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Tuesday December 12, 2006 - 11:40:05 GMT
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Forex: Mellon FX Daily - U.S. Edition

Key Points
• EUR-USD edges higher – FOMC meeting now awaited.
• German ZEW rebounds slightly.
• JPY prospects are not looking good but further weakness may be limited ahead of Friday’s Tankan.
• UK CPI lends support to Feb rate hike expectations.
• US and Canadian trade data also feature today.

Market Outlook

EUR-USD was already trading close to the day’s highs at the European close when Greenspan added to yesterday’s move by noting in a speech that the USD would remain weak in coming years. The current account deficit//reserve diversification arguments behind this statement do not represent anything new and EUR-USD failed to build on the move any further in Asia. It firmed up for a while during the European morning, helped by the strength in cable seen after the release of stronger than expected UK CPI data. There was also a stronger than expected German ZEW survey, but most of the gains had already been seen by that time. However, it failed to move above 1.3270 and some of the gains were taken back. The ZEW survey merely saw a reversal of some of the recent unusual weakness – see chart

Attention is now on the FOMC meeting and whether there is any adjustment to the recent stance taken with regard to future inflation and policy risks (see below for preview). A major change looks unlikely and the market will be left waiting for key US data releases during the remainder of the week – retail sales tomorrow, CPI, NY Fed index, industrial output on Friday. As long as there is no major change in today’s Fed statement, there is a risk that EUR-USD revisits the 1.3130 low seen in Asia yesterday. However, negative USD sentiment is unlikely to be given up completely just yet. Initial support today comes in at 1.3220 – resistance at 1.3270.

USD-JPY is also below yesterday’s highs and the market may be a little wary about pursuing further aggressive JPY weakness with the Tankan still outstanding. Recent evidence that excessive JPY short positioning is being closed is a negative factor for the JPY, but the Tankan needs to be seen. In the unlikely event of a strong Tankan, BoJ rate hike fears (for next week) will be reignited.

GBP was boosted for a time this morning by stronger than expected CPI data, although 0.2% of the uplift in the y/y rate was due to petrol prices. The m/m fall recorded in petrol prices this November fell well short of the large fall recorded at the same time last year – hence the higher y/y rate. The CPI y/y rate of +2.7% was the highest since 1996. Core CPI also rose to +1.6% from +1.5%, with the lower rate (compared to CPI) due to stripping out strength in food and utilities prices. The latter again contributed to the higher CPI y/y rate but this effect should wane next year when sharply lower wholesale natural gas prices are finally passed on to the consumer. The data is not that bad, but it will maintain nervousness at the MPC about the need to err on the side of caution in its approach to dealing with inflation and to this extent it supports the notion of a February rate hike. However, news about the consumer sector will also influence sentiment on this matter in coming weeks.

Day Ahead
Canada – trade data will be watched for any gross indications from exports. Last month, exports fell 2% m/m and it will be interesting to see whether this is a one-off or the prelude to further weakness. Another weak number would put pressure on the CAD. 1.1525-40 is resistance on USD-CAD and this has already been put to the test in Europe this morning (high of 1.1529).

US – the FOMC meet today and while there is a very small chance of a more even-handed policy risk assessment, such tampering could prove premature if not backed up by subsequent data developments. The Fed has typically shied away from changing its view on something until it is absolutely convinced for fear of confusing the market. While most housing numbers remain fairly soft and the ISM is suggesting some early signs of weakness in the manufacturing sector, the consumer and service sectors are holding in well and until there is evidence of a broader economic slowdown the Fed is unlikely to change its message in a major way. They will most probably just acknowledge some of the recent data developments as evidence that tighter policy is starting to take effect and that they will continue to monitor the incoming data.

On the data front, the monthly trade data is due and in the current circumstances of negative USD sentiment, the market will be sensitive to anything unusual. Weekly store sales will also be watched after recent weakness.

Data/event EDT Consensus*

US Chain store sls (w/e Dec 9) w/w 07.45 -2.6% last
US Trade balance (Oct) 08.30 -$63bn
CA Trade balance (Oct) 08.30 C$3.8bn
US Redbook sls (w/e Dec 9) m/m 08.55 -1.8% last
US Federal budget (Nov) 14.00 -$73bn
US FOMC meeting outcome 14.15 unch
US ABC consumer conf (w/e Dec 10) 17.00 -1 last
AU Consumer sentiment (Dec) 18.30 -9.7% last
JP Current account (Oct, sa) 18.50 ¥1.6trn
JP Ind prod (Oct, final) m/m 23.30 +1.3%

Latest data Actual Consensus*
JP Domestic CGPI (Nov) y/y +2.7% +2.7%
SE CPI (Nov) y/y +1.7% +1.5%
SE CPI UND1X (Nov) y/y +1.3% +1.2%
IT Ind prod (Oct) m/m +0.6% +0.5%
GB CPI (Nov) y/y +2.7% +2.6%
GB CPI core (Nov) y/y +1.6% +1.5%
GB RPIX (Nov) y/y +3.4% +3.3%
GB RPI (Nov) y/y +3.9% +3.8%
DE ZEW expectations (Dec) -19.0 -25.0
EU ZEW expectations (Dec) -3.0 -8.5
* 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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