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Tuesday March 28, 2006 - 11:34:42 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Very strong German IFO/Eurozone money numbers boost EUR-USD prospects post-FOMC.
• Brazilian finance minister resignation will provide a good test of BRL sentiment.
• US consumer confidence also due.

Market Outlook

Stronger than expected IFO and Eurozone money data pushed the EUR higher in the European morning and such developments bode well for EUR-USD once today’s FOMC announcement is out of the way. The strength in this morning’s releases will provide more ammunition for those (ECB members included) who believe ECB rates should increase at a faster pace and this should boost the EUR ahead of next week’s ECB meeting. It will take something fairly hawkish from the FOMC or some very strong US data (consumer confidence is due today) to offset this likely development in sentiment. The market will probably remain a little apprehensive until the FOMC announcement, but today’s statement is unlikely to provoke any major changes in general thinking about Fed policy (see below for preview). 1.2120, 1.2210 and 1.2322 are parameters that could come into play for EUR-USD over the next week or so.

Brazilian finance minister Palocci resigned late yesterday amidst allegations of corruption (there had been rumours of such an event over the weekend) with his replacement, economist and former university professor Guido Mantega, pledging that policies will remain unchanged. S&P also announced that the change of personnel would not affect their Brazil’s ratings, as they took the view that recent fiscal policy was the policy of the government and not just Palocci himself. We would agree with this, although there could be some nervous moments as the market may fear an acceleration in spending ahead of October’s presidential elections. Palocci was under pressure late last year from other cabinet members who thought he was being too strict with regard to spending policies. With Lula doing well in the polls and the economic climate improving, there is less urgency for him to ‘buy votes’. However, the market reaction to this will be another good test of BRL sentiment and how robust it is in the current more fragile environment for higher risk markets in general. So far it has held in well because of the improving fundamental backdrop and we would expect the BRL to remain favoured during 2006. However, this could be put to the test today and tomorrow, especially with other markets like the MXN also still suffering. A move above 2.20 on USD-BRL would provoke some short-term corrective activity - 2.10-2.20 being the range that has held activity since the 2nd week of February.

Day Ahead
US – a further hike in rates to 4.75% is generally expected at today’s FOMC meeting but there is some uncertainty about the accompanying statement. Over the past couple of meetings the FOMC has been watering down the message about the inevitability of future tightening. On Dec 13 they said that “some further measured policy firming is likely to be needed”, while on Jan 31 this changed subtly to “some further policy firming may be needed”. One could argue that the next logical step would be to drop the prescription of future tightening completely, stating simply that future decisions will depend upon the data. However, given that evidence of data weakness is still fairly thin on the ground and that potential inflation pressure is still lurking, this seems unlikely. One option would be to merely repeat the January 31 statement, to underline the seamlessness between the Greenspan/Bernanke chairmanships. A middle ground would be to keep the comment that further tightening may be required but to acknowledge more explicitly that future rate decisions will be dependent on the data. However, the latter has always been implicit in any case in the final phrase of the statement “In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives”.

The market will be on the lookout for any signs of a change in presentational style under Bernanke. At some point Bernanke will want to put his own personality on the policymaking process and this is likely to mean more transparency. Ultimately, he would prefer this to be in the form of some kind of inflation target, but in the short-term it will probably mean more detailed post-policy statements. However, it could be too early in his tenure to expect any major changes today. Overall, it seems unlikely that today’s statement will significantly reduce the risk of a 5% funds rate being seen in May or June. Consumer confidence data is also due today and any strength or weakness will also affect sentiment about Fed policy in the months ahead. Confidence fell back to 101.7 in February after hitting 106.8 in January, which was the highest level seen since May 2002.

Data/event EDT Consensus*

US Chain store sls (w/e Mar 25) w/w 07.45 -0.1% last
US Redbook sls (w/e Mar 25) m/m 08.55 -2.4% last
US Consumer confidence (Mar) 10.00 102.0
US FOMC meeting outcome 14.15 4.75
US ABC consumer conf (w/e Mar 26) 17.00 -8 last
JP Retail sales (Feb) y/y 18.50 +0.7%

Latest data Actual Consensus*
SE Retail sales (Feb) m/m +0.1% -0.2%
IT Business confidence (Mar) 94.2 92.5
DE IFO index (Mar) 105.4 102.9
DE IFO current (Mar) 105.1 102.0
DE IFO expectations (Mar) 105.7 104.0
EU M3 (Feb) y/y +8.0% +7.7%
EU M3 (Feb) 3m y/y +7.6% +7.5%
EU Private sector lending (Feb) y/y +10.3% +9.7% 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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