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Friday December 1, 2006 - 11:44:40 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD steadier in Europe, but strong US economic data is required to truly check current negative momentum.
• 2.00 on cable is becoming a magnet, but UK data was weak this morning.
• Mixed data out of Japan - backdrop still fragile for the JPY.
• IMM positioning data (out late US) will be closely watched to see how far excess JPY shorts have been pared back.
• Canadian employment & US manufacturing ISM feature today.

Market Outlook

The USD has stabilised a little this morning, although it is corrective (being a Friday) more than any fundamental change in market sentiment. Having made the break above the 2004 highs around 1.9550, it is cable that has the real momentum behind it at the current time and 2.00 is now in danger of becoming something of a magnet. EUR-USD looks similarly unshackled ahead of 1.34-1.35 and some very strong US data is required to undermine the directional biases now in place. Yesterday’s Chicago PMI (3 ½ yr low of 49.9) has not helped the USD’s cause, even though this number is prone to volatility. It is the ISM number today and ISM non-manufacturing on Tuesday that will be key to the USD’s fortunes in the short-term, while non-farm payroll next Friday will also be significant. Data outcomes in line with the market consensus will not be enough to stop USD weakness in the short-term – strong numbers are required.

However, we would stick with the view that sustained USD movement beyond the levels mentioned above is unlikely. A sharply falling USD is unlikely to be welcomed by many countries at the present time, not least the US given the residual concern about inflation. This is the main difference from a couple of years ago when the US fear was one of deflation rather than inflation.

A mixed set of data out of Japan. The BoJ’s preferred measure of core CPI (excluding fresh food prices) slipped back to a weaker than expected +0.1% y/y from +0.2%, although excluding food and energy there was a modest improvement to -0.4% y/y from -0.5%. The Tokyo measure of CPI excluding food and energy improved to 0.0% y/y from -0.1%. However, all things considered and in terms of demonstrating a move away from deflation, the CPI data remains unconvincing. There was better news on consumer spending, where the y/y rate improved to -2.4% from -6.0%. This is hardly strong and after the weakness seen in recent months it is a long road back, but it is one step in the right direction. In terms of seasonally adjusted m/m changes the rise was 4.1%, although this came after several monthly falls - Jun -0.9%, Jul -1.7%, Aug -0.6% and Sep -2.0%. Key now is what happens next month and whether this latest rise can be built upon. As it currently stands it is too early to sound the all-clear on the consumer, while the CPI backdrop is unconvincing.

On this basis, the BoJ will struggle to sell a rate hike to the government or the general public and the JPY will retain vulnerability from an interest rate perspective. There is a risk of some further position adjustment against the USD, although this is unlikely to be sustained unless there is negative economic news out of the US over the coming week. Key support on USD-JPY is at 115.00-50. Also significant later today (around 15.30 EST) will be the release of the latest IMM positioning data, to see how far this excessive net short JPY positioning has been cut back. As of Tuesday November 21 the net spec short JPY position stood at 80,421 contracts, although USDJPY weakness started the following day. If the cutting back in positioning is very dramatic it will be a positive factor for USDJPY and a JPY negative in general.

Data this morning for Eurozone manufacturing PMIs was slightly weaker than expected, but the solid growth backdrop remains intact (Eurozone PMI at 56.6). Manufacturing PMI was also softer in the UK – more worrying perhaps as it fell to a lowly 52.6 (weakest since March). This follows yesterday’s poor CBI retail sales data, suggesting that apart from the strength in the housing market, other numbers are leaving some question marks over arguments in favour of further tightening. Also of some comfort to the MPC will be the 53.8 reading on the output price category (lowest since May), although the latest CBI survey suggested that manufacturers expect to raise prices more aggressively over coming months, so judgement will be reserved on this issue.

Day Ahead
Canada – employment data will be watched closely after yesterday’s disappointing GDP data, which supplemented fears about activity slowdown. The CAD will be sensitive to the data.

US – the ISM for manufacturing will be significant after recent weakness – last month’s 51.2 reading was the weakest since June 2003. Some signs of strength will be required to bolster sentiment about the US economic backdrop and the outlook for Fed policy.

Data/event EDT Consensus*

CA Employment (Nov) 07.00 +13.5k
CA Unemployment rate (Nov) 07.00 6.3%
US ISM manu (Nov) 10.00 51.8

Latest data Actual Consensus*
JP CPI Tokyo ex-fresh food (Nov) y/y +0.2% +0.2%
JP CPI Nat ex-fresh food (Oct) y/y +0.1% +0.2%
JP CPI Nat ex-food & energy (Oct) y/y -0.4% -0.5% last
JP Unemployment rate (Oct) 4.1% 4.2%
JP Job-to-applicants ratio (Oct) 1.06 1.09
JP Overall PCE (Oct) y/y -2.4% -3.9%
CN PMI manu (Nov) 55.3 54.7 last
CH GDP (Q3) q/q +0.4% +0.7%
SE PMI manu (Nov) 61.5 60.4
SE GDP (Q3) q/q +1.0% +0.9%
CH PMI manu (Nov) 67.0 61.5
IT PMI manu (Nov) 54.8 56.0
FR PMI manu (Nov) 56.5 56.1
DE PMI manu (Nov) 58.3 58.6
EU PMI manu (Nov) 56.6 57.0
GB PMI manu (Nov) 52.6 54.0
EU Unemployment rate (Oct) 7.7% 7.8%
* 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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