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Monday December 18, 2006 - 11:36:40 GMT
Mellon Bank Foreign Exchange -

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Forex: Mellon FX Daily - U.S. Edition

Key Points
• USD retreats slightly but stronger tone remains intact.
• Corrective pressure has been overbearing, but Friday’s US CPI number remains a potential USD negative for future weeks.
• Key support on EUR-USD at 1.2950-1.3000 remains intact.
• JPY is waiting for BoJ message.
• US balance of payments and NAHB housing index feature today.

Market Outlook

The USD has retreated a little overnight following the gains registered in another topsy-turvy Friday session, although the stronger tone remains intact. This was the second Friday in succession that the USD (against the EUR in particular) experienced sharp gains, with previous market positioning being adjusted. The IMM positioning data released later on Friday also helped to explain why EUR-USD was on the defensive in the second half of last week. As of last Tuesday spec net EUR-USD longs stood at 96,683, only marginally down on the 98,265 position seen the previous Tuesday. This is surprising given the scale of the sell-off seen on Friday Dec 8. The liquidation pressure seen last week was also promoted perhaps by the fact that the holiday season is fast approaching.

However, Friday’s weaker than expected US core CPI is still extremely significant and is a potential USD negative for coming weeks. If the weakness in this data also shows up in this Friday’s core PCE price index (the Fed’s favoured measure of core consumer price inflation) it will be a significant step in the direction of the FOMC adjusting their language on inflation risks. Alongside these developments the status of economic activity will also be important and this has changed for the better over the past couple of weeks. Since the dismal 49.5 reading for ISM manufacturing on Dec 1, the data news has been reasonably good – strong ISM non-manufacturing, solid payrolls, strong NY Fed survey last week and two strong weekly rises in mortgage applications.

Given the more benign core inflation backdrop that seems to be developing it is important that the data on economic activity holds in well, otherwise Fed rate expectations will be adjusted lower and this will mean renewed problems for the USD. A key factor over the next couple of weeks will be the January 2 reading on ISM manufacturing and whether sub-50 levels are maintained. This data could set the scene for the USD through January.

Looking at the chart, the price action does not look that unusual – a sharp break through the top of the old range at 1.2950- 1.3000 and subsequent pullback towards the initial breakout point (i.e. normal corrective activity and no real damage done just yet). There may be slightly more left in this correction and any move below 1.2950 would signal that the previous break has been a false one and that the old range may be reoccupied. Support is now at Friday’s low at 1.3060 as well as 1.2950- 1.3000, while on the upside above 1.3200-20 would be a positive sign and through 1.3300 would suggest the likelihood of an attack and possible break of the recent high at 1.3367.

The pullback in EUR-USD last week also left some pressure on EUR-GBP, although it has recovered slightly this morning and could do so further over coming weeks. There is strong support at 0.6670-80. 1.9470 needs to hold on cable to prevent further corrective activity. 1.9730 is the major level on the upside and is the equivalent in technical terms of 1.3300 on EUR-USD

The JPY has also managed to stabilise against the USD with Friday’s USD-JPY high of 118.33 (seen before US CPI) below the next resistance point at 118.60. Key for the JPY will be what sort of message is sent from tomorrow’s BoJ meeting outcome. A rate hike seems unlikely although a significant factor will be what Fukui signals about their intentions for January.

Day Ahead
US – the Q3 current account and balance of payments data is due and a very large deficit number will probably be required to generate market impact, especially after last week’s reported improvement in the merchandise trade deficit. The data will also reveal key balances on the financial account and the main area of interest will be what is happening on FDI and equities. The NAHB housing index (a combination of measures relating to current and expected sales and the number of prospective buyer inquiries) is also due. This has recovered over the past couple of months (albeit from 15 ½ year lows) and will be bwatched closely given tentative but growing expectations about the possibility of some stabilisation in the housing market.

Data/event EDT Consensus*

NZ Business confidence (Dec) 07.00 -14 last
US Current account (Q3) 08.30 -$225bn
CA Net portfolio balance (Oct) 08.30 -C$5.7bn last
CA Leading indicator (Nov) m/m 08.30 +0.3%
US NAHB housing index (Dec) 13.00 34
GB RICS house price balance (Nov) 19.30 46%
JP BoJ rate announcement unch
JP BoJ monthly report 01.00

Latest data Actual Consensus*
AU New home sales (Nov) m/m -5.3% +1.3% last
EU Trade balance (Oct, sa) €1.7bn €0.0bn
* 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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