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Wednesday October 25, 2006 - 11:01:15 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD slightly softer but still range bound against majors.
• JPY showing some signs of liquidation risk.
• FOMC unlikely to change basic message today.
• Australian CPI shows enough strength to suggest
the need for a Nov RBA rate hike.
• NZ CPI not as weak as the headline suggests – RBNZ rate hike tonight cannot be ruled out with confidence.
• German IFO stronger than expected.
• US existing home sales also feature today.

Market Outlook

The USD remains confined to recent ranges against the majors and any movement looks like being fairly limited ahead of today’s FOMC announcement. The FOMC are unlikely to say anything different from the September 20 meeting, so market impact should be limited (see below for preview). USD movement will depend upon the tone of the week’s US data releases (existing home sales today, durables tomorrow, GDP, new home sales, Michigan sentiment Friday). The EUR-USD range is at 1.2460-90 to 1.2630-50, although the latter did receive a modest boost this morning from stronger than expected IFO data.

IFO was supported by advances in both current conditions and expectations components. If the ZEW survey suggests some unease amongst investors about whether German growth rates will be sustained into 2007 (amidst the threat of the January 1 VAT hike), this is not evident in the German business community. The resilience of the IFO will help to bolster sentiment about a continuation of ECB tightening in 2007.

The turnaround in the USD seen yesterday was initially prompted by USD-JPY – an example perhaps of the positional risk in place given the combination of extreme short JPY positioning and USD-JPY being close to recent highs. Friday’s Japanese CPI is still to come and will have an influence on where the JPY ends this week, but the positional backdrop remains challenging and USD-JPY may need some appropriately strong US or weak Japanese data to offset downside liquidation risk.

Australianheadline CPI was stronger than expected while core readings were close to or just below market expectations (see Diary for details). However, both the core y/y rates cited in the table were 0.1% higher than Q2 so upward pressure remains in place. This was not the barnstorming inflation number to guarantee a November RBA rate hike, but in combination with other data it should be enough. With growth well underpinned the RBA is free to concentrate on snuffing out inflation risk so a 25bp rate hike and possibly another in Q1 could be seen. This should boost the AUD in the run-up to the announcement on November 8 - there is scope to 0.77 initially. AUD-NZD also looked better for time after moving above 1.1500, although it has since slipped back and caution is advised until tonight’s RBNZ announcement has been seen (see next para for more on NZ).

The NZD weakened after its own Q3 CPI release, with the headline number coming in well below market expectations. However, as noted yesterday, this may be due in part to the weight revisions seen in this index, which upped the weight of petrol and in doing so most probably amplified the impact of the recent fall in fuel prices. This was especially felt on the y/y rate, which fell back to +3.5% from +4.0%. However, looking further into the data reveals some worrying trends in core inflation, with the weighted-median y/y rate jumping to +3.6% from +3.2%. While the market will now be sceptical about the possibility of an RBNZ tightening tonight, such an action should not be ruled out. The NZD should maintain some support ahead of that announcement.

Day Ahead
US – existing home sales have fallen in each of the past five months and the trend looks well established. Even a m/m rise today, while likely to cause some mild consternation in the market, would not be enough in itself to nullify the underlying trend.

The FOMC announcement will likely see a reiteration of the message seen at the last meeting, noting signs of growth moderation, continuing elevated core inflation readings, the likelihood that inflation pressure will moderate over time but that some overall inflation risk remains. This should build up to a repeat of the final sentence seen in the September 20 statement – “the extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” The data dependency indication is only natural as the Fed, like the rest of the market, is uncertain about how economic activity and inflation trends will actually develop. The reiteration of the possibility of further tightening would have been seen as hawkish compared to market expectations a few weeks back, but expectations have adjusted since then so market impact should be modest.

Data/event EDT Consensus*

CA BoC’s Dodge spks 08.35
US Existing home sales (Sep) 10.00 6.21m
US FOMC rate announcement 14.15 unch
NZ RBNZ rate announcement 16.00 unch/+25bp
CA BoC’s Dodge, Jenkins testify 16.00
JP CSPI (Sep) y/y 19.50 +0.3%

Latest data Actual Consensus*
US ABC consumer conf (w/e Oct 22) -7 -7 last
NZ CPI (Q3) q/q +0.7% +0.8%
NZ CPI (Q3) y/y +3.5% +3.8%
NZ CPI weighted-median (Q3) y/y +3.6% +3.2% last
JP Trade balance (Sep, sa) ¥420bn ¥505bn
AU CPI (Q1) q/q +0.9% +0.7%
AU CPI (Q1) y/y +3.9% +3.7%
AU CPI mkt prices ex-volatile (Q1) y/y +2.1% +2.1%
AU CPI-RBA trimmed-mean (Q1) y/y +2.9% +3.0%
DE Import prices (Sep) y/y +3.7% +4.3%
FR Own company ind outlook (Oct) +18 +10
FR Business climate indicator (Oct) 108 107
SE Trade balance (Sep) SEK10.2bn SEK14.1bn
IT Business confidence (Oct) 97.1 97.0
DE IFO index (Oct) 105.3 104.5
DE IFO current (Oct) 111.8 111.5
DE IFO expectations (Oct) 99.2 98.0
ZA CPI (Sep) y/y +5.3% +5.2%
ZA CPIX (Sep) y/y +5.1% +4.9%
* 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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