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Friday November 3, 2006 - 11:38:42 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Markets awaiting key US data releases.
• Trichet stance unchanged but further tightening in 2007 looks likely.
• AUD holding firm but 0.7800 could be difficult shortterm with RBA hike already discounted.
• US employment report, non-manufacturing ISM and Canadian employment feature today.

Market Outlook

A fairly quiet overnight session, with Japan away on holiday and markets essentially on hold ahead of today’s US employment and non-manufacturing ISM data. The tone of this data will be significant for USD sentiment after the weak manufacturing ISM seen on Wednesday. Any negative shocks would add to sentiment in the market about a slowing US economy and the risk of a Fed rate cut in Q1 (although we would still see such expectations as being premature for the time being). This would set EUR-USD up for a test towards the top end of the trading range at 1.2900-50. Any strength in the data would prompt a move back into the 1.2650-1.2700 area.

Trichet did not reveal anything new yesterday and while he said he was unwilling to offer guidance on rate prospects for 2007, the repeat of the comment “if our assumptions and baseline scenario continue to be confirmed, it will remain warranted to further withdraw monetary accommodation” makes it clear where the directional bias lies. Further tightening looks likely in 2007 and this may not be confined to one move. Improving labour market conditions in the Eurozone, especially Germany, bode well for positive ‘multiplier effects’ (via consumer spending) next year, which should be enough to nullify the threat of the German VAT hike.

USD-JPY has also been quiet but will take its cue from today’s US data. However, in the absence of anything unusual in today’s data the tone will remain in the JPY’s favour due to positional considerations.

The AUD remains supported with the market still having an eye on next week’s likely RBA rate hike as well as the higher gold price. However, the RBA move should be fairly well discounted and this could make it difficult for the AUD to progress further than 0.7800 in the short-term, unless there is gross USD weakness. 0.7800 is the first level of a major resistance area running up to 0.8000. Below 0.7670-0.7700 area would suggest a correction lower.

UK PMI services data this morning was stronger than expected, supporting current market expectations about MPC tightening prospects. The headline number of 59.3 was the highest since April, although more comforting to the MPC perhaps was the prices charged number, which eased back to 53.0 (lowest level since February) from 54.8 in September and 55.4 (6-year high) seen in August. EUR-GBP did weaken initially on the number, but it failed to sustain the move, in part perhaps because the focus today is on other things i.e. US data. The EUR side of the EUR-GBP equation also looks well supported given ECB rate expectations. Key for GBP over the next couple of weeks will be whether the MPC validates the hawkish tone in the UK money market and this may only be known after the Inflation Report (due November 15).

Day Ahead
Canada – labour market data and the employment situation has become a little unclear after recent volatility. This began in May with the huge rise of 96.7k, which was then followed by threen months of small declines before last month’s rise of 16.2k. The average monthly rise for this period as a whole turns out to be +17.4k, which is below the +25-30k average seen previously.

US – today’s non-manufacturing ISM and employment data will provide further information about the extent of the economic slowdown, with market sentiment on the matter already on the defensive after the weak manufacturing ISM seen on Wednesday. Last month’s ISM non-manufacturing was very weak at 52.9, which apart from Mar/Apr 2003 around the time of the Iraq war was the lowest since August 2002. Indeed, if the non-manufacturing number sustains last month’s drop it would be a further negative signal about economic activity. Recent employment reports have been consistent with a softening labour market (3mth average for m/m change in payrolls is at +121k), although hourly earnings (4% y/y last time) remains quite high. This basic theme of labour market moderation is likely to be in evidence again and on hourly earnings the ‘base effect’ relating to last October’s strong 0.6% m/m rise suggests a lower y/y rate. Hours worked data (average workweek, overtime hours and manufacturing hours) will also be examined for any signs of falling labour usage.

Data/event EDT Consensus*

Market holiday – Japan, Sweden (half-day)
CA Employment (Oct) 07.00 +15k
CA Unemployment rate (Oct) 07.00 6.4%
US Non-farm payrolls (Oct) 08.30 +125k
US Unemployment rate (Oct) 08.30 4.6%
US Average workweek (Oct) 08.30 33.8
US Hourly earnings (Oct) m/m 08.30 +0.3%
TR CPI (Oct) y/y 09.30 +10.3%
US ISM non-manu (Oct) 10.00 54.7

Latest data Actual Consensus*
GB PMI services (Oct) 59.3 56.7
EU Unemployment rate (Sep) 7.8% 7.8%
3-mth moving average of m/m change

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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