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Wednesday June 14, 2006 - 10:32:59 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Markets waiting for key US CPI data.
• +0.2% ‘consensus’ outcome on core CPI would probably prompt a relief rally (at least initially) in equity markets and a softer USD.
• Fed Beige Book also due.

Market Outlook

Asian markets managed to stabilise a touch overnight despite another soft and nervous close in the US equity market, while European equities are slightly lower. FX markets have shown little direction after the USD strength seen in recent days, although the commodity price background (better this morning after sharp falls in Asia) is still weighing on the AUD, NZD and CAD. The market is essentially waiting for the US CPI data before reacting further.

This data will be critical for most markets (see below). A third successive +0.3% rise in core CPI would weigh heavily on equity markets globally given the fear that higher global rates will put the squeeze on both growth prospects and general liquidity. This will also most probably help the USD, more because of the flows that will be generated back into the USD investor base and short-term position adjustment rather than any positives conveyed about the US via the prospect of higher interest rates. Longer-term growth prospects (and USD fundamentals) would be undermined if CPI continues to strengthen. A weak number (less than +0.2%) would prompt a sizeable relief rally for equities and emerging currencies and a weaker USD, while +0.2% would also prompt some relief after the market weakness seen in the run-up to the data. The formal market consensus may be +0.2%, but the market has been fearing the worst. This should also see the USD weakening but by a lesser magnitude. The Beige Book will also be significant.

UK labour market data was fairly uneventful. Unemployment (ILO measure) continues to rise, with the unemployment rate of 5.3% the highest seen since September 2002, but the LFS measure of employment is still rising. Of significance in current circumstances is that average earnings (wage) growth remains subdued.

US – May CPI and the Beige Book for the June 29 FOMC meeting are the main features. The core CPI number will be significant for how sentiment about Fed policy, general inflation risk and global market sentiment develops in the short-term. The last two monthly outcomes have been +0.3% and a third reading of such magnitude would clearly add to current fears about a pick-up in inflation and more Fed tightening to come. Of course, the FOMC prefers looking at the core PCE price index, but also acknowledges the impact that any major measure of inflation can have on inflation expectations. The core PCE price index (+0.3% in March and +0.2% in April) has not been as strong as core CPI, but it has still been a cause for concern at the Fed based on recent comments. The next release is not scheduled until June 30, a day after the next FOMC meeting, although it seems like the FOMC will have a pretty good idea what the number will be during that meeting.

The observation in the Beige Book about the ability of price setters to pass on higher input prices will influence sentiment about the June 29 FOMC. In the last beige Book it was noted that while inflation pressure was in evidence, companies were still having mixed success in passing on higher input prices.

Data/event EDT Consensus*

US CPI (May) m/m 08.30 +0.4%
US CPI core (May) m/m 08.30 +0.2%
CA Manu shipments (Apr) m/m 08.30 -0.5%
EU Trichet speaks 13.00
US Beige Book for Jun 28-29 FOMC 14.00
US Fed’s Minehan speaks 19.00
GB RICS house price balance (May) 19.30 14%
JP Tertiary index (Apr) m/m 19.50 +1.0%
JP BoJ policy outcome

Latest data Actual Consensus*
US ABC consumer conf (w/e Jun 11) -15 -17 last
AU Consumer sentiment (Jun) -0.5% -6.0% last
FR CPI (May, prel) y/y +2.1% +1.9%
GB Claimant count (May) +5.8k +5.5k
GB Average earnings (Apr) 3m y/y +4.4% +4.5%
GB Earnings ex-bonuses (Apr) 3m y/y +3.8% +3.8%
* 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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