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Wednesday November 22, 2006 - 11:42:04 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD remains soft overnight in thin volume.
• Today’s Michigan sentiment may have an impact before the holiday sets in.
• Japanese government report downgrades economic assessment, but JPY strengthens.
• UK MPC minutes show two dissenters.
• Canadian CPI also due today.

Market Outlook

The USD weakened a little in the US afternoon yesterday and again in Asia, with the move being largely attributed to the White House cutting the growth forecasts used in its budget projections. GDP growth for 2006 was revised down to +3.1% from a +3.6% forecast made in June, while 2007 growth was cut back to +2.9% from +3.3%. However, it was a good hour or so after the White House announcement before the USD started to weaken against the EUR and the JPY and markets have been very thin. In the winding down to the Thanksgiving break it is often difficult to find any rationale behind market movement. A few isolated orders can exert greater impact than normal because of the thinning in volumes.

With many US players likely to leave early today (and Japan also on holiday tomorrow) the week is already close to being effectively over, although today’s Michigan sentiment number does offer some scope for last minute surprises (see below). It will take a very weak number to suggest a move in EUR-USD up towards 1.2900-50, which is the top end of the current trading range. A move lower seems more likely.

The JPY has been the main mover in Europe this morning. In European hours, the Japanese government downgraded its assessment of the economy, related to the recent softness in consumer expenditure. They said “the economy is recovering, although there is some weakness in consumption”. This initially saw the JPY weakening, although the downgrade had been widely rumoured in the media since the weekend and in comments after the release government ministers said their view of a broad recovery remained intact. The JPY stabilised on these comments then bounced back even further when the EU’s Juncker said “we think that the JPY is not developing correctly and in the last few months the drop in the JPY has been too rough”. EUR-JPY needs to hold 150.75 to avoid further short-term corrective pressure. However, when the dust settles the government report will be seen as an additional factor reducing the risk of a near-term BoJ rate hike. The BoJ is supposed to have independence, but with the move away from deflation being such a sensitive issue the BoJ needs to have public and governmental support for its moves, at least in the early stages. This backdrop remains a JPY negative going forward. A better gauge of market sentiment will appear once this Thanksgiving week is out of the way. Japanese trade data released last night showed seasonally adjusted exports up 0.5% m/m after the previous month’s 0.6% decline. Overall, the export backdrop remains solid, but growth seems to be slowing a little. Net exports will be key for future expectations about overall Japanese growth.

UK MPC minutes showed two dissenters (Blanchflower & Lomax) against the November 25bp rate hike. This was initially take negatively by GBP, although it soon bounced back. One could argue that this slightly reduces the risk of another ratehike in February, although market rate expectations have pulled back a little in any case in recent weeks. Also, much will depend upon the data and the MPC’s overall inclination to fight inflation suggests that a rate hike will follow in February.

Day Ahead
UK – the minutes of the November MPC meeting will be closely watched to see whether there is more than one dissenting voice to the 25bp rate hike. Last week’s Inflation Report was seen as being less alarmist about the inflation threat and this has raised some speculation about an extra dissenter. Yesterday’s CBI survey will have rung a few alarm bells for the MPC. Output price expectations (up at +19 from +12) were the highest since the +19 number also seen in January 2005. One has to go back to the +27 reading in March 1995 for the last time +19 was bettered. This will raise concerns about what manufacturers have planned by way of 2007 price adjustments, many of which are reviewed for introduction in the New Year.

Canada – CPI data is due in Canada. Core CPI was stronger than expected last month, with the BoC’s core measure (which also takes account of changes in indirect tax) coming in at +2.3%, the strongest since early 2003. However, after recent weak data BoC rate expectations are likely to remain subdued. Upside risk remains in place on USD-CAD while above 1.1400-25.

US – the weekly consumer sentiment number has been rising over the past few weeks and currently stands close to 4½ year highs, so today’s the University of Michigan measure of national consumer sentiment should at least show some resilience. One of the big issues for the market at the present time is how the consumer will fare amidst the contrasting influences coming from the housing market on the one hand and fuel prices and the equity market on the other. The confidence data will be an important part of that picture.

Data/event EDT Consensus*

CA CPI (Oct) y/y 07.00 +1.0%
CA CPIX-8 (Oct) y/y 07.00 +1.7%
CA BoC core CPI (Oct) y/y 08.30 +2.3% last
US Initial claims (w/e Nov 18) 08.30 310k
US Continuing claims (w/e Nov 11) 08.30 2443k last
US Michigan sentiment (Nov, fin) 10.00 93.1

Latest data Actual Consensus*
US ABC consumer conf (w/e Nov 19) 0 +1 last
JP Trade balance (Oct, sa) ¥649bn ¥667bn
JP All industry activ’y index (Sep) m/m -0.9% -1.0%
FR H’hold consumption (Oct) m/m +1.0% +1.0%
IT Consumer confidence (Nov) 109.2 108.8
GB MPC minutes (Nov 8-9 meeting) 7-2
EU Manu orders (Sep) m/m -1.3% -2.4%
* 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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