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Thursday May 18, 2006 - 10:35:27 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Equities still edgy after yesterday’s US CPI data.
• USD also aided by comments from G7 officials.
• Some element of downside risk on EUR-USD – key support at 1.2685-1.2700.
• Canadian CPI, Philly Fed feature today – Japanese GDP and BoJ due tonight.

Market Outlook

Fairly big moves in the USD yesterday, with EUR-USD, USDJPY, USD-CHF and the AUD all recording ‘outside’ days suggesting a possible reversal of recent trends. A similar performance was seen in EUR-USD on Monday although yesterday’s was more substantial. This sort of development may just be a reflection of the volatility in markets in general at the present time, although a solid performance is required in EUR-USD today to nullify near-term downside risk. Once again the USD seems to be trading in line with the developments in other asset markets (the USD negatively correlated with investor risk appetite) although this should start to subside a little as spec positioning is cut back.

There has also been an extra dimension to USD strength over the past couple of days in the form of comments from G7 officials about recent FX developments. French officials have been particularly vociferous, while we noted after Noyer’s comments that the ECB also have an interest in EUR-USD not running away on the upside, as this would make it more difficult for them to raise rates, which they feel is essential given ongoing developments in interest rate sensitive sectors of the economy. The fact that Snow also added some cautionary comments yesterday, dismissing the notion of a sudden sharp drop in the USD, also left the market with the idea that some are now getting a little uncomfortable about recent volatility.

A resumption of USD weakness is likely at some point, but further downside testing could be seen today on EUR-USD, especially if equities show any fresh signs of major slippage in the wake of yesterday’s CPI data. Key will be whether it can hang on to support at 1.2685-1.2700. Below there would suggest further slippage back to 1.2570-1.2600. A firm footing above 1.2800 is needed to stabilise the situation a little.

UK retail sales came out ahead of market expectations (+0.6% compared to +0.5%) and the previous number was revised up to +0.9% from +0.7%. The data follows other releases that have been suggesting better times for the consumer and the economy as a whole. The consumer has been identified by the MPC as one of the downside risks to their growth forecast, so any further strength in this sort of data will invite speculation about more members being won over into voting for a rate hike. There were market rumours of a regional newspaper report about BoE governor King telling a local business group meeting in the North of England that there was no rush to raise interest rates. However, on inspecting the article, this appears to have been the view of the business group and not necessarily King. There remains a risk of some further slippage towards 0.6700 on EUR-GBP in the short-term.

Day Ahead
Canada – CPI is due and the market is expecting a modest uptick in the core CPIX y/y rate to +1.8% after +1.7% the previous month. However, it will take something unusual to move the market. CPIX has been remarkably stable for many months – the y/y rate being at +1.6% or +1.7% in each of the past eight months.

US – the Philly Fed survey is due and this has been fairly steady in recent months albeit at more subdued levels to those seen earlier in 2005 and through 2004. The slightly softer outcome seen on the NY Fed index earlier this week suggests a similar story today.

Japan – GDP data for Q1 is out, while the market will also be watching the BoJ policy outcome and their latest monthly report. There has been a lot of mixed speculation in the media about the outcome of the monthly report and whether there will be a mild upgrade to their assessment of the economy. There are unlikely to be any major changes at the BoJ meeting, with their near-term objective being a further normalisation in current account balances back towards Y10trn and a likely modest firming in the o/n rate. However, in recent comments BoJ governor Fukui has been fairly keen to contain rate hike speculation, so they may be at pains to do this again.

Data/event EDT Consensus*

CA CPI (Apr) y/y 07.00 +2.4%
CA CPIX (Apr) y/y 07.00 +1.8%
US Initial claims (w/e May 13) 08.30 320k
US Continuing claims (w/e May 6) 08.30 2392k last
US Fed’s Moskow speaks 09.15
US Fed’s Bernanke spks on Basel II 09.30
US Lead indicators (Apr) m/m 10.00 +0.1%
US Philly Fed index (May) 12.00 12.0
US Fed’s Poole on yield curve 12.45
JP GDP (Q1 1st est) q/q 19.50 +0.3%
JP BoJ policy outcome
JP BoJ monthly report 01.00

Latest data Actual Consensus*
AU AWOTE wages (Q1) q/q +0.9% +0.4% last
GB Retail sales (Apr) m/m +0.6% +0.5%
* 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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