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Monday November 27, 2006 - 11:29:25 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• Last week’s moves will be viewed with some suspicion, but the price action suggests short-term upside risk for EUR-USD.
• Big danger is that participants like ‘hedgers’ are forced into selling USDs.
• There is talk that pressure on China has contributed to the latest EUR-USD move.

Market Outlook

EUR-USD strengthened significantly at the Asian open this morning, but has since traded lower. Last week may have been affected by US holidays but as it currently stands the price action is significant and the danger is that this in itself will force many market participants into action this week. The initial activity last week was the stopping out of range traders, while directional players will now be looking to capitalise from the range-breakout. The other main category of potential EUR-USD buyers is the hedging community. This relates to both corporates and US asset holders and the danger here is that after such a lengthy period of relative EUR-USD stability, hedge ratios may be lower than they would ordinarily be. This presents a potentially large upside risk for EUR-USD this week. However, there could be some cautiousness initially today as last week’s moves will still be viewed with suspicion. This week will be a significant one, to see how much follow-through there is to last week’s move.

Technically, EUR-USD could reach 1.35 in the short-term, but we would be sceptical about this being the start of sustained and major move higher. While ECB rate support arguments will continue to look very appealing, there is every chance of Fed rate hike expectations being stirred up again at some point in the next 2-3 months. However, until that happens a window of opportunity for EUR-USD upside will remain open. Conversely, any move below 1.2950-1.30 would suggest a false breakout and a turn in sentiment back to the downside. Key levels on cable are at 1.9500-50 and 1.9325, 1.9220 and 1.9150.

Despite the talk about ‘carry trade’ closing (which helped to depress EUR-JPY for a time last week), the EUR has been strong against the JPY since Friday’s upside break in EURUSD. Furthermore, the relative interest rate arguments remain very negative for the JPY. Key CPI and consumer spending out of Japan this week will have an influence on such sentiment this week. EUR-JPY upside remains tentatively favoured, but in this environment (nervousness about carry-trade closing) there is clearly room for much volatility. Because of Thanksgiving the weekly IMM positioning data is not due until later today, although the latest reading (for last Tuesday’s close) was before the latest USD-JPY sell-off. Next week’s data will be more interesting to see how much of the positional excess has been skimmed off. Any future normalisation in his number would itself be a positive development for USD-JPY and EUR-JPY.

One story circulating last week was about the EUR-USD move being related to a change in behaviour from China. It has been claimed that at the recent G20 meeting China came under attack from the BoJ and others for manipulating the FX market (EUR-USD especially) by the options strategies it was pursuing, involving the defence of certain option barriers. The story goes that China agreed to back off and that the normal spot selling did not appear at the top end of the range – hence the EURUSD move higher.

One could argue that EUR-USD being hemmed into tight ranges would be a blessing for most policymakers, although it seems that some have become more concerned about the side effects of such low volatility. One such consequence is that it boosts carry trades and this has been a source of concern to both the SNB and the BoJ. The SNB are concerned about the inflationary impact of a weak CHF, while the BoJ fears the possible financial dislocation that may be caused by an unwinding of such trades if they are allowed to build-up excessively.

Day Ahead
Japan – tonight sees the latest retail sales release and the weakness of the consumer in recent months has been a source of much concern to the Japanese authorities. This type of data (reported by retailers) has not been as weak as overall PCE (a survey of households). The latter is due later in the week. The tone of this week’s data on spending could have a significant bearing on sentiment about BoJ policy.

Data/event EDT Consensus*

NZ Business confidence (Nov) 07.00 -21.7 last
JP Retail sales (Oct) m/m 18.50 +0.3%
AU RBA’s Richards on inflation 20.30

Latest data Actual Consensus*
JP CSPI (Oct) y/y +0.1% +0.3%
SE Consumer confidence (Nov) +14.1 +20.0
SE Manufacturing confidence (Nov) +7 +5
SE Current account (Q3) SEK49bn SEK44.1bR last
GB BBA mort approvals (Oct, nsa) y/y +3.7% +3.0% last
* 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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