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Thursday June 15, 2006 - 11:11:43 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Market stabilisation suggests that some of the bad news has been discounted for now, but further problems look likely given US inflation developments.
• EUR-USD direction looking difficult short-term.
• SNB raises rates 25bp, UK retail sales slightly disappointing.
• US TIC portfolio data and NY/Philly Fed surveys (especially the price components) feature today.

Market Outlook

The news on inflation out of the US remains poor, but the market’s reaction to the news suggests that a fair slice of the bad news has been discounted for now. However, in such circumstances of mounting inflation and moderating growth, it will be difficult for higher risk markets such as equities and emerging currencies to launch sustainable recoveries and more likely is that these markets will continue to exhibit vulnerabilities in the weeks ahead, especially with the June 29 FOMC decision looming. The way the inflation data is now developing and more importantly the way the Fed is verbally responding to it, the nmarket is likely to look more pointedly at the risk of a rate hike at the August 8 meeting as well as June 29.

Yesterday’s Beige Book also noted a slight increase in inflation signs (“High energy costs were fuelling price increases in manufacturing and, to a much lesser extent, retail. Reports of costs being passed forward varied considerably but were more prevalent than in the last Beige Book.”) although this was not as bad as it could have been. Key price components of today’s Fed surveys will also be watched (see below).

The calmer feel to global markets has been one factor helping to stabilise EUR-USD, but the market is likely to be wary about chasing this move too far. In particular, the previous range support area at 1.2685-1.2725 should now prove to be effective resistance. Support is at 1.2500-30. This range may be difficult to break in the short-term.

The BoJ left policy unchanged and reiterated past views in their monthly report. Later on, Fukui said in the press conference that the timing on future rate rises was not related to the normalisation in current account deposits. This is clearly a preemptive move to try and head off speculation about a rate rise as and when the BoJ achieves its target of bringing current account deposits back towards a more normal level around ¥5trn. Such a normalisation remains their primary concern for the time being and they do not want to undermine this process by introducing any fresh hawkishness into the market. As it is they are so far struggling to get it below ¥10trn, with the o/n rate having firmed up again this week (average of 0.066% both yesterday and today).

The SNB raised its target band for 3-mth LIBOR by 25bp to 1%- 2%, aiming at a mid-point of 1.5% - generally expected by the market. They also signalled that further rate rises were likely, but in no way suggested the possibility of a faster pace of tightening. Indeed, they made a point of saying that they would respond appropriately to any sudden revaluation in the CHF. With global markets also on the mend (for the time being at least) some further upside should be seen for EUR-CHF today. Above 1.5560-65 would allow room up to 1.5630. However, given the high risk of a resumption of global market instability, EUR-CHF strength is unlikely to last too long.

UK retail sales data for May was a touch stronger than expected at +0.5%, although given the sharp rise in spending on TVs etc ahead of the World Cup (the ONS also noted the strength in such spending), the overall outcome was perhaps a little disappointing. More important will be what happens to sales over coming months to see whether such strength is sustained.

The Eurozone CPI y/y rate for May was confirmed at +2.5%, in line with the flash estimate already released, although core measures were weaker (ex-fresh food and energy down at +1.5% from +1.6% and ex-food, energy, alcohol and tobacco down at +1.3% from +1.5%). The ECB is more focused on the headline rate. The ECB monthly bulletin (as it typically does) reiterated the sentiments aired by Trichet at last week’s ECB press conference. It was forthright about the upside risks to inflation because of the combination of low interest rates and very strong lending growth, but short on detail about future tightening prospects.

Day Ahead
US – both the NY and Philly Fed surveys are released along with industrial output and the latest TIC portfolio data. In the current circumstances, the best outcome on the headline numbers of the Fed surveys would be something nice and steady – not too strong, not too weak. However, there will also be a keen interest in the ‘prices received’ component of these surveys. As opposed to the prices component of the ISM, which is a measure of input/raw material prices or ‘prices paid’, ‘prices received’ is the price of finished goods, so is a better indicator as to whether higher input prices are being passed on. The chart on page 1 shows that while the balances on these categories are in positive territory they have actually been falling back a little in recent months.

The TIC data has been less of a focal point for the market in recent months, but anything unusual on the headline number will attract attention. Today’s TIC data is for April, but what will be interesting is the May and June data, when there should be some indication about the weight of repatriation flows as a result of recent market volatility.

Data/event EDT Consensus*

NZ PMI manu (May) 08.00 53.1 last
US NY Fed index (Jun) 08.30 10.9
US Initial claims (w/e Jun 10) 08.30 323k
US Continuing claims (w/e Jun 10) 08.30 2415k last
US TIC intl portfolio balance (Apr) 08.00 +$60.0bn
US Ind prod (May) m/m 09.15 +0.2%
US Capacity utilisation (May) 09.15 82.0%
US Philly Fed index (Jun) 12.00 11.0

Latest data Actual Consensus*
GB RICS house prices (May) +20% +15%
JP Tertiary index (Apr) m/m +1.3% +1.0%
CH SNB LIBOR range announcement 1%-2% 1%-2%
NO Trade balance (May) NOK30.6bn NOK33.6bn
GB Retail sales (May) m/m +0.5% +0.4%
EU CPI (May) y/y +2.5% +2.5%
EU CPI ex-energy/fresh food (May) y/y +1.5% +1.6% 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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