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Thursday May 4, 2006 - 10:58:30 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Correction in USD/Europe likely ahead of FOMC meeting if today’s ECB event fails to reveal fresh hawkishness.
• More UK data strength boosts GBP.
• Dodge comments help USD-CAD higher.
• US productivity and unit labour costs also feature today, RBA policy statement due tonight.

Market Outlook

The USD has stabilised somewhat against a number of currencies, although some lingering anticipation ahead of today’s ECB meeting is probably offering some residual support for EUR-USD and European currencies in general. However, if rates are left unchanged and Trichet’s language does no more than confirm the likelihood of a June rate hike, this will add little to market intelligence. He will need to offer the hope of a faster pace of tightening in the second half of the year to add something extra to the EUR.

The ongoing strength of the US data, amongst other things, has led the market to slightly reassess Fed policy risk going forward, although Bernanke did seem to make it fairly clear anyway in last week’s testimony that a ‘pause’ in rates would not necessarily represent a ‘peak’. The big question now is what the market focuses on ahead of Tuesday’s FOMC – the possible confirmation of a future ‘pause’ or the likely indication that further data strength would most probably prompt further tightening. The uncertainty over the issue will probably weigh on positioning in general and this itself suggests the likelihood of a USD recovery between now and Tuesday, especially against the EUR. If today’s ECB meeting passes without fresh hawkishness, this could be the trigger for such a move.

This may not be similarly felt against other currencies like GBP, which is rapidly gaining support from domestic data developments (see below). There is also an absence of over positioning on cable, in contrast to EUR-USD. It follows that if EUR-USD does slip it may also mean more weakness in EURGBP, especially after breaking below support at 0.6840 (early March lows and 200-day MA).

Key levels to look at on European currencies are 1.2550 and 1.2500/1.2480 on EUR-USD, 1.2450 on USD-CHF and 1.8335 on cable. All are levels that if broken would encourage corrective activity. Main resistance on EUR-USD remains at 1.2730-75.

The main element of today’s UK data was a much stronger than expected PMI services – bouncing back to a 27-mth high of 59.7 after the dip to 57.4 (from 58.9) seen last month. Volatile it may be but it does appear to be heading in an upward direction. Consumer credit was very weak (+£0.3bn down from +£1.2bn), but this was offset by very strong mortgage lending (+£9.3bn up from +£8.0bn). This may reflect further debt restructuring – extending mortgages to pay off more expensive credit card debt. Mortgage approvals were steady, while HBOS house prices were up a strong 2.0% m/m. Overall, the data continues to support the shift in rate expectations currently underway, with Sep short sterling (currently at 4.89% - see chart) discounting a 25bp hike by the time of the August Inflation Report (UK repo currently 4.5%). This sentiment could continue to develop in GBP’s favour in the short-term, but whether this eventually translates into a rate hike we are far less confident about. Housing market strength could soon blow over, while consumer sector fragility could easily return at some point.

USD-CAD bounced following comments by Dodge. He said that while most of the CAD gains in recent years where related to Canadian fundamentals (what the BoC term as Type I CAD gains) the advances of the previous week or so had been due to USD weakness (or Type II gains). He also said that it was tough for some sectors such as manufacturing to adjust to a rising CAD, but that this was happening faster than in previous periods. As it currently stands, this is a warning on CAD strength but not an aggressive one. 1.10-1.12 is the range that needs to break to suggest near-term direction on USD-CAD.

Day Ahead
Eurozone – the ECB meeting is the major focal point and while the data continues to suggest a need for tightening, Trichet’s comments last time seemed to make it clear that rates would be left on hold until June. This does not necessarily preclude a rate hike today, but Trichet’s reputation would be undermined by such an outcome. The strength of his language at the press conference will be monitored to see whether there is any indication about a faster pace of tightening in the second half of the year. On the data front, the PMIs for services are likely to show continuing strength in activity.

US – productivity and unit labour costs data for Q1 are released and after the recent strength in GDP, solid productivity and soft cost data should arithmetically follow. However, there does appear to be some strength in hourly compensation so this leaves some support/upside risks to unit labour costs.

Australia – trade data and the RBA’s quarterly policy statement are out tonight. The trade data has been highly volatile over the past few months so the market will most probably disregard this until a clearer picture becomes available i.e. two month’s worth of fairly similar numbers would be a start. The main focus will be on the RBA statement for more clues about policy intentions going forward. Few were offered when the RBA hiked rates on Wednesday and the market will be left with the view that much will depend upon the evolution of the data. Some consolidation may now be seen in the AUD after recent gains, but solid support looks likely. The tone of data releases will be key going forward and the major ones next week are retail sales on Monday and employment on Thursday. A pullback to 0.7600 could be seen before then unless there is some surprise encouragement from the RBA. Resistance is at 0.7720 and 0.7750.

Data/event EDT Consensus*

JP Market Holiday (today)
GB MPC rate announcement 07.00 4.5%
EU ECB meeting outcome 07.45, press conf 08.30 2.5%
US Productivity (Q1, 1st est) saar 08.30 +2.9%
US Unit lab costs (Q, 1st est) saar 08.30 +1.3%
US Initial claims (w/e Apr 29) 08.30 308k
US Continuing claims (w/e Apr 22) 08.30 2449k last
CA Building permits (Mar) m/m 08.30 +2.3%
CA PMI (Apr, nsa) 10.00 61.0
JP Market Holiday (tomorrow)
AU RBA quarterly policy statement 21.30
AU Building approvals (Mar) m/m 21.30 +1.0%
AU Trade balance (Mar) 21.30 -A$1.3bn

Latest data Actual Consensus*
CH CPI (Apr) y/y +1.1% +1.1%
GB HBOS house prices (Apr) m/m +2.0% +1.1%R last
IT PMI services (Apr) 59.6 59.1
FR PMI services (Apr) 59.4 60.5
DE PMI services (Apr) 57.3 57.0
EU PMI services (Apr) 58.3 58.6
NO Unemployment rate (Apr, nsa) 2.8% 2.8%
GB PMI services (Apr) 59.7 57.6
GB Consumer credit (Mar) +£0.3bn +£1.3bn
GB Mortgage approvals (Mar, sa) 116k 117k
EU Retail sales (Mar) m/m -0.8% +0.1%
* 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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