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Tuesday March 21, 2006 - 11:34:59 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Bernanke speech is fairly non-committal but it fails to offer support for recent dovish move in sentiment.
• Market will most probably wait until next week’s FOMC before reaching any further conclusions on policy, although today’s PPI data will be worth watching.
• Focus remains on so-called commodity currencies.

Market Outlook

The speech by Bernanke slightly weighed on EUR-USD overnight but he didn’t say anything too dramatic. His speech on ‘policy and the yield curve’ was fairly non-committal, concluding that the implications for policy of the current curve were not clear-cut. He once again made the point that a flat curve does not mean a recession and that the overall level of rates was historically low. This in itself he said suggests that policy may need to be tighter than it would otherwise be. However, he also said it was possible that the overall equilibrium level of interest rates was now lower than it was previously and that policy rates would also be subsequently lower. Nevertheless, this appeared to be a less convincing argument. In the Q&A session that followed he said that a weaker housing market was only to be expected and was not necessarily a major threat to the consumer sector.

Overall, there was nothing in the speech to directly back-up the conclusion that rates will peak at the next meeting and this accounts for the slight strengthening in the USD. The market will probably want to wait until next Tuesday’s FOMC statement before attempting to reach any major conclusions on policy, but today’s US PPI data may exert an influence. Key short-term parameters on EUR-US are at 1.2080-1.2100 and 1.2200-35.

Volatility continues on the so-called commodity currencies. The AUD, CAD and ZAR have joined the NZD in pulling back sharply over recent days and it is no coincidence that this has happened while the JPY has been strengthening against the USD. Nervousness about the JPY funding issue is clearly weighing on sentiment and this has prompted some position adjustment, which is now being fed by the price action itself.

More volatility is likely for such currencies in the short-term, although it is the NZD more than the other currencies that has the biggest scope for weakness, given the domestic risks that are mounting and the heightened Uridashi exposure in that currency. Other currencies like the AUD and especially CAD are likely to be better supported from a medium-term perspective. Commodity prices for example have shown few signs of weakness while the Canadian and Australian economies are looking solid. Canada also enjoys a large current account surplus. For these currencies it is more a question of when this positional adjustment move runs its course and the formation of some kind of short-term base being built for a recovery.

For the AUD, above 0.7230 would be a step in the right direction, but the move below 0.7180 in early Europe shows that sentiment is still fragile, suggesting some residual risk down towards 0.7000-50. Below 1.1500 is required to shift attention back to the downside on USD-CAD and 1.1775- 1.1800 should be the limit of any further adjustment. Above 0.6280 is needed to generate a recovery on the NZD, but the move below 0.6230 this morning again shows fragility. The NZD is starting to look oversold so a pullback at some point in the next couple of days would not surprise, but from a medium-term perspective it carries the biggest downside risk – all the way back to 0.59-0.60.

How far the correction ultimately runs will depend in part upon the JPY itself. If for example USD-JPY breaks below support at 115.45 and threatens the January lows below 114.00 this would see more weakness for the aforementioned currencies. For the time being though USD-JPY looks to have survived this attempt on the downside. Next resistance is at mid-range around 117.00-30.

Day Ahead
US – PPI data will be closely watched today to see whether last month’s stronger than expected 0.4% rise in core PPI was a one off. The data is seasonally adjusted, but January last year was also a strong month for core PPI, so much so in fact that the y/y rate on core PPI fell back last month to +1.5% from +1.7% (the Jan 2005 m/m being +0.6%). Last year, January strength was followed by a soft 0.1% m/m showing on core PPI for February. If this can be repeated it will underpin the more dovish inflation outlook, while another strong number would do much to counter it.

Canada – retail sales data has been mixed over recent months, with total sales showing strength, but sales ex-autos flattening out after a strong Q4.

Data/event EDT Consensus*

SE Riksbank’s Oberg spks 07.00
US Chain store sls (w/e Mar 18) w/w 07.45 +0.1% last
US PPI (Feb) m/m 08.30 -0.3%
US PPI core (Feb) m/m 08.30 +0.1%
CA Retail sales (Jan) m/m 08.30 +1.2%
CA Retail sales ex-autos (Jan) m/m 08.30 +1.5%
CA Leading indicator (Feb) m/m 08.30 +0.5%
US Redbook sls (w/e Mar 18) m/m 08.55 -2.4% last
SE Riksbank’s Nyberg spks 09.00
US ABC consumer conf (w/e Mar 19) 17.00 -8 last

Latest data Actual Consensus*
FR H’hold consumption (Feb) m/m +1.8% +0.3%
GB CPI (Feb) y/y +2.0% +2.0%
GB CPI core (Feb) y/y +1.4% +1.3%
GB RPIX (Feb) y/y +2.3% +2.3%
GB RPI (Feb) y/y +2.4% +2.4%
* 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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