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Friday June 30, 2006 - 10:23:40 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• FOMC statement reveals no fresh bad news for the market – but policy prospects are left open.
• Relief rally can extend further in the short-term, but US data developments will remain crucial.
• A close above 1.2725-30 is needed today on EURUSD to enhance prospects ahead of the ECB
• US core PCE price index is in focus today – Michigan sentiment also features.

Market Outlook

The market has warmed to the FOMC statement, helped by an absence of aggression on the need to combat inflation and the retained focus on growth moderation as a possible constraint on future inflation. However, all options remain open for the Fed to respond accordingly to whatever happens in the data and to this extent little has changed, other than the removal of an event that had the potential to worsen current market uncertainties. In the statement the Fed merely acknowledges the recent evidence of growth moderation and elevated core inflation and suggests that further tightening may be necessary depending upon future data developments. This basic open-ended message is not really a major surprise. Ultimately, the situation remains finely balanced and future policy developments will depend upon which theme gains more prominence in the data – growth moderation or a pick-up in core inflation. This could go either way so it is premature to call an end to the market’s recent troubles purely on the basis of this Fed announcement. What has been seen thus far is essentially a relief rally and while it may extend further in the short-term, some corroboration from the data will be required to turn it into something permanent.

Today sees the latest release of the Fed’s preferred measure of core inflation – the core PCE price index (see below for full preview). If this were to come out on the weak side it would be well timed to extend the developments of the past 12 hours, while a strong number would check such optimism.

With equities and other higher risk assets rallying, potential risk appetite has improved and as long as this remains intact it will weigh on the USD. Adding to potential EUR-USD strength going into next week will be the risk attached to a rate hike at next week’s ECB meeting. This is a difficult one to call and the silence of Trichet on these key issues most probably reflects a split council on how best to proceed. It seems clear from some of the recent comments that the hawks are anxious to present their case, but the ‘noise’ from this camp is perhaps a sign that they are still in the minority. The more comfortable ‘doves’ may have less reason to be vocal on the matter. If a move above the 1.2725-30 area can be held today then a further advance could be seen next week, but for this to turn into a sustainable and fresh attack on the previous highs just below 1.30 there will need to be some supporting developments in the data.

Day Ahead
US – the core PCE price index is the major feature and as is typically case for the main core US inflation numbers there is a median expectation of +0.2% m/m. The y/y rate has recently moved above 2%, seen as the upper limit of Fed tolerance on inflation, while in recent times the Fed has also been drawing attention to more contemporaneous measures of annual inflation such as the 3-mth annualised rate. For the core PCE price index this is now running at +3.0%, while for core CPI it is at +3.8%. The latest core CPI number was again boosted by owner-equivalent rents, which does not have a parallel in the core PCE price index, so there is a chance of the latter coming in below the +0.3% m/m seen on core CPI.

The 3-mth annualised rate is a fairy volatile number and has been at elevated levels at other times in recent years. For example, if the core PCE price index rises today to 111.4 from 111.2 (i.e. a 0.16% m/m rise) the 3-mth annualised rate will remain at 3%, while index readings of 111.5 (+0.25% m/m) or 111.6 (+0.34% m/m) would give 3-mth annual rates of +3.4% and +3.8% respectively. The chart above smoothes this number out by averaging further over 3-mths and as of last month this was still at +2.4%, but would increase to +2.8%, +3.0% or +3.1% on the three outcomes outlined above. Compared to recent history these would look on the high side. Michigan sentiment and Chicago PMI are also due and recent evidence suggests some pick-up in consumer sentiment

Data/event EDT Consensus*

US Personal income (May) m/m 08.30 +0.2%
US PCE (May) m/m 08.30 +0.4%
US Core PCE price index (May) m/m 08.30 +0.2%
US Core PCE price index (May) y/y 08.30 +2.1%
US Core PCE prices (May) 3m ann 08.30 +3.0% last
US Michigan sentiment (Jun, fin) 09.45 82.5
US Chicago PMI (Jun) 10.00 59.0

Latest data Actual Consensus*
FR Unemployment rate (May) 9.1% 9.3%
FR ILO job seekers (May) m/m -45k -20k
JP CPI Tokyo (Jun, core) y/y +0.3% +0.4%
JP CPI Nwide (May, core) y/y +0.6% +0.6%
JP Unemployment rate (May) 4.0% 4.1%
JP Job-to-applicants ratio (May) 1.07 1.04
JP Overall PCE (May) y/y -1.8% -2.3%
AU Private sector credit (May) m/m +1.1% +1.1%
JP Housing starts (May) y/y +6.7% +5.1%
DE Retail sales (May) m/m -2.2% 0.0%
FR Household survey (Jun) -28 -28
GB GDP (Q1, final est) q/q +0.7% +0.6%
GB Current account (Q1) -£8.3bn -£10.3bn
EU CPI (Jun, flash est) y/y +2.5% +2.4%
EU Econ sentiment (Jun) 107.2 106.2
EU Business climate index (Jun) 1.41 1.02
IT CPI (Jun, prel) y/y +2.3% +2.3%
GB Consumer confidence (Jun) -4 -4
* 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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