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Thursday April 27, 2006 - 10:36:18 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD retains gains despite positive economic news for the US.
• Ongoing data strength is a cause for concern for USD bears - inflation indications will be key.
• Bernanke’s speech is the main feature today.
• RBNZ statement implies they are content with current NZD levels – this could allow further NZD
recovery in the short-term.
• BoC monetary policy report also due today.

Market Outlook

EUR-USD continues to shrug off strong US data developments, reflecting the move in sentiment on to balance of payments rather than interest rate factors. This either a very powerful move in the works or the market is being sucked into something it will regret. The price action has to be respected and the negative BoP backdrop for the USD is not in doubt, but there is a risk of US rate expectations once again coming back to bite EUR-USD if current data developments continue, as was the case in February. The Beige Book also offered an upbeat account of the economy yesterday, citing rising retail sales and manufacturing orders, but crucially noting that companies were still having mixed success in passing on higher input prices. How the Fed sees the situation will of course be of primary importance in the short-term and Bernanke’s speech will be key today (see below). His observations about inflation will be significant, as will Monday’s core PCE price index. Upside progress on EUR-USD today could be more difficult and 1.2490-1.2500 should hold it for now. 1.2325-60 is key support.

A mixed statement from the RBNZ in leaving rates unchanged. They said that the economy had weakened faster than expected since the early March meeting, but that inflation pressure had intensified. They saw the slowdown in domestic demand continuing through this year, but that this would be partly offset by improvements in net exports due to the lower exchange rate. They also cited the lower exchange rate as a factor in the worsening inflation backdrop, due to the impact on import prices. However, they reiterated that policy would not be used to counteract one-off shocks on prices and that they did not expect to raise rates again in this cycle, before adding that vigilance was still needed over the possibility of such shocks spilling over to wage and pricing behaviour in general. They also made it clear that there was no scope for a rate cut this year.

None of this makes a whole lot of difference to the NZD, although it does confirm the impression given over the past month that the authorities will be less keen on actively pursuing NZD weakness. This removal of the sense of panic surrounding the NZD suggests that a further recovery may be seen in the short-term, but this may also require a weaker USD in general. Above 0.6375 would be the trigger for such a move, although 0.65 should hold it. Stabilisation in a 0.60-0.65 range would probably be ideal for now as far as the RBNZ are concerned.

The USD-CAD move below 1.1300 is a threatening one and with the spec market not that long of CAD, further progress could be seen in the short-term towards the 1991 low at 1.1190. However, USD developments in general will be closely watched, while the BoC Monetary Policy Report is also due (see below for preview).

Day Ahead
US – Bernanke gives his much anticipated testimony on the economic outlook and the market will be looking for more clues about the proximity of a possible peak in the funds rate. It seems unlikely that Bernanke will offer anything too different from recent Fed messages. In other words, he will express optimism about the prospects for sustainable non-inflationary growth and reiterate that Fed tightening is nearly done. Key factors will be 1) his observations about inflation e.g. does he lay more stress on the lack of a pick-up in core inflation or the lingering threat of a pick-up given high resource utilisation? 2) the wording of any reference to a possible end to Fed tightening e.g. close, fairly close, very close etc and 3) whether he refers to the impact yet to come of previous tightening. Overall, it seems unlikely that outstanding issues of uncertainty will be resolved by this address.

Canada – the BoC monetary policy report will likely reiterate the themes mentioned by the BoC on Tuesday – namely, that the economy is now operating at or above its production capacity rather than just ‘at capacity’ while the strength of the CAD is posing challenges for some sectors (recent weakness in exports). On the basis of the observations made about the economy it would appear that the BoC is still set on more rate rises, although there are elements of doubt. On Tuesday, they also said that economic developments would be monitored “in light of the cumulative increase in the policy interest rate since last September." This is a sign that they are mindful of the tightening effects that have now accumulated. Whether this issue has a bearing on short-term policy decisions is something the market will be looking for guidance on today, especially at BoC governor Dodge’s press conference.

Data/event EDT Consensus*

US Initial claims (w/e Apr 22) 08.30 305k
US Continuing claims (w/e Apr 15) 08.30 2439k last
US Fed’s Bernanke testifies on economy 10.00
CA BoC Monetary Policy Report 10.30
CA BoC Mon Report press conference 11.15

Latest data Actual Consensus*
NZ RBNZ rate announcement 7.25% 7.25%
NZ Trade balance (Mar) NZ$59m -NZ$268mn
JP Small business confidence (Apr) 50.8 51.5
GB N’wide house prices (Apr) m/m +0.1% +0.5%
SE Consumer confidence (Apr) 17.5 15.0
IT Business confidence (Apr) 96.1 93.5
DE Unemployment (Apr) -40k -35k
DE Employment (Mar) -15k +5kR 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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