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Friday April 28, 2006 - 10:54:33 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Bernanke confirms likely ‘pause’ but not a ‘peak’ in rates.
• Economic data will remain crucial for sentiment about policy.
• 1.2590 is important on EUR-USD, although some consolidation could now be seen.
• Key is whether USD hedging dynamics are triggered.
• Japanese data fails to excite – Australian data strong.
• CHF outperforms in Europe.
• US GDP and employment cost index feature today.

Market Outlook

Bernanke yesterday confirmed more plainly what the Fed had been suggesting and the market had been suspecting for some time - namely that a pause in rate hikes will most probably happen after the next meeting. However, in doing so he also made it clear that a pause would not necessarily represent a peak in the rate cycle. This will depend upon the Fed’s expectations of growth moderation coming to fruition and core inflation remaining subdued. In other words, rates and rate expectations will remain sensitive to developments in the data, so USD positive developments could still materialise further down the track. The money market reaction was also cautious. The rate implied by the August Fed funds future is only back to where it was a couple of weeks ago, while 10-yr yields remain above the levels seen last week.

However, in the short-term, confirmation that a pause is near will support the current move in sentiment away from rates and on to structural balance of payments factors and this provides a window of opportunity for more USD weakness. As far as EURUSD is concerned the first barrier comes in at 1.2590 (Sept 2 2005 high), which could be tested today, with 1.2730-75 beyond that. US data (see below) could have an influence. Some consolidation is now favoured and whether the USD weakens materially from here will depend upon hedging behaviour. With EUR-USD having been fairly stable over the past year or so, there has been no need for panic hedging of USD asset positions or forward selling of USDs by exporters to the US. This is always a risk in the circumstances of the US trade deficit. If exporters fear a run on the USD, many months of the trade deficit can effectively be transacted (forward) in a short period of time. Likewise, holders of US assets may also look for protection. This can result in a one-way market and is what basically happened in Q4 2004 when EUR-USD shot up above 1.36. The big difference this time is that it is more expensive to hedge, with interest rates above 5% right down the curve. In Q4 2004, 3-mth money was only just above 2%. If protection is truly desired, this should not matter that much, but at the margin it could make a difference.

From the Eurozone side the data continues to show strength, with this morning’s M3, private sector lending, business climate indicators and flash estimate of CPI all coming out stronger than expected. This sort of data backdrop continues to raise questions over why the ECB is not tightening faster and if it had not been for Trichet’s verbal intervention at the April meeting, the EUR and especially rate expectations would probably be higher.

Japanese data last night failed to add anything fresh to the policy debate, but generally it was a little disappointing, with the nationwide core CPI y/y rate staying at +0.5% and most labour market numbers giving back some of the recent strength. The Chinese rate hike was a shock, but in itself is unlikely to seriously derail the strong growth environment in China and it does not necessarily mean anything for the CNY or the JPY. Indeed, given the desire on the part of China to avoid deflation, from a domestic point of view they may see higher rates or restrictions on lending as a more suitable alternative to excessive CNY strength, as the latter will push import prices lower. 113.50-75 should remain intact on USD-JPY for now.

Private sector credit data out of Australia again showed strength, leaving suspicions in the market that a precautionary rate rise may be announced as soon as next week. The risk of this occurring (odds just slightly against) will maintain support for the AUD.

EUR-NOK has slipped below support at 7.78 and this leaves risk down to the November 2005 low at 7.7080 (interim support at 7.74). This should hold for now – break down towards 7.50 favoured later in the year.

EUR-CHF has been falling throughout the morning, initially perhaps due to today being the deadline for Iran to comply with the UN’s nuclear demands. However, they have been indicating all week that they will ignore the deadline. USD-CHF breaking below the January low at 1.2560 also gave the CHF some independent momentum, while later in the morning a much stronger than expected KoF indicator (helped by back revisions) caused a brief spike below 1.5700 on EUR-CHF. This is the next level that needs to break to keep the move going and there will be sensitivity to any announcements made relating to the Iranian issue. Overall, the situation is likely to be an ongoing one and it is unlikely that anything new will materialise today.

Day Ahead
US – GDP (1st estimate) and the employment cost index are due for Q1, while Michigan sentiment and Chicago PMI are also due. The GDP data will likely be strong, while the employment cost index will be closely watched for any signs of a pick up in wage inflation. The y/y rate for the earnings number released as part of the employment report has been edging higher in recent months, while this week’s Beige Book also reported that some districts had seen a pick-up in wage growth. Michigan sentiment will also be keenly watched to see whether it reflects either the strength in the Conference Board measure or the latest drop in the weekly sentiment index. It is not clear whether the Conference Board came late enough to show any anxieties relating to the recent rise in fuel prices.

Data/event EDT Consensus*

UN UN Deadline for Iran nuclear compliance
US GDP (Q1, 1st est) saar 08.30 +5.0%
US Core PCE prices (Q1) saar 08.30 +2.4% last
US Employment cost index (Q1) q/q 08.30 +0.9%
CA GDP (Feb) m/m 08.30 +0.2%
US Michigan sentiment (Apr, fin) 09.45 89.0
US Chicago PMI (Apr) 10.00 58.0

Latest data Actual Consensus*
FR Unemployment rate (Mar) 9.5% 9.6%
FR ILO job seekers (Mar) m/m -30k -10k
JP CPI Tokyo (Apr, core) y/y +0.3% +0.2%
JP CPI Nwide (Mar, core) y/y +0.5% +0.6%
JP Unemployment rate (Mar) 4.1% 4.1%
JP Job-to-applicants ratio (Mar) 1.01 1.05
JP Employment (Mar) -230k +240k last
JP Overall PCE (Mar) y/y -2.1% -0.3%
JP Retail sales (Mar) y/y +1.0% +1.3%
JP Ind prod (Mar, prel) m/m +0.2% +0.2%
AU Private sector credit (Mar) m/m +1.2% +1.1%
JP Housing starts (Mar) y/y +3.3% +7.4%
DE Retail sales (Mar) m/m -2.7% +0.4%
FR Household survey (Apr) -27 -26
SE Riksbank repo announcement 2.0% 2.0%
SE Retail sales (Mar) m/m -0.1% +0.1%
EU M3 (Mar) y/y +8.6% +7.9%
EU M3 (Mar) 3m y/y +8.1% +7.9%
EU Private sector lending (Mar) y/y +10.8% +10.4%R last
EU CPI (Apr, flash est) y/y +2.4% +2.3%
EU Econ sentiment (Apr) 105.3 103.3
EU Business climate index (Apr) 1.12 0.78
IT CPI (Apr, prel) y/y +2.2% +2.2%
GB Consumer confidence (Apr) -4 -6
CH KOF indicator (Apr) 2.03 1.32
* 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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