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Monday March 20, 2006 - 11:43:21 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Trichet does little to counter the hawkish rumours of last week.
• USD remains soft against EUR and JPY but a recovery could be seen today ahead of Bernanke.
• NZD, AUD and CAD remain weak.
• German PPI not as strong as it looks.

Market Outlook

Comments from Trichet this morning did little to offset the main story of last week about the possibility of ECB rates moving to 3.5%. His comment that ‘nothing is pre-planned’ is only natural, but his accompanying remark about the fact that the ECB will do all to combat inflation reveals where the current thrust of policy now lies and he is clearly not interested in making any apologies for that. In this regard there is some support for EUR by way of a follow-on from last week’s developments.

However, there is very little scheduled today other than an after US hours speech by Bernanke on the ’yield curve and policy’ and market uncertainty over this could see the USD recovering. There is a clear risk that his comments fail to chime with the way sentiment has been developing over the past week. Indeed, when he talked about the yield curve in February he was hawkish (see below for full preview). Key parameters on EUR-USD come in at 1.2235 and 1.2325 on the topside, although a push up there may require a lack of hawkishness from Bernanke. Below 1.2140 would suggest a pullback to towards 1.2080-1.2100.

Data this morning included another strong German PPI number (y/y rate of +5.9%), although once again this was driven by high energy prices. If energy is stripped out the y/y rate falls back to just +1.1%. The same story also applies on CPI, which is due later in the week. Last month the headline German CPI y/y rate was +2.1%, but taking out energy and seasonal foods it is +0.8%. The ECB tend to focus on headline CPI because of the possible impact on wage negotiations, but if the forthcoming wage round is orderly and energy price rises are not repeated, some softer inflation rates should eventually be forthcoming. This in turn should ultimately put a lid on ECB rate expectations, but for the time being they will likely remain in the ascendancy.

The NZD is still under pressure, the AUD is desperately searching for a short-term base and the CAD is also in danger of correcting further against the USD. Both the AUD and the NZD are looking oversold from a short-term perspective and while some further weakness could be seen initially today (0.6230 and 0.7190 are important on NZD and AUD respectively) a bounce back looks likely before further meaningful weakness is seen. USD-CAD would also look due for more gains if it can progress beyond the March 10 high at 1.1650 (risk to 1.1770-1.1800). The USD-CAD move is unlikely to be sustained but for the time being position adjustment has taken over as the prime mover on price action.

Day Ahead
US – lead indicators is due but this is merely the product of other data already released. Key focus will be Bernanke’s speech about the yield curve and policy (even though it is after hours). In his semi-annual policy testimony on Feb 15 he made the following remark. “Currently the short-term real interest rate is close to its average level and the long-term interest rate is actually relatively low compared with historical norms. And so, with real interest rates not creating a drag on economic activity, I don't anticipate that the term structure is the signal of oncoming slowing of the economy.'' Although he was talking about real rates in general, there is an implicit point here that longer term rates are historically very low. One possible implication of this is that short (official) rates need to more than would otherwise be the case to achieve policy goals. It will be interesting to see whether he remarks on this issue. If he does it could go some way in offsetting the recent more dovish move in money market sentiment, especially with next week’s FOMC meeting looming.

Data/event EDT Consensus*

CA Net portfolio balance (Jan) 08.30 -C$7.7bn last
US Lead indicators (Feb) m/m 10.00 -0.3%
US Fed’s Minehan speaks 11.00
US Fed’s Bernanke on yield curve and policy 19.00

Latest data Actual Consensus*
GB Rightmove house prices (Mar) y/y +4.3% +4.0% last
DE PPI (Feb) y/y +5.9% +5.3%
IT Ind orders (Jan) m/m -0.6% -0.8%
GB BBA mortgage lending (Feb) +£4.4bn +£4.6bn last
GB PSNCR (Feb) £1.7bn £0.7bn
* 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.


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