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Tuesday May 9, 2006 - 11:22:15 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD consolidating ahead of FOMC – supports at 1.2570-1.2600.
• US adopt a more conciliatory tone towards China.
• ECB rhetoric remains strong, suggesting an attempt to change market expectations. This week’s GDP will be significant.
• NZD still under the cosh – steadier JPY may eventually help.
• UK data remains strong – EUR-GBP near-term scope to 0.6800.

Market Outlook

EUR-USD finally gave up some ground yesterday, with positional pressure and some lingering uncertainty about the FOMC outcome most likely taking its toll. This could have further to go today, although reasonable support looks like ahead of 1.2570-1.2600. There is very little on the schedule today.

The key events of this week are Wednesday’s FOMC meeting, which should offer encouragement for a pause (but not necessarily an end) to rate hikes and the German/Eurozone GDP data the following morning. This will be significant in determining whether the recent hawkish move in Eurozone money market sentiment can develop further. ECB rhetoric remains strong and consistent with a possible uplift in the pace of tightening. Would they need to be this aggressive if a simple schedule of 25bp rate rises in June, Sept and Dec was all they had in mind? They appear to be orchestrating a shift in market thinking, stressing the need for ‘strong vigilance’ rather than vigilance, downplaying the significance of the stronger EURUSD and stating that the outlook for activity is better than it was previously. This morning’s German industrial output data was actually quite weak (-2.4% m/m), although this data is notoriously volatile and the stats office also said the number may have been affected by strike activity. It does raise a slight doubt about the Q1 GDP outcome as well as a possible excuse (strike activity) if it is weak.

USD-JPY has also managed to stabilise and this could recover up towards 112.50-85 today, below which downside risk remains. However, 114.25 and 115.50 are both levels that need to be won back to truly stabilise the situation. The US said yesterday that their much-awaited FX report would be released on Wednesday at 16.00 EDT and comments from Treasury spokesman Fratto, while not conclusive, were fairly friendly to China, indicating that they will not be formally naming China as a currency manipulator. While stating that China could move with more speed towards currency flexibility, he also said “when you look at what China is doing in executing their commitment on putting in place a foreign exchange regime that has greater flexibility and an economy that is more flexible, you'll see some evidence that they're doing that,'' and “we're going to focus in the report on their actions.” If this is confirmed it may take some of the pressure off USD-JPY, although USD-CNY may well fall in any case. History suggests that China rewards diplomacy rather than aggressive posturing.

USD-JPY was temporarily knocked lower in Asia on a report that the BoJ may upgrade its assessment of the Japanese economy in its next monthly report on May 19. There is also increasing talk that this could pave the way for a rate rise as soon as June. The current account deposits left with the BoJ by the banking system have been falling recently and the o/n rate has been higher either side of Golden Week (0.005%-0.006%) than it was previously (0.002%). However, there is still some way to go before the o/n rate reaches its current ceiling of 0.1%.

The NZD has been hit on all sides over the past 24 hours. There has been no fundamental news to speak of, other than the continuing weakness in the share price of NZ’s largest company (Telecom NZ), but the recent strengthening of the JPY was certainly a contributory factor, given the unique properties of that cross. Many Japanese investors are long of Uridashi and problems on that cross can prompt possible hedging activity as well as being a deterrent to future Uridashi buying. The move in AUD-NZD beyond recent highs in the 1.2050-70 area yesterday also generated NZD selling pressure. The next level of AUDNZD (which has risen again this morning) is at 1.2350 (February 2002 high), but 1.2500-1.2650 is the next big area. If USD-JPY stabilises in the very short-term, this could actually
ake some of the pressure off the NZD, at least for a while. NZD-USD support is at 0.6200-30.

UK data continues to shine brightly for GBP, with a sharp jump in BRC retail sales (+6.8% y/y) coming on top of yesterday’s stronger than expected PPI data. In fairness, the strength in the BRC survey is explained in part by the different timing of Easter, so one should treat the data with some caution. However, taking the two months together still gives an average y/y growth rate well above those seen for many months, so it will add further fuel to recent developments in money market sentiment. EUR-GBP has scope to 0.6800 in the near-term.

The AUD was largely unmoved on the announcement of the Australian Budget. A$36.7bn worth of cuts in personal income tax are scheduled for the coming four years, although A$21.7bn of this appears to have been announced already in last year’s Budget. This will lend a positive bias to the growth backdrop that monetary policy will have to deal with, but in itself (spread over four years) is unlikely to spark any fresh developments in rate expectations for the near-term. It is mildly positive for the AUD.

Day Ahead
Data/event EDT Consensus*

US Chain store sls (w/e May 6) w/w 07.45 +0.7% last
US Redbook sls (w/e May 6) m/m 08.55 +4.9% last
US ABC consumer conf (w/e May 7) 17.00 -13 last

Latest data Actual Consensus*
GB BRC retail survey (Apr) y/y +6.8% -1.4% last
GB Land registry house prices (Q1) y/y +5.1% +4.6% last
DE Ind prod (Mar) m/m -2.4% +0.4%
* 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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