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Tuesday November 28, 2006 - 11:43:48 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• A number of important events for EUR-USD today.
• Durable orders, consumer confidence and existing home sales are released, while Paulson may also speak further.
• Technical risk remains to the upside for EUR-USD in the short-term and some positive USD news is needed to offset this.
• Japanese sales remain weak – highlighting the poor fundamental backdrop for the JPY.

Market Outlook

It could be an important day for determining the likely longevity of the recent EUR-USD upmove. US data releases including durable orders, existing home sales and consumer confidence are due and the tone of these releases will be significant in determining whether the relative interest rate arguments behind recent USD movement are advanced or rebutted – these are previewed below. Going into today the technical arguments remain in EUR-USD’s favour and something USD positive will need to materialise out of today’s events to stop EUR-USD advancing further this week. There is some risk up towards 1.35 in this latest move, although the USD could easily fight back on any data strength. The key issue is how long it takes for such US data strength to return. Until this happens the risk will remain to the upside as a variety of accounts – short-term directional, options, hedgers (corporates, US asset holders) have all turned into potential USD sellers.

The plight of the JPY is more contentious. Talk continues about carry trade liquidation, although the news flow remains JPY negative. Japanese retail sales released last night were again softer than expected – down 0.2% m/m after a 1.5% m/m drop in the previous month – while vice-minister for financial services Watanabe (not to be confused with Watanabe at the finance ministry) said that it would be dangerous for the BoJ to raise rates as the outlook for growth had become more uncertain.
This highlights the very poor interest rate backdrop facing the JPY, suggesting that over and above any near-term position adjustment, JPY rallies will be difficult to sustain and weakness could easily return. The ongoing strength in EUR-JPY highlights this JPY vulnerability.

Treasury Secretary Paulson has been speaking in London this morning, although so far he has limited his comments to arguing against trade protectionism and calling for greater FX flexibility from China. It will be interesting to see whether he ventures into talking about the USD. His approach to ‘supporting’ a strong USD has generally been more robust than that of his predecessor Snow, whose typical approach was
generally as follows - "we believe that a strong dollar is in America's national interest". The Paulson approach has been slightly more emphatic. September 18, “A strong USD is clearly in our nation’s interest; September 8 “I am very much in favour of a strong USD because that’s in our nation’s interest”; August 1, “I believe very strongly that a strong USD is in our nation’s interest”. There may be nothing in this and it could just be his way of responding to prior speculation about him favouring a weaker USD after he failed to mention the strong USD at his Senate confirmation hearing in June. The market reaction to any further comments he makes today will also depend upon how much emphasis he lays on his other typical observation - that markets should be allowed to set exchange rates.

However, there are reasons why the US may not want to overly encourage the latest USD move. First, Paulson may sense that a USD decline is inevitable and that he needs to ensure that such a move does not become disorderly. Second and not unrelated, is the significance of the USD with regard to the inflation backdrop. A few years ago the US was concerned about deflation and a weaker USD was consistent with attempts to ward this off. However, the tables have now turned and inflation is now a threat, so a USD decline, especially a rapid one, is suddenly less desirable. Third, is that excessive weakness in the USD will undermine foreign investor interest in US asset markets.

Day Ahead
US - durable orders, consumer confidence and existing home sales are due today and collectively they will exert an influence on sentiment about the US economic backdrop and the outlook for Fed policy. Durable orders are naturally volatile and while they have come off the boil a little over the past couple of months, this weakness is not severe enough just yet to represent a threat to the uptrend of recent years. However, the orders components of the ISM and Philly Fed surveys have been weakening in recent months (less so the NY Fed) so some softening in durable orders would not be surprising. Existing home sales have been weakening sharply in recent months and a continuation in this trend will maintain market nervousness about the consumer. Indeed, this is where consumer confidence is significant, as it will show whether consumers are shrugging off the negative influence from the housing market. Evidence about sales over the Thanksgiving holiday weekend has been mixed so far. There are also a number of Fed speakers today, including Bernanke.

Data/event EDT Consensus*

US Chain store sls (w/e Nov 25) w/w 07.45 +1.2% last
US Durable orders (Oct) m/m 08.30 -5.0%
US Durables ex-transport (Oct) m/m 08.30 +0.2%
US Redbook sls (w/e Nov 25) m/m 08.55 +0.2% last
US Consumer confidence (Oct) 10.00 106.0
US Existing home sales (Oct) 10.00 6.15m
US Fed’s Bernanke spks on econ 12.30
US Fed’s Plosser spks on econ
US ABC consumer conf (w/e Nov 26) 17.00 0 last
JP Ind prod (Oct, prel) m/m 18.50 -0.4%
AU Trade balance (Oct) 19.30 -A$1.07bn

Latest data Actual Consensus*
JP Retail sales (Oct) m/m -0.2% +0.3%
DE Consumer confidence (Dec) 9.4 9.4
SE Retail sales (Oct) m/m +0.8% +0.5%
EU M3 (Oct) y/y +8.5% +8.7%
EU M3 (Oct) 3m y/y +8.4% +8.5%
EU Private sector lending (Oct) y/y +11.2% +11.4%
ZA GDP (Q3) saar +4.7% +4.8%
* 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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