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Wednesday May 31, 2006 - 11:08:13 GMT
Mellon Bank Foreign Exchange -

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Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD remains stuck in recent range.
• ECB rate hike expectations on the boil – CPI edges up further.
• Markets will reserve judgement on Paulson.
• BoJ reasserts control over short rates.
• Australian data strong again – should eventually be a positive for AUD.
• Norges Bank meeting, Canadian GDP, FOMC minutes feature today.

Market Outlook

EUR-USD has failed to build on the advances seen yesterday, with the air of general uncertainty continuing to weigh on risk appetites. While most Asian equity markets were down sharply overnight, following the losses experienced in European and US indices yesterday, European markets have bounced this morning, after themselves initially opening a fair way lower. Even a stronger than expected Eurozone CPI number (+2.5% up from +2.4%) was not enough to prevent the recovery in equities, which seemed unusual in itself given the current anxiety about higher interest rates and higher inflation. This demonstrates how unclear market sentiment is at the present time and in such circumstances it could be difficult for genuine trends to emerge on the FX majors, especially given current positioning. The case for a 50bp rate rise from the ECB next week looks solid in terms of data alone, but the more volatile markets are the less likely it is that the ECB will make such an aggressive move.

The Paulson appointment is a positive one in terms of the impression that foreign investors could potentially have of American economic policy, but many will reserve judgement on this until they hear in some detail what he has to say on key issues. It is not abundantly clear that there will be any major change in the thrust of the Administration’s current policies. Other data this morning included solid looking business sentiment indicators in the Eurozone, a strong KoF number in Switzerland and mixed data in the UK. The rise in the KoF in Switzerland leaves an outside chance of a more aggressive approach to tightening by the SNB, but initial EUR-CHF weakness after the release of the data has been partly reversed, probably because of the stabilisation in European equity markets (reducing the safe-haven appeal of the CHF). German and French labour market data was also better, although actual employment will need to grow more quickly to generate real hopes of a pick-up in labour demand. This should happen in due course.

In the UK, mortgage approvals and consumer confidence were weaker, while CBI sales (y/y measure) were higher. The softer approvals data is consistent with the observations made by the MPC at its recent meeting, while the underlying sales picture in the UK is unclear at the present time. The April CBI survey was boosted by Easter, so the fact that this has been more than sustained in May would appear to be impressive. However, further distortions are possible from strong pre-World Cup spending on TVs etc, which could merely be displacing future sales.

The BoJ appears to have reasserted some control over the money market by adopting a more accommodative stance over the past few days. They allowed current account balances to rise on Monday and Tuesday and this contributed to a much lower weighted average for the call rate of 0.023% yesterday and 0.021% today. This has helped to bring rate expectations in the 0-12mth area down from the peaks of late last week.

More strong Australian data last night, with private sector credit up 1.3% m/m. Issues relating to risk averseness, volatility in commodity prices etc do not lend themselves to excessive positioning on the AUD at the current time and this is a constraint in the short-term. However, if and when such conditions stabilise, the AUD will be very well supported by current data developments. If this sort of data performance continues for another month the RBA may be forced into believing that another ’precautionary’ rate rise in necessary.

Day Ahead
Norway – the Norges Bank announce their latest policy decision today and there is a fair chance of a further 25bp rate hike. On the basis of recent economic data developments, a rate hike is certainly justified, but the strength of the NOK and recent stock market volatility may argue for caution. A further problem with hiking rates only two months since the last move in March is that it would be more difficult (but not impossible) for them to reiterate the ‘small not frequent steps’ approach to tightening that was adopted in the middle of last year.

Canada – GDP data for March and Q1 as a whole is due out, but it is unlikely to significantly affect market sentiment about BoC policy, now that the BoC has made it clear that rates will be on hold for the time being. It could be a big day for USDCAD if it can hold below the recent lows at 1.0970, which broke this morning. This would signal the likelihood of another leg lower in the short-term.

US – Chicago PMI may have some effect on sentiment about the full ISM, although it is an unreliable indicator of ISM and prone to volatility. The minutes of the May 10 FOMC meeting are also out and will be closely scrutinised for any hints about the June 29 policy outcome. The basic message is that a pause may well be seen on June 29, with the proviso being that much data is due between May 10 and June 29. Also, for this to turn into a peak there will need to be some moderation in the growth of economic activity, which is currently the Fed’s central scenario. How much weight they attach to the impact of past tightening will also be a key factor in determining how the market views the FOMC’s appetite for a rate hike pause.

Data/event EDT Consensus*

US Chain store sls (w/e May 27) w/w 07.45 -0.8% last
NO Norges Bank policy outcome 08.00 2.5%
CA GDP (Mar) m/m 08.30 +0.4%
CA GDP (Q1) saar 08.30 +3.0%
NO Norges Bank press conference 08.45
US Redbook sls (w/e May 27) m/m 08.55 -2.8% last
US Chicago PMI (May) 10.00 56.2
US Minutes of May 10 FOMC 14.00
AU Private new capex (Q1) q/q 19.30 +2.0%

Latest data Actual Consensus*
US ABC consumer conf (w/e May 28) -17 -19 last
FR Unemployment rate (Apr) 9.3% 9.5%
FR ILO job seekers (Apr) m/m -39k -12k
AU Private sector credit (Apr) m/m +1.3% +1.1%
AU Trade balance (Apr) -A$1.1bn -A$1.4bn
JP Housing starts (Apr) y/y +15.0% +5.6%
GB N’wide house prices (May) m/m +0.2% +0.7%
DE Retail sales (Apr) m/m +2.8% +1.9%
DE Employment (Apr) +11k +4k last
FR Consumer confidence (May) -30 -25
DE Unemployment (Apr) -93k -15k
NO Retail sales (Apr) m/m -0.4% +0.4%
NO Unemployment rate (Mar, sa) 4.0% 3.8%
GB Consumer credit (Apr) +£0.8bn +£1.0bn
GB Mortgage approvals (Apr, sa) 106k 115k
EU CPI (May, flash est) y/y +2.5% +2.4%
EU Econ sentiment (May) 106.7 104.9
EU Business climate index (May) 1.06 1.05
IT CPI (May, prel) y/y +2.2% +2.2%
GB Consumer confidence (May) -5 -4
CH KOF indicator (May) 2.30 2.10
GB CBI retail trades survey (May) +9 +2 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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