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Thursday June 1, 2006 - 11:08:06 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Position liquidation depresses EUR-USD. Eurozone PMIs stronger than expected.
• FOMC minutes contribute to sense of uncertainty –
today’s US ISM will be significant.
• Swiss data continues to improve, but CHF is currently more driven by the state of global markets.
• AUD hit by further gold price weakness.
• US pending home sales, unit labour costs also feature today.

Market Outlook

EUR-USD continues to pullback from another failed attempt at the higher levels, with more positions getting cut out of the market. However, a strong round of Eurozone PMIs this morning did offer some support and this data reinforces the risk of a 50bp ECB rate hike next week.

The FOMC minutes were cited as a factor behind the downmove overnight, although the minutes did not really add that much to the current debate about monetary policy. The market was initially spooked by headlines about inflation pressure having been somewhat higher than the FOMC had expected, but the basic prognosis on policy was in line with prior expectations i.e. that a pause in rates could happen at any time. The minutes also pointed to the recent weakening of the USD as an additional factor supplementing inflation pressure, but retained the conclusion that core inflation would remain under control and that growth should moderate. Unchanged rates are still favoured for June 29, but a run of very strong data would clearly increase the risk of one more hike.

Fed funds futures nudged up a little further, with July (a clean measure of the June 29 policy outcome) now priced at 5.19% compared to 5.15% earlier yesterday. It is the added uncertainty over the Fed policy issue, on top of other anxieties, that probably prompted more EUR-USD longs to liquidate – a move that was already in train yesterday before the minutes were released. Key support remains at 1.2685-1.2700 and this should hold ahead of next week’s ECB meeting. Today’s US ISM (see below) will also be significant, while the employment report is due tomorrow.

More strong data out of Switzerland this morning following yesterday’s stronger than expected KOF indicator. GDP, CPI and manufacturing PMI were all ahead of expectations this morning and this may see a resumption of speculation about a faster pace of tightening from the SNB. However, such speculation will need to be substantial to boost the CHF, which is currently being driven by safe-haven issues (global markets having been more stable over the past 24 hours). In late April, when the SNB broached the possibility of a faster pace of tightening they were linking it to circumstances of more CHF weakness, but the latter has strengthened over the past month, so the urgency to tighten more aggressively from this angle is less apparent. However, the data has clearly been developing in excess of SNB expectations and if the ECB moves 50bp next week, which is a clear possibility, then speculation of a similar SNB move could easily follow. 1.5545-60 is current support that has to be pierced on EUR-CHF to open up some downside risk, while above 1.5630-35 would prompt a further recovery. Further upside testing looks likely today unless there is fresh slippage in equity markets.

The dangers of taking AUD positions in the current climate have been clearly highlighted over the past 24 hours. Local data may be improving the chances of a further RBA rate hike, but the weaker gold price has been inflicting damage. Gold has moved below the lows seen last week and the chart is not looking good from a short-term perspective. A close below $637 or an intraday break of $630 would suggest further losses over the next couple of days. The AUD is now close to the lows seen last week (when gold was also dipping lower) and a break below this area at 0.7465-70 (now looking likely) would open up risk towards 0.7365. AUD-NZD would also be at risk in the short term if 1.1800 were to break. Ultimately, the AUD should recover, but it is difficult to fight the current downside risk.

Day Ahead
US – productivity/unit labour costs, jobless claims, ISM manufacturing and pending home sales are the data features and the ISM will be highly significant in determining sentiment about the June 29 FOMC policy outcome. Markets and the Fed alike still seem to be undecided about the likely course of action on June 29 and sentiment on the issue will be highly sensitive to any definitive developments in key releases like the ISM. Last month the ISM rose to its highest level (57.3) since November. Pending home sales are also out and this data series has been steadily weakening since the middle of last year, suggesting downside risk for housing in general. Unit labour costs will also be watched, although a downward revision looks likely after the recent upgrade to GDP.

Data/event EDT Consensus*

US Productivity (Q1, 2nd est) saar 08.30 +3.9%
US Unit lab costs (Q1, 2nd est) saar 08.30 +1.8%
US Initial claims (w/e May 27) 08.30 320k
US Continuing claims (w/e May 20) 08.30 2420k last
US ISM manu (May) 10.00 55.7
US Pending home sales (Apr) m/m 10.00 -1.0%

Latest data Actual Consensus*
AU Private new capex (Q1) q/q +0.6% +2.0%
CN PMI manu (May) 54.8 58.1
CH GDP (Q1) saar +0.9% +0.7%
CH CPI (May) y/y +1.4% +1.3%
SE PMI manu (May) 61.3 59.0
CH PMI manu (May) 63.5 63.2
IT PMI manu (May) 56.6 57.0
FR PMI manu (May) 56.1 55.1
DE PMI manu (May) 58.5 57.8
EU PMI manu (May) 57.0 56.5
NO Unemployment rate (May, nsa) 2.5% 2.7%
GB PMI manu (May) 53.2 53.5
EU GDP (Q1, prel) q/q +0.6% +0.6%
EU Unemployment rate (Apr) 8.0% 8.1%
* 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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