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Tuesday October 17, 2006 - 11:45:28 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD a little higher but any recovery attempts should be capped at 1.2580-1.2610 for now.
• JPY corrects further against USD and EUR.
• AUD still looking good, but break above 0.7580- 0.7600 may be difficult ahead of next week’s CPI.
• UK CPI stronger than it looks – ZEW once again an oddity.
• US PPI, NAHB housing, US ind prod, BoC policy announcement feature today.

Market Outlook

The USD has continued to give up some ground overnight, with the recent response to the adjustment in US rate expectations seemingly complete for now. An indication of this was the inability of the USD to respond positively to a very strong looking NY Fed number yesterday. The Fed number is not insignificant, but the market is perhaps not ready just yet to contemplate moving further on rate expectations i.e. to discounting a Fed rate hike. The Fed index will gain extra resonance if the rest of this week’s data is also stronger than expected. PPI and the NAHB housing index are due today, while the ZEW also features (see below for previews).

In the meantime, EUR-USD could attempt to recover a little today, although should be well capped by the 1.2580-1.2610 area. The JPY has been the biggest mover, with position liquidation risk being triggered further by moves below 149.00 on EUR-JPY and 118.80 on USD-JPY. 118.45 is the next level on USD-JPY, with 117.40 below that.

The ZEW once again threw up an unusual outcome, with the headline expectations indicator for Germany reaching a 13-yr low of –27.4 and the current conditions component (42.9) at a 6-yr high and close to the all-time high of 45.8. As noted last month, the weakness of the ZEW expectations component may be directly related to the strength in current conditions. Respondents are asked whether they are optimistic or pessimistic about the economic situation in six months time and there is always a chance that such responses are made with reference to how things are presently, which are very good. This negative ‘base effect’ is probably being compounded by fears about the impact of the German VAT hike. However, while the latter could lead to lopsided growth - strong Q4, weak Q1 – there is unlikely to be any major and permanent effect on German growth.

UK CPI was +2.4% y/y for September, seemingly in line with the market consensus, although the breakdown painted a different picture. The impact of lower fuel prices was much greater than expected and overall CPI was supported by core factors – highlighted by the uptick in the core y/y rate to +1.4% from +1.1% (market had expected +1.2%). The main contributions to the upward creep in the core measure were household goods, electrical goods and clothing and footwear. In all these cases the y/y rates are individually negative or just above zero, but are not as negative as they have been in recent years and this may fuel concerns that the so-called ‘China effect’ is starting to wane. The total y/y rate was also supported by food prices (up at +4.0% y/y from +3.3% previously). GBP has strengthened against the EUR, although with two 25bp rate hikes already discounted, the mileage for a greater response than this could be limited and dependent upon other data strength this week.

The AUD continues to edge higher following last week’s solid looking data (consumer sentiment and employment) and the RBA’s reiteration of a tightening bias. Higher commodity prices are also probably helping sentiment. 0.7580-0.7600 is the next barrier and although we would favour such a break at some point, it is not clear whether the market will manage this ahead of next week’s CPI data.

Day Ahead
US – PPI, TIC portfolio data, NAHB housing index, industrial output and capacity utilisation feature. Core PPI has been softer of late, with -0.4% and -0.3% the last two m/m outcomes. Anything unusual in the core data will have market-moving potential given the current natural interest in inflation. Headline rates (especially y/y measures) are likely to be very weak given what has happened to fuel prices this September as opposed to last September (i.e. sharp m/m falls as opposed to the hurricane related m/m increases seen last year). Housing data has been weak of late with last month’s NAHB housing survey index (a combination of measures relating to current and expected sales and the number of prospective buyer inquiries) falling to its lowest level (30) since February 1991, when it hit 27. During that latter period of housing market weakness the low point for the NAHB index was 20 in January 1991.

Last month’s TIC number for July (net inflow of $32.9bn) was the worst since the $26.9bn seen in May 2005 and there will be interest in whether this has been sustained. The poor July performance was due to lower foreign buying of all types of US bonds (Treasuries, Agencies and Corporates). However, so far this year the TIC data has been painting a better picture in terms of overall net equity flows, with a net inflow of $23bn compared to a net outflow of $48bn for all of 2005.

Industrial output does not attract much attention compared to the variety of manufacturing surveys available. Capacity utilisation also seems to be less of a focal point these days, even though it has recently been threatening to move above the 82%-82.5% area that used to be seen as the threshold of genuine inflationary pressure.

Canada – the Bank of Canada is likely to leave rates unchanged and indicate a steady policy message. However, there could be some sensitivity to any indication about slower growth ahead. The BoC’s new growth and CPI assumptions will be revealed in Thursday’s Monetary Policy Report, but today’s policy statement should give some indication about the direction of any revisions. Key levels on USD-CAD are at 1.1460 and 1.1300-25.

Data/event EDT Consensus*

US Chain store sls (w/e Oct 14) w/w 07.45 +0.5% last
US PPI (Sep) m/m 08.30 -0.7%
US PPI core (Sep) m/m 08.30 +0.2%
US Redbook sls (w/e Oct 14) m/m 08.55 +0.5% last
CA BoC policy announcement 09.00 4.25%
US TIC intl portfolio balance (Aug) 09.00 +$50bn
US Ind prod (Sep) m/m 09.15 -0.1%
US Capacity utilisation (Sep) 09.15 82.2%
US Fed’s Stern spks 12.00
US NAHB housing index (Oct) 13.00 30
US Fed’s Bies spks 13.45
US ABC consumer conf (w/e Oct 15) 17.00 -8 last

Latest data Actual Consensus*
JP Tertiary index (Aug) m/m +0.7% +0.8%
GB CPI (Sep) y/y +2.4% +2.4%
GB CPI core (Sep) y/y +1.4% +1.2%
GB RPIX (Sep) y/y +3.2% +3.1%
GB RPI (Sep) y/y +3.6% +3.4%
EU CPI (Sep) y/y +1.7% +1.8%
EU CPI ex-energy/fresh food (Sep) y/y +1.5% +1.5%
EU Ind prod (Aug) m/m +1.8% +1.3%
DE ZEW expectations (Oct) -27.4 -20.0
EU ZEW expectations (Oct) -12.5 -9.9
* 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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