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Tuesday June 27, 2006 - 10:59:47 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Strong IFO fails to offer lasting boost to EUR-USD.
• ECB rate hike speculation could advance going into next week, but this may only be a short-term EURUSD positive.
• CB’s continue to talk tough on inflation.
• JPY afflicted by further Fukui speculation.
• US existing home sales and consumer confidence due today.

Market Outlook

Key FX rates are still lacking clear direction ahead of Thursday’s FOMC announcement and indeed amidst the broader uncertainty about what will happen to rates in other countries.

ECB members (Quaden and Mersch) were talking tough on policy yesterday, noting that they can raise rates at any time and by any magnitude. They also said that just because the August 3 meeting was a teleconference without a scheduled press conference did not necessarily mean that policy could not be changed on such occasion. This morning, another council member, Garganas, was also suggesting the possibility of larger rate hikes and/or a faster pace of tightening.

All of this points to renewed rate hike speculation ahead of next week’s (July 6) ECB meeting and this will be intensified if there is any additional strength in the key private sector lending and CPI data out of the Eurozone scheduled for Thursday and Friday respectively. There are of course a number of other things for the market to consider before it can fully focus on next week’s ECB meeting – Friday’s US core PCE price index as well as Thursday’s FOMC outcome – and even a strong IFO number this morning only had a temporary impact. However, there could eventually be some EUR-USD strength going into next week if US events do not affect market expectations any further. EUR-USD is back in the range of the past two weeks, although there is some residual downside risk ahead of Thursday’s FOMC decision. The 1.2680-1.2720 area needs to be won back to shift attention back to the upside. Support is at 1.2530 and last week’s low of 1.2478.

So how serious is ECB rate hike risk and how will this affect EUR-USD? Given the current circumstances of strong data, upside risks to inflation and the current low level of interest rates, there is a constant risk of the ECB raising rates, so a move next week is possible. Such speculation would be a positive for EUR-USD, although it may not necessarily equate to a significant move higher, even if they did raise rates. It is not clear that markets are looking at rate hikes individually at the present time – but more from the standpoint of global market risk. Note the comments from BIS spokesman Knight yesterday, saying that central banks were increasingly mindful of combating inflation pressures and that there was a risk that future policy responses would be more aggressive than the market had been accustomed to in recent years. Such comments will only heighten expectations that central banks may embark on monetary overkill to mollify their inflation concerns. If this is the case, market volatility will likely be more pronounced in bonds, equities and emerging currencies – less so major FX. The ECB move would just be part of the global tightening story and the impact this could have on higher risk markets, rather than just a EUR positive.

The JPY has also been a mover this morning on fresh speculation about Fukui’s resignation as BoJ governor. In spite of the support being advanced by government and other BoJ officials, his public standing is not showing any signs of recovery so he may be forced to go. However, this should not have any lasting impact on the JPY.

Day Ahead
US – existing home sales will be watched closely after the strength in yesterday’s new home sales. The latter has now risen in each of the last three months, but still remains below the December level from which it fell so precipitously in Jan and Feb. Existing home sales has also been subject to some sizeable m/m swings, but has been less volatile. The softer trend in these numbers is still intact and it is notable that yesterday’s report also showed the price of homes sold also tailing off. However, there is clearly more resilience in this series than the market had expected and if it continues there will be a sense that the Fed could become more emboldened in its tightening ambitions. Other evidence, such as pending home sales, still suggest a sharp slowdown in sales (see chart below). Consumer confidence is also out and it will be interesting to see whether talk of higher rates and general market volatility has seriously undermined sentiment in the sector. The weekly ABC surveys have actually recovered from the lows seen in May.

Data/event EDT Consensus*

US Chain store sls (w/e Jun 24) w/w 07.45 0.0% last
US Redbook sls (w/e Jun 24) m/m 08.55 +1.9% last
US Existing home sales (May) 10.00 6.62m
US Consumer confidence (Jun) 10.00 104.0
US ABC consumer conf (w/e Jun 25) 17.00 -12 last
NZ Trade balance (May) 18.45 NZ$50m
JP Retail sales (May) y/y 19.50 -0.6%

Latest data Actual Consensus*
DE Import prices (May) y/y +7.5% +7.5%
SE Consumer confidence (Jun) 15.7 18.0
SE Manufacturing confidence (Jun) 7.0 2.5
IT Business confidence (Jun) 98.9 96.4
DE IFO index (Jun) 106.8 105.0
DE IFO current (Jun) 109.4 107.3
DE IFO expectations (Jun) 104.2 103.0
GB BBA mortgage approvals (May) y/y +20% -4.0% 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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