying that rates may move up to a neutral level and that a neutral level could be 3.5%. This has created some excitement in the money market. Interest rate futures are already looking for a fair degree of tightening, although this story could cause them to expect such tightening to happen more quickly. At the time of writing Dec Euribor is at 3.39% and Jun 07 Euribor is at 3.55%, both up about 4bp on the day. This story increases the risk of EUR-USD nudging through the key area mentioned above, although a sustained break may require some softer US developments, which are not assured.

Yesterday’s US news flow was inconclusive. The NY Fed survey was very strong (see below) and the Beige Book was mixed. The latter reported a further expansion in activity in Jan and Feb and noted that price pressures and potential capacity problems (widespread skilled-labour shortages) were still prevalent. However, the survey also noted that there was hardly any evidence of wage growth picking up or of price pressures being passed through to final consumer prices.

Yellen also spoke again last night and once again just about came down on the dovish side of the fence, although it is not apparent that such sentiments are shared throughout the rest of the FOMC. She repeated that she was ‘sensitive’ to the idea that Fed policy could overshoot. She also said that housing market cooling could become more evident and that there may be more labour market slack than implied by looking at the unemployment rate. However, while she thought that inflation should remain well contained, she did say it was currently at the high end of her own comfort zone. She also said that Fed policy was essentially data dependent. Guynn also spoke and was more equivocal on what lay ahead – his basic message was ‘watch the data’.

Overall, the arguments on policy remain finely balanced – will activity slow? and/or will final inflation pick-up? – so the market will remain uncertain and be sensitive to any definitive developments in the data. More US data due today (see below).

UK retail sales data was slightly softer, taking into account back-revisions (previous revised down to -1.6% from -1.3%), although the ECB story has been the main driver of EUR-GBP. This is not inconsistent with the type of scenario we alluded to yesterday i.e. that the news flow on rates would generally favour the EUR over GBP in the months ahead. 0.6925 needs to break on EUR-GBP to allow some room to 0.6980 0.7000 and this could develop if EUR-USD breaks through 1.2100.

Underlying vulnerabilities on the NZD have again resurfaced, with the catalyst being a comment from NZ PM Clark about the recent fall in the NZD (which she still sees as strong) as being good for exports. Key today will be whether it can proceed beyond recent extremes – 0.6320 against the USD, 74.90 NZDJPY and 1.1590 AUD-NZD. This is where the risk lies in coming weeks. February NZ PMI was released late in the European morning and jumped up to 51.2 from 48.0 in January. This data is now being seasonally adjusted for the first time so 48.0 is also an adjusted number for January. The weak numbers previously reported for recent months (44.1 Jan, 47.6 Dec) were unadjusted. On the face of it 51.2 does look better, but it is still a fairly soft level, so any relief could be limited.

Day Ahead
Norway – GDP (at least the mainland measure) was fairly solid this morning and the Norges Bank announcement is due later on. A 25bp hike is expected by the market and it seems unlikely that the Norges Bank will veer away from its steady tightening stance.

Canada – CPI is out in Canada and the ongoing stability of the key CPIX measure has been a major factor behind the relaxed approach to tightening adopted by the BoC. The CPIX y/y rate has been either +1.6% or +1.7% in each of the past six months and has not been outside of a +1.4%/1.9% range since March 2004 when it was +1.3%. It will take a couple of months or so of much weaker or stronger data to cause any excitement.

Switzerland – the SNB is likely to raise rates by 25bp but this is generally expected and it also seems unlikely that the SNB will want to spur rate hike speculation any further. Their comments are likely to do little more than support the market’s current view of a 25bp rate hike per quarter for the rest of this year. Short-term parameters on EUR-CHF are at 1.5680 and 1.5634. What the SNB move could do is to help consolidate the JPY’s position as the main funding currency, so it will be interesting to see how the JPY reacts to today’s announcement.

US – CPI, housing starts and the Philly Fed survey are variables that are pertinent to all aspects of the Fed policy debate (inflation, housing market and overall economic activity), so anything unusual could potentially influence rate expectations and the USD. However, more likely is that there is a continuation of recent trends – steady inflation, a moderating housing market and solid economic activity. While core PPI was strong last month, core CPI and core PCE prices have remained fairly well under control. However, the appearance of anything above +0.2% m/m would cause some alarm. Housing starts are expected to pullback sharply in February after the strong weather-related rise in January, which itself came after a sharp fall in December. Such volatility does not lend itself to the formation of strong conclusions and in any case, measures such as mortgage applications and home sales are seen as more timely indicators of housing market fortunes. Both have been weakening in 2006, although mortgage applications have stabilised in recent weeks, albeit at much lower levels than those seen over the past couple of years. The Philly Fed should be strong if the NY Fed is any guide. The NY Fed index has only been running since July 2001, but yesterday’s average workweek category was the highest on record and the employment component reached its 2nd highest ever level. The overall index was at its highest since July 2004.


Data/event EDT Consensus*

CA CPI (Feb) y/y 07.00 +2.4%
CA CPIX (Feb) y/y 07.00 +1.7%
NO Norges Bank policy outcome 08.00 2.5%
CH SNB policy outcome 08.00 1.25%
US Initial claims (w/e Mar 11) 08.30 298k
US Continuing claims (w/e Mar 4) 08.30 2506k last
US CPI (Feb) m/m 08.30 +0.1%
US CPI core (Feb) m/m 08.30 +0.2%
US Housing starts (Feb) 08.30 2049k
US Fed’s Kohn spks on policy and asset prices 10.10
US Philly Fed index (Mar) 12.00 13.4

Latest data Actual Consensus*
US NAHB housing market index (Mar) 55 56
GB RICS house prices (Feb) +17% +10%
SE Unemployment rate (Feb, nsa) 5.6% 5.9%
NO GDP – total (Q4) q/q +0.2% +0.6%
NO GDP – mainland (Q4) q/q +1.1% +0.8%
GB Retail sales (Feb) m/m +0.5% +0.4%
EU CPI (Feb) y/y +2.3% +2.3%
EU CPI ex-energy/fresh food (Aug) y/y +1.3% +1.3%
NZ PMI manu (Feb) 51.2 44.1 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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