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Wednesday November 1, 2006 - 11:37:58 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Yesterday’s EUR-USD move reflects current trading bias.
• US data not that disastrous – ISMs still to come.
• JPY and AUD support shines through current price action.
• CAD hit by change in ‘income trust’ taxation.
• Focus on NOK with Norges Bank meeting due and critical day for oil.

Market Outlook

A strong move on EUR-USD yesterday following the weaker than expected consumer confidence data, but it has not managed to advance any further overnight and some minor weakness to 1.2730-40 could be seen ahead of today’s US ISM number. Consumer confidence falling short of expectations was disappointing, but it is not a major blow as yet. Michigan sentiment last week was stronger than expected, while the latest weekly measure of confidence out last night was at its highest level (-3) since the -3 number also seen in January 2004 (itself the highest since April 2002).

The movement in EUR-USD perhaps owes more to the positivetechnical bias in place since the move back above the pivotal 1.2630-50 area. It is often the case that having failed to break one end of a range, the market is immediately drawn to the other extreme. In the case of EUR-USD this would be the 1.2900-50 area, although such a development will also require some suitable data releases and in itself yesterday’s data is not enough. The ISM surveys today and Friday as well as the employment report will be a more significant indication of how activity is developing.

Yesterday’s USD move did allow some underlying market themes to develop further. One was the position-liquidation support for the JPY - the JPY being better able to sustain the advance against the USD. US data today will be significant for USD-JPY, but ‘short JPY’ liquidation risk will continue to offer support for the JPY in the short-term. The other was the upmove in the AUD, with the USD weakness enabling the AUD to vault above the next resistance area at 0.7700-25. Building approvals data last night were also stronger than expected, adding support to next week’s expectation of a rate hike from the RBA. Retail sales (the last possible barrier to a rate move) is due tonight. Gold is also looking set for a further run higher. 0.7800 is the next target on the AUD.

The CAD has fallen sharply overnight following the announcement from the Canadian government (at 5.00 EST yesterday afternoon) that alters the taxation structure of so called income trusts. Many normal corporations have switched to being income trusts in recent years in order to reduce tax liabilities – payments distributed to unit holders are deducted against tax. However, yesterday’s announcement means that income trusts will essentially be taxed the same as corporations, although for existing trusts this will only be introduced in 2011. For income trusts that begin trading after yesterday’s announcement the rules will apply from next year. Much money has been following those companies that have made the conversion or who have been indicating that they will do so and many such funds will now exit. However, the blow should be slightly softened by the fact that in most cases the measures will only apply in 2011. Furthermore, if Canadian exposure is still desired then the money may be reinvested elsewhere in Canada. Accompanying yesterday’s announcement (termed the Tax Fairness Plan) was a 0.5% cut in corporate income tax (from 2011) and tax breaks (from this year and next) for seniors and pensioners adversely affected by the plan. USD-CAD will probably take its cue from the equity market today and while some initial weakness should be seen a major sustained move looks unlikely. 1.1325 is the first level of importance although a sustained move above 1.1415 is needed to cause lasting damage. Below 1.1285 would prompt a pullback to 1.1245-55.

Day Ahead
Norway – the Norges Bank announce their latest policy decision and with the Inflation Report also due there is a chance of them signalling the possibility of a faster pace of tightening next year. The language used at their last meeting was more aggressive. However, a hawkish statement may be needed to shield the NOK from further problems regarding the oil price. In fact it is also a key day for oil with the latest weekly inventories report due in the US. Last week (the week-ending Oct 20) there was a sharp fall in inventories, although it is generally believed that this was purely related to the 71-hour closure of the Louisiana Offshore Oil Port, which severely disrupted crude imports. According to officials cited on Reuters, imports were back on schedule by Wednesday last week so the market is expecting a recovery in stocks.

If there is any comfort for the NOK in the latest episode of oil price weakness is that it appears to have prompted less equity outflow from the country (according to our in-house flow data) than was the case earlier in October. The Statoil share price has also been more resilient over the past week or so. Key now will be whether oil can hold recent lows.

US – the ISM manufacturing is due today after the softer 52.9 showing of last month. The tone of this data will be significant for sentiment about the extent of the US economic slowdown and will be important for the USD. Pending home sales are also due having shown some gross volatility in recent months (Aug +4.3% m/m, Jul -7.1% m/m), although the downtrend remains intact. The ADP employment measure may also influence sentiment about the nature of Friday’s payroll outcome.

Data/event EDT Consensus*

EU Holiday in parts of Europe, but most markets are open
NO Norges Bank policy outcome & Inf Report 13.00 +25bp
US ADP employment (Oct) 13.15 +78k last
US ISM manu (Oct) 15.00 53.0
US Pending home sales (Sep) 15.00 -0.9%
US Crude inventories (w/e Oct 27) 15.30 +2.5m
JP Monetary base (Oct) y/y 23.50 -21.8%
AU Retail trade (Sep) m/m 00.30 +0.5%
AU Trade balance (Sep) 00.30 -A$0.2bn

Latest data Actual Consensus*
US House prices (Aug) y/y +5.2% +6.8%R last
US ABC consumer conf (w/e Oct 29) -3 -7 last
AU Building approvals (Sep) m/m +6.1% +2.2%
CN PMI manu (Oct) 54.7 57.0 last
SE PMI manu (Oct) 60.7 61.0
CH PMI manu (Oct) 62.3 64.0
GB PMI manu (Oct) 53.7 53.8
* 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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